National Post (National Edition)
HOW THE SHUTDOWN HAS FORCED DEALMAKERS TO PLAY HARDBALL.
SUDDEN APPEARANCE OF COVID-19 THROWS WRENCH INTO MANY M&A PLANS
Jim Osler and his team of dealmakers at Origin Merchant Partners were on the phone every day in early March trying to lock down the final details of Centric Health Corp.'s purchase of competitor Remedy Holdings Inc., a transaction that would create a major player in specialty pharmacy services for senior care across the country.
The global coronavirus pandemic was bearing down, less than two weeks from shuttering virtually all non-essential businesses and, it turned out, pushing the pause button on merger and acquisition activity. But it hadn't yet stopped people from making plans to travel in order to conduct due diligence and sign documents to seal deals.
Still, there was a sense of urgency for Osler, principal at the Toronto-based boutique investment firm, with a $30-million commitment lined up to fund Centric Health's acquisition and strengthen the balance sheet of the combined company.
“I've never seen the tone change so quickly,” Osler said recently from his home office, relieved that the deal was completed just before plans for other transactions were put on hold indefinitely. The deal was announced on March 24.
The veteran deal-maker, who cut his teeth at Canadian Imperial Bank of Commerce and Genuity Capital Markets, a one-time upstart filled with expats from CIBC that was later purchased by Canaccord, is still working on potential deals in the telecommunications, education, health-care and agri-food sectors, a fact punctuated by a ringing doorbell as couriered packages continued to arrive during an interview.
But he also talked about a deal in the hard-hit food and hospitality sector that was spiked just as the winning bidder was going to be selected from a field of strategic and financial suitors.
These days, spiked deals are becoming more common and any completed merger or acquisition stands out, a stark contrast to what had been one of the longest deal making bull runs of the past couple of decades, according to M&A specialists at law firms and banks.
The lack of M&A activity has implications for company owners, managers and investors alike, especially since the deals that are getting done tend to be isolated to crisis-agnostic sectors or those that may benefit from disruptions caused by the pandemic, and are more often all-stock deals with some transactions taking place at low or no premium.
Some of these changes, including the growing popularity of deal structures that make the full purchase price contingent on future performance, could be relatively short-lived. Others, such as hardball negotiations over what is covered by a “material adverse effect” clause and the language that goes into closing covenants to protect a buyer — or seller — from a neverbefore-seen event like a government-imposed economic shutdown are likely to be around for much longer.
“I have no doubt that our approach to these provisions will change going forward as a result of this pandemic,” said Warren Katz, managing partner at law firm Stikeman Elliott LLP in Montreal. “The precise language of an agreement is critically important. Some buyers will have the right to terminate while others will not.”
Some deals that were close to fruition when the pandemic shut down much of the North American economy may now have been returned to the negotiating table, while others that were announced could yet wind up in court over the contract's language and whether it provides an out for buyers, Katz said.
“I expect that some of these agreements will be litigated as it becomes clear that the effects of the pandemic will continue for at least the next few months with governments continuing to limit business activities across sectors,” he said.
To be sure, bankers and lawyers are still negotiating deals, and some are even making it to the finish line.
One such transaction is SSR Mining Inc.'s $2.4-billion acquisition of Alacer Gold Corp. announced May 11. There have been a handful of other M&A deals in the mining and metals sector, including Silver Corp.'s acquisition Guyana Goldfields Inc., Gran Colombia Gold Corp.'s merger with Gold X Mining Corp., and Endeavour Mining Corp.'s acquisition of SEMAFO Inc. for US$1 billion in an all-stock transaction.
But there are also the headline-grabbing deals that have gone off the rails, with failed and stumbling transactions in both the United States and Canada already ending up before the courts.
For example, private-equity firm Sycamore Partners and Victoria's Secret owner L Brands Inc. sued each other over whether the lingerie retailer's furloughing of thousands of employees and failure to pay rent in April violated the terms of their deal struck in February. Sycamore walked away in May.
In an Alberta court, auto finance companies CanCap Group Inc. and Rifco Inc. are tangling over whether “recent events” constitute a “material adverse effect” on Rifco's business that would allow the purchaser, CanCap, to walk away from their Feb. 2 deal.
The $1.18 a share all-cash offer represented a 39-percent premium to Rifco's share price on Jan. 31. The shares fell as low as 65¢ on April 13, before recovering to around 90 cents on May 20 as both sides wait for a judgment that will determine whether CanCap has to go through with the purchase.
“It seems like every week, there's another busted deal on a global scale,” said a veteran Bay Street lawyer, who rhymed off more than half a dozen, including Alphabet Inc.'s decision to pull Sidewalk Labs out of a plan to transform Toronto's waterfront, and Alimentation Couche-Tard Inc.'s abandonment of its $5.6-billion bid for Caltex Australia Ltd.
In the U.S., Boeing Co. walked away from a merger with Brazilian aerospace manufacturer Embraer SA, while Xerox Holdings Corp. cited economic fallout from the COVID-19 pandemic when it called off its hostile takeover of HP Inc.
“And that's just what we know about — many more private deals are renegotiated or terminated behind the scenes,” said the Toronto-based M&A legal specialist who spoke on condition he would not be named.
In some quarters, dealmakers are feeling a “chill on M&A” as executives turn their “laser focus” to operational and recovery plans and capital preservation, he said.
Many of the deals moving forward in Canada are in the mid-market, don't rely on raising new funding and are concentrated in the mining and precious metals sector.
“Often, that's a bit of a contrarian sector,” said Stewart Busbridge, co-head of Canadian mergers and acquisitions at Canaccord Genuity.
However, gold is viewed as a safe haven in this pandemic, he said, and the sector is benefiting from the steps governments are taking.
“There's a different set of risks now” when it comes to deals on the table, Busbridge said, adding that market volatility is part of that mix. Much of the focus right now is on negotiating how those risks will be shared between buyers, sellers and financiers.
To get a transaction across the finish line, dealmakers must overcome pandemic-related challenges that include difficulties in pricing deals, valuing assets and contemplating how to integrate businesses when shutdowns and ruptured supply chains make revenue hard to predict.
They must also navigate longer or delayed regulatory reviews, and overcome never-before-seen difficulties in conducting due diligence as a result of travel and social-distancing restrictions.
Some of the transactions making it out of the gate are in “crisis-agnostic” sectors and subsectors, many of them outside Canada, such as warehousing, transportation logistics, video conferencing, waste management and technologies that allow for web-based gatherings, the Toronto-based deal making veteran said.
In Canada, activity is usually concentrated in the mid-market and Katz, who specializes in cross-border mergers and acquisitions at Stikeman Elliott, said factors related to the current crisis are driving activity there, while fewer large-cap deals are taking place.
“This is no surprise given the volatility in the market and the availability of financing,” he said, adding that uncertainty about financing amid the pandemic crisis is factoring into negotiations.
“Buyers are more likely to consider constructs such as reverse termination fees to mitigate against financing risks,” Katz said.
These reverse break fees are paid to the seller if the transaction can't be completed, whereas traditional break fees have the seller paying the buyer if a deal isn't consummated.
By and large, “negotiating leverage” has tipped in favour of buyers, Katz said.
A sign of this shift are the earn-outs negotiated into acquisitions to close the gap between what the seller thinks a business is worth and what the buyer is prepared to pay.
In an earn-out, part of the payout to the seller is delayed and is less certain since it depends on how the business does after the sale. Earn-outs reward the seller if things go well, but not if they don't.
Such a structure would prevent the buyer from overpaying in a scenario where the bought business doesn't recover or shuts down again in a subsequent outbreak of COVID-19 cases.
With the virus already disrupting what was one of the longest bull runs in mergers and acquisitions during the past couple of decades, dealmakers are busying themselves with other forms of financing and investments.
For example, Osler's team at Origin Merchant Partners put a $25-million strategic financing in place for children's entertainment company WildBrain Ltd., which was announced May 13.
“Both strategics and financial sponsors remain very active in other areas, such as loans and strategic investments, including PIPES (private investments in public companies),” Katz said.
M&A specialists are also sizing up opportunities that could emerge from the current crisis.
“We may see governments encourage Canadian companies to expand into other areas, such as food and health, for national security reasons,” Katz said, adding that incentives such as tax changes could drive deal making in the years ahead as these industries are built up to weather future shocks.
“Growth in certain sectors will likely result in consolidation through mergers and acquisitions," he said.