Acquisitors like HudBay Minerals are looking for their next source of earnings growth (HudBay Minerals)
Any baseball player will tell you he’s happy just to get on base. But when he steps into the batter’s box, his hopes inevitably rise. What he really wants is to knock one out of the park.
Many investors think the same way. Once they’ve bought in, they would love nothing more than to see one of their stocks shoot up by 40%. Those sorts of home runs are hard to come by—but it helps if you know what pitches are coming your way.
One means of getting that kind of return is to buy a takeover target just before a merger or acquisition. Unfortunately, few such deals have materialized in Canada over the past year. Several of the country’s top M&A specialists believe, however, that the conditions are ripe for change. So what potential targets should investors be looking at? “It’s almost across the board,” says Peter Hodson, CEO of 5i Research. “Certainly in mining there are sitting ducks all over the place.”
Some might find that hard to believe. The mining sector, which typically accounts for a quarter of all M&A activity in Canada, barely registered last year. Deals in energy, too, were down a whopping 81%, to $13.7 billion. The impact from the downturn in those two sectors was noticeable. In 2013, the total value of deals in Canada fell 33% to $92.8 billion.
But things are starting to change. A quarter of the way through 2014, some $26.5 billion in deals are already in the works. Grupo Bimbo’s $1.5-billion play for Canada Bread, Mattel’s $438-million friendly offer for Mega Brands and Essilor International’s $364-million deal for Coastal Contacts are just a few of the high-profile transactions waiting to close. And there are more deals in the wings, says Sharon Geraghty, a partner with Torys LLP who specializes in mergers and acquisitions. One key reason is the availability of capital: Private-equity companies and pension funds are flush with cash, and acquisition lending is quite accessible. “All of that pent-up availability of money has got to find a home,” she says.
Much of the recent M&A activity has involved retailers and consumer products, but the experts are now seeing activity shift back to the resource sector. For years, mining and energy companies have been cutting costs and retrenching; lately investors have been asking where their growth is going to come from, says Paul Knight, vice-chairman at Barclays Investment Bank. Miners can placate investors for a while by buying back shares and hiking dividends, but sooner or later they have to show that they have a new project in the pipeline, he says.
“I’m not sure we will see an explosion in mining, but we will see more activity,” Knight says. Already, a bidding war has broken out over gold miner Osisko. If more takeovers start happening, investors hoping to be rewarded for holding on to their mining shares could get their wishes. Given the low valuations, Knight expects the opening offers in the sector could carry a premium of 30% to 40%. Even for the companies not specifically targeted, such bids can cause a rising tide in the target’s peer group.
Some tire kicking is already underway. Mick Davis, the former head of Xstrata, recently announced he has raised about US$3.75 billion with his new London-based venture, X2 Resources, and is now ready to start investing. While X2 hasn’t indicated where it is going to look, Davis’s management team has considerable experience in Australia, Canada and South Africa, suggesting those markets won’t be ignored. Davis isn’t the only acquisitor with a war chest looking for deals, either. Ernst & Young reports that private funds have now raised more than US$10 billion to invest in the mining sector worldwide.
Resource companies in need of capital typically look at traditional M&A, joint ventures, restructuring or spin-offs. But today’s low valuations also create a good environment for hostile takeovers, such as Goldcorp’s move on Osisko and HudBay Minerals’ bid for Augusta Resources, says Geraghty. Activist investors, which are becoming a more significant factor in Canada, are another wild card that could help drive deals.
Knight suggests gold and copper companies as the best place to start looking for potential M&A targets. Both commodities have been hit hard over the past year, and while valuations have perked up recently, prices are still well off their peaks, meaning mining assets can be picked up on the cheap. Knight singles out copper in particular, noting the scarcity of good copper assets available. Look for companies with prized assets whose stock prices have finally begun to rise.
There are still some factors that could limit the amount of M&A activity we see this year, though. The federal government’s murky stance on foreign takeovers in the oil and gas sector following CNOOC’s purchase of Nexen has made foreign investors wary of investing in Canada. Quebec’s 2012 decision to designate Rona a strategic asset to deter a bid from Lowe’s also hurt Canada’s reputation as a destination for foreign capital. “You can’t count on foreign investors to distinguish between transactions in Quebec and elsewhere in Canada,” says Geraghty. “We aren’t big enough for someone to pay us that much attention.”
Ottawa is taking steps to repair the damage, however. In late March, the new finance minister, Joe Oliver, signalled he was going to push through a bill to lift the 25% foreign investment restriction on Nordion, a company that supplies medical isotopes and sterilization equipment. Hours later, Nordion announced it had a $727-million buyout deal with U.S.-based Sterigenics, a sterilization services provider owned by private-equity firm GTCR LLC.
Nicolas Marcoux, managing director at PricewaterhouseCoopers, identifies a few other industries that could see more acquisitions this year. On the heels of Loblaw’s Shoppers deal and Sobey’s $5.8-billion purchase of Canada Safeway, Marcoux expects more action in the consumer staples space. “When there are big transactions, there are a few me-too transactions,” he says. “I wouldn’t be surprised to see another one of the food chains go after a pharmacy chain.” Given the gains the U.S. has made recently on job growth and housing prices, Marcoux thinks building products is another industry to watch.
Geraghty suggests we might also see more deals in the pharmaceutical sector. Endo Health Solutions’ $1.6-billion takeover of Paladin Labs closed in March. Pharma companies are currently looking for opportunities to migrate out of the U.S. tax system, he says.
In almost every sector, 2014 is likely to offer up more deals. In baseball terms, it’s a good time to swing for the fences.
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