Torys’ guide to private equity in 2015: Adjusting to a new normal

What’s in store for Canadian private equity in 2015?

Torys LLP recently released its annual Private Equity in Focus, which looks at how M&A activity involving private equity in 2014 has set the stage for this year’s transactions.

The report considers trend lines from three levels of focus: fundamental shifts in market dynamics; the broadening scope of PE investment activity; and the influence of new deal terms.

In an exclusive to peHUB Canada, my Torys colleagues and I are sharing findings from the report with readers in three installments.

In this first installment, Guy Berman, Sophia Tolias and I discuss how recent shifts in Canadian market dynamics have shaped current opportunities.

For example, private equity funds seized on very favourable dynamics for exiting investments in 2014 and adjusted their investment tactics to match opportunities in the new market environment. We think an emphasis on in-house expertise and industry specialization and a strong diligence focus are among the themes that emerged in 2014 and will continue to influence deal making in the months ahead.

The market’s new normal

Last year, PE funds responded to momentum in the Canadian market in a number of ways.

2014 was a good year for PE deal making in Canada as the market continued to maintain M&A volume levels in line with those in 2012 and 2013. However, the activity of PE funds was impacted by the challenges of sourcing quality assets, high investment multiples for good businesses, and competition from strategic buyers. The result was a slight decline in the number of Canadian M&A transactions involving a financial buyer or seller in 2014, relative to the two previous years.

Big year for exits

Despite having capital and an appetite for M&A, fewer financial investors acted on the buy-side in 2014. Given strong valuations for good assets, private equity funds took advantage of this seller’s market to exit portfolio investments, which contributed to a third year of growth in realizations.

Strategic buyers are serious contenders

Strategic buyers showed a greater readiness to pursue transformational deals in 2014, turning to M&A to implement growth strategies. Their willingness to pay a premium for quality assets and recover value through synergies made them serious contenders in M&A auctions. This greatly increased the competitiveness of the Canadian market environment.

Significant demand from strategic buyers translated into a surge in private equity sales to them. These deals increased to 60 percent of total private equity portfolio sales in 2014, up from 53 percent in 2013. Sponsor-to-sponsor transactions were an equally important theme last year, reflecting yet another growth trend in Canada’s PE market.

PE practices evolve

The more competitive market dynamics of 2014 influenced private equity investment practices.

PE funds have been developing industry specialization and in-house expertise to seek out opportunities in new sectors, such as mining and oil and gas. For Torys, the most active deal sectors in 2014 included natural resources and industrials. Our clients, especially those in Western Canada, were particularly active in acquiring assets from large resource players that are seeking to focus on core operations and improve efficiency.

Private equity investors continued to be active in mid-market M&A, which has for a long time led deal making in the Canadian market. Recently, we have seen sustained growth in transactions below $100 million, and in the range of $100 million to $500 million in value.

Reinforcing diligence

With current high valuations and EBITDA multiples, many PE funds are modeling for lower multiples on exit, requiring them to be that much more focused on earnings growth. As a result, funds are testing more than ever the strength of their investment thesis and the quality of target earnings analyses at the pre-acquisition phase, especially once a letter of intent to buy a business has been signed.

We expect this renewed focus on strong diligence practices to continue in 2015.

The entire Torys’ report and related statistical charts can be viewed here.

Michael Akkawi is a partner at Torys LLP and head of the firm’s Private Equity Group. Guy Berman is a Torys partner focused on corporate and commercial law, in the area of M&A, private equity and venture capital. Sophia Tolias is an associate at Torys, focused on M&A and private equity transactions.

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