Return to search

Torys’ Private Equity in Focus in 2016: in the markets

Last week Torys LLP released its Private Equity in Focus 2016 report.

In an exclusive to PE Hub Canada, Torys is sharing report findings with readers in several instalments. In our first instalment, Sophia ToliasGuy Berman and I discuss some of the key dynamics of Canada’s private equity market in 2015 and what they tell us about trend lines in the coming months.

Additionally, my colleagues Neville Jugnauth and Derek Flaman share their expertise on the nature of emerging deal opportunities in Canada’s oil and gas sector.

Canadian private equity in 2015

Sell-side activity dominated Canadian private equity deal-making in 2015. Despite the slight decline in domestic M&A deal volume involving a financial buyer or seller, PE investors continued to seize on favourable market conditions to exit their investments. Over 60 percent of transactions in 2015 involved sell-side activity, which is in line with trends reported in 2014.

Sales to strategics

Many Canadian businesses are being sold to strategic buyers. In 2015, strategic sales accounted for the majority of private equity exits, representing 58 percent of domestic M&A transactions involving financial players. On the rise since 2013, acquisitions continue to appeal to strategics as a way to pursue business growth.

Capital investments decline

Despite global private equity dry powder having reached US$752 billion at the end of last year, the Canadian domestic buy-side activity by PE investors declined in 2015, continuing a downward trend since 2013. The decline in domestic PE investments tracked a broader domestic M&A downturn as the aggregate deal value of Canadian M&A at home fell in contrast to significant growth in outbound investments in 2015.

A competitive deal environment

PE investors are facing ongoing competition from pension funds, strategic buyers and international investors, who are increasingly seeking opportunities in Canada. Last year, foreign investment in Canada’s private equity M&A market grew, reversing a three-year decline since 2011. Some 40 percent of foreign investment involved a financial buyer, up from 34 percent in 2014. The relative pricing of Canadian assets, accessible leverage markets, and a weak Canadian dollar are all positive factors drawing global interest.

Enhancing sourcing strategies

Market Trends Concept 2In this competitive environment, and in the face of persisting economic uncertainty, PE investors are adopting differentiated strategies to source deals. These include increasing the focus on deeper vertical expertise and building networks of potential vendors and partners. Investors are continuing to look for opportunities to bypass competitive auction processes and source proprietary deals. They are also seeking to unlock post-acquisition value by leveraging the industry expertise of operators in their portfolio companies.

Over the last three years, we have seen sustained deal activity in Canadian small to mid-sized transactions, with deals valued under $500 million accounting for nearly 90 percent of activity. In targeting specific sectors, investors are cautious. They are focusing on industrial cycles, evaluating past industry performance in a recessionary environment as a potential indicator of future successes.

Additionally, more Canadian private businesses are expected to come to market as baby boomers retire. This is likely to continue to draw private equity interest in those smaller and mid-size market segments.

As has been the trend of late, funds with specialized investment strategies are continuing to emerge, such as private equity funds with a niche industry focus, energy funds dedicated to oil and gas plays, and infrastructure funds focused on particular sectors.

PE sponsors are also allocating more time to deepen relationships with their limited partners. LPs are increasingly focused on the number of sponsors they are prepared to invest with and this discretion is resulting in more co-investment opportunities for them. Another result of the deepening relationships between LPs and sponsors is enhanced transparency.

Maximizing value on exit

Managing an effective sale process has become an important focus for the private equity industry as a means of maximizing value on exit.

Vendor due diligence reports, long popular in Europe and making headway in North America, are more often being prepared by PE sellers for potential buyers to anticipate and manage diligence issues and centralize costs. Sellers can streamline the sales process by supplying a single diligence report to prospective buyers on their business (rather than run separate diligence processes for each potential buyer).

Such reports are not necessarily restricted to legal matters, but may involve reports by independent accounts or consultants addressing target-specific issues, such as environmental matters. Although a vendor due diligence report may help shorten the sale process, it can be costly to the vendor—and if the report is not sufficiently comprehensive, buyers may insist on conducting their own diligence, risking delays in the process.

Seller-friendly terms are also being embraced in PE transactions, and in some instances we are seeing sellers of private companies attempting to sell their businesses “public-company style”―that is, without offering a post-closing indemnity.

Market Trends Concept 3The current environment is set to sustain deal-making in the year ahead through a number of factors. From international investors looking to take advantage of favourable market conditions to retiring baby boomers divesting their assets, PE and strategic investors are ready and willing to take advantage of the opportunities—in the hope, of course, that buyers’ and sellers’ price expectations will align.

Oil and gas industry insights

Domestic energy industry M&A in Canada saw a significant decline in the number of transactions in 2015 as PE investors pursued deal making in retail and consumer products, alongside steady activity in technology, industrial and natural resources sectors.

The decline in energy-specific M&A was largely due to weak industry fundamentals and depressed public company share prices that often made buy-side and sell-side expectations difficult to reconcile.

This was compounded by market uncertainty about the potential impacts of policy initiatives of the new government in Alberta—initiatives that include a provincial energy royalty review, a higher corporate tax environment, and new commitments to climate change legislation. With the Alberta government having released the results of its royalty review in January, and deciding largely to maintain the existing structure, some of this uncertainty should be reduced.

Market access continues to be a big concern for the industry given the political headwinds that have impacted proposed pipeline projects to date. In early February, Prime Minister Trudeau delivered a message of federal support for opening up markets to Alberta energy through new pipelines. However, the message fell short of providing assurances regarding new pipeline approvals, instead emphasizing the need for thorough regulatory review without undue political interference.

A rise in energy deal activity is anticipated in the coming year. With the market adjusting to the realities of a more pronounced oil price decline that isn’t expected to recover substantially in the short term, capital budgets have been slashed. And distressed companies have had few options to consider other than asset dispositions or other M&A strategies to address over-leveraged balance sheets and the resulting concerns of lenders, or to raise capital for high priority projects.

Additionally, there has been robust activity with respect to midstream oil infrastructure opportunities, as producers look to monetization strategies around the infrastructure they own in order to address liquidity issues. Both financial buyers and well-capitalized strategic buyers will look to take advantage of these opportunities.

A relatively low Canadian dollar is also expected to motivate foreign buyers hoping to find attractive investments in the current environment.

To download the entire Torys’ report (complete with figures), please visit Private Equity in Focus.

Michael Akkawi is a partner at Torys, and head of the firm’s Private Equity Group. Other contributors to this article included: Sophia Tolias, Torys’ counsel with a focus on M&A and private equity transactions; Guy Berman, a partner focused on corporate and commercial law; Neville Jugnautha partner practicing corporate and securities law in the areas of private equity, corporate finance and M&A; and Derek Flamana partner with a focus on commercial law in the energy sector. 

Photos courtesy of Shutterstock