Canadians have a reputation for being more conservative than their US neighbors, and the results of the 2010 Canadian buyout market did nothing to help that stereotype.
Around this time last year, indications were that the US and Canadian economies were beginning to stabilise.
In Canada, banks’ balance sheets were strong. The Bank of Canada was talking about raising interest rates. Business performance was improving and public equity valuations were strong. After a two year break, entrepreneurs were willing to discuss succession planning. The Canadian deal community was collectively rubbing its hands in excitement: 2010 was poised to be a great year.
In hindsight, there were three major factors that explain much of the difference in deal activity:
1.) LBO Financing Availability: New Year Eve 2009 was marked not only by the popping of champagne corks, but also the cap that had been placed on the availability of LBO debt from US banks. As early as Q1, staple financing packages were as high as 5x debt to EBITDA and taking valuation expectations along for the ride. Canadian banks, on the other hand, were offering term sheets for 2.5x to 3.25x Debt to EBITDA and maintaining strict covenants – placing an effective cap on private company valuations that were unattractive to sellers.
2.) Sponsor Motivation: The availability of LBO financing opened up a window of opportunity for sellers in the US, as there were a number of sellers (mostly sponsors) who were motivated to show realisations (and accompanying distributions to LPs) and to beat the expected 31 December, 2010 expiration of the Bush tax cuts.
3.) Canada-Specific Challenges: Canadian manufacturing companies were challenged by both the US recession and the strengthening Canadian dollar. Many owners preferred to work through this rough patch and grow earnings rather than sell at low valuations. Even in the resource services sector, business activity didn’t start to pick up until 2010, so business owners decided to focus on business growth in 2010 rather than to sell ‘early’.
Looking forward to 2011, the outlook for Canadian private equity is attractive, as all of the elements of a healthy M&A market appear to be in place. The economy continues to improve and companies that have successfully restructured are more efficient, profitable and looking for growth. The Canadian resource sector, particularly oil and gas, is seeing increased activity and is seeking financing. Canadian banks are offering LBO debt packages in excess of 4x debt to EBITDA and on better terms than earlier on the year, which is buoying valuations to a point where sellers will transact.
So once again, we find ourselves anticipating a good year for Canadian M&A. But this year, that optimism may be realised, as many of the factors causing sellers to pause have improved. And as such, our New Years’ resolution is to not only pop the cap to celebrate 2011’s arrival, but to do so at many closing dinners throughout the year.
Dale Tingley is a director at CAI Capital Management.