It’s said that one man’s misfortune is a blessing for others, and the credit crunch in the U.S. may just fall into that category for savvy Canadian businesses.
The unsettled U.S. economy and the fallout out of the asset-backed commercial paper and mortgage credit debacle have created a ripe opportunity for strategic acquisitions and growth for Canadian businesses, says David Cohen, Gowling Lafleur Henderson LLP’s client team leader in the financial services department.
“I was at a conference in the U.S. recently and the feeling is the downturn there is a quite a bit more pronounced than people think it is,” says Cohen. “While there seemed to be a slight recovery in the spring, the thinking is it’s a ‘dead cat bounce.’ [The theory that even a dead cat will bounce off the pavement after plummeting from great heights, suggesting that the sudden upward tick is not the beginning of a recovery but a false signal that obscures a darker reality.]”
While mergers and acquisitions have gone quieter since capital pools tightened, there are indications strategic acquisitions are primed to take off.
He says the effect of the current downturn layered on top of soaring oil prices could also affect industries and sectors once thought to be recession-proof.
“Even gaming, which was thought to be immune, could feel the effects,” he says. “Destination resorts like Las Vegas could be affected by higher hotel prices and gas prices.”
Because Americans can deduct the interest costs of their home mortgages, homeowners tend to keep refinancing to leverage their equity to fund purchases of cars, ATVs, and big screen TVs.
However, says Cohen, with the value of homes dropping because of the ABCP crisis and money supply getting tighter, consumers are getting squeezed and have reined in their spending. That in turn has caused many manufacturers to shut down plants and lay off workers, creating a classic downward spiral.
It’s a scenario which is laying bare the rocks hidden below the surface of the U.S. economy, much of it built on heavy debt.
“It’s like a lake, where the water is the amount of liquidity or excess cash,” he says. “When the water level is high all boats can sail and avoid hitting the rocks on the bottom. But when the water levels drop and the rocks are exposed there’s nowhere to hide.”
Bad management, under-capitalized expansions, and poor productivity can’t be covered up with infusions of cheap cash any longer, he says, and that means some companies will go into a tailspin, making them ripe for acquisition.
While the availability of investment funds has been pinched somewhat by events in the U.S., since Canadians don’t tend to over-leverage their assets, there’s still money to be found in what is a comparatively stable economy - though obviously we will feel the chill.
For Canadian businesses it’s an opportunity to expand south of the border, he says, though those windows vary by region, with oil-rich Calgary probably more stable than southwestern Ontario, which is heavily dependent on exports to the U.S. and has seen a massive erosion of its manufacturing base.
The paradigm shift which has prompted private equity funds to begin amassing pools of capital in readiness for
opportunities.
“Most of the private equity funds and hedge funds have mandates which don’t include this kind of investment,” he says. “But we’re seeing some of their managers move out to start up funds for this type of strategic investment. At the conference we were told that money is coming in at the rate of $1 billion a week.”
He says the convergence of opportunity and capital means companies and their advisors should be proactive in looking at which of their competitors or which similar operations could be integrated horizontally or vertically.
“Whereas the multiple [the sale value of a company based on annual revenue as set by multiplying its EBITDA (Earnings Before Deduction of Interest, Taxes and Amortization) by a number common to the sector] previously may have been anywhere between seven and 11, now it could be only three, four, five or six.” The key is to know the sector that puts those already in that industry ahead of the pack since they’re familiar with the players and the mitigating factors.
With private equity, stocking up on cash-strategic acquisitions may make sense, either on a partnership basis or in the form of a simple investment, says Cohen.
And whereas, traditionally, investors want an exit plan to cash out their capital with interest in three to five years, the emerging economic realities suggest that could be stretched to seven years.
Those looking to take advantage of such distress sales are well advised to have their strategic plans well organized and not look to such purchases for a fast turnaround and profit.
The companies are distressed for fundamental reasons beyond the apparent triggers of tighter credit and an economic slowdown or recession.
However, says Cohen, having done the due diligence and assessment of how the acquisition will fit, it’s important to open talks early and close a deal quickly.
“You want to get in there before it goes into CCAA or Chapter 11 before it becomes public,” says Cohen.
