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M&A and COVID-19: A Strategic Update

May 22, 2020
Some of the provisions that we are starting to see in deal terms and negotiations are things that a well-advised buyer wouldn’t have even put on the table three months ago
Rory ffrench, Partner in the Blakes Mergers & Acquisitions group
In this episode of our podcast, Blakes lawyers Rory ffrench and Cassandra Brown tackle market-related questions and concerns ― from shifting M&A projections to strategic opportunities and the government’s approach to competition and foreign investment in the time of COVID-19.


Mathieu: Hi, I’m Mathieu Rompré.

Peggy: And I’m Peggy Moss. This is episode 6 of the Blakes Continuity podcast.

Mathieu: To merge or not to merge, that is the question. Whether ‘tis nobler in a time of pandemic...

Peggy: Thank you, Shakespeare Rompré. That was dramatic.

Mathieu: Thanks, quite proud of that one.

Peggy: But there’s no reason to get theatrical. Our guests are pragmatic and candid about what lies ahead in the Canadian M&A world.

Mathieu: So, without further ado, let’s open the mic to Blakes Partners Rory ffrench of our Private Equity group and Cassandra Brown of our Competition & Antitrust team.

Peggy: Hi Rory. Thank you for joining us. We’re here to talk to you about the current M&A market. A whole lot has changed in the last few months. Can we assume that all projections from the beginning of the year are now pretty much out the door?

Rory: You know, we’ve had a very strong M&A market in Canada for a number of years now, and in the early part of the year, people were projecting pretty much all the same things. Q1 results were generally aligned with those forecasts. So, everything was, you know, on the up and up, and things were going well. But any time you have those projections, they're always caveated with the “oh, but you never know what kind of uncertainties and what sort of events might unfold,” and obviously, we’re experiencing very much that type of uncertainty.

You know, early measures about Q2 results are suggesting that we are going to see a significant decline in deal activity, and I can tell you, on the ground, that is very much what we’re seeing. It’s not like there's no deals happening. You’re still seeing, you know, deals that were well advanced before COVID-19 emerged. You know, those are certainly still getting to closing, getting through signing. In fact, I’ve been part of at least a couple of deals that actually accelerated in light of the emergence of COVID-19. Strategic sellers are still selling their non-core assets. PE funds or portfolio companies are still buying add-ons.

So, you know, deals are still happening, but we’ve definitely seen a slow-down as people are looking to preserve some capital to make sure your existing businesses are continuing to run and make sure your portfolio companies are well taken care of and ready to pursue, you know, future growth in operations.

Mathieu: What big changes to the M&A markets have you noticed since the beginning of the pandemic?

Rory: The most noticeable change is likely the big step back in change in mentality from the sellers’ market dynamic. I regularly present the Blakes Private Equity Deal Study, and one of the key factors that we often talk about with clients is the fact that with all of these various seller-favourable conditions, you’re seeing, you know, I guess a trend in deal terms towards, you know, things that are going to be very seller-friendly. Sellers are coming in with very lofty expectations about what their businesses are valued at. They’re trying to get clean or near clean exits, and you’re getting a bunch of buyers that are willing to play ball with that.

Some of the provisions that you're starting to see in deal terms and negotiations are things that a well-advised buyer wouldn’t even have put on the table three months ago, but now it’s very much part of the conversation and actually being part of the ultimately negotiated agreements.

Mathieu: Can you expand on that? How does the current climate and market uncertainty affect transactions?

Rory: From a due diligence perspective, I think you’re seeing buyers looking, and taking a really detailed look, at the supply side, the demand side, both from a business operations, financial perspective, trying to assess, okay, on the supply side, how have they fared? Is the demand prospects for the business on the flip side? Is it there? Will the business be able to survive through this first wave, through the second wave, through a potential third wave of COVID-19 or, you know, are there problems and hurdles that need to be overcome? Legal due diligence is following right alongside that. You know, you’re seeing people look at employment commitments, at other contractual commitments and understanding, is there flexibility to be able to handle, you know, those sorts of future uncertainties that may still arise and the increases or decreases [in] operations that result.

On the valuation side, I mean, I think the easy statement is "valuations are hard right now." Forecasts are all over the map, and so you have buyers and sellers that are having difficulty coming to agreements as to, you know, what that price for that transaction should be. You also have the problem of sellers that are coming to market having mentally anchored themselves to the valuations that they thought their business was going to get just a few months ago. And it’s hard to break yourself away from that and accept a lower price today, when it’s really only a few months away. I think that’s the real reason why you're seeing the big emergence of earnouts again. Something that would have been a fairly taboo subject, let’s call it, a while ago. And now, I think you’re seeing a real resurgence of earnouts because people are seeing there’s a real way to try and bridge the valuation gap.

And finally, you know, in financings, it’s not that debt financing isn’t available anymore, but I think you’d say that it’s, you know, probably available in maybe smaller amounts or with terms that aren’t as favourable as they were just a few months ago. And so I think you're seeing buyers trying to be more creative whether it’s using vendor take-back notes or considering greater proportions of equity to fund their purchase price with ideas of refinancing down the road when debt terms are a little bit more favourable and a little bit more to their liking.

Peggy: Rory is anybody seeing a silver lining here? Is the pandemic creating opportunities for investors or for strategic buyers?

Rory: You know, savvy investors have done very well in a market downturn. And it’s not to say that every investor who invests in a downturn does well, but you know, certainly, it’s not lost on market participants that there are certainly opportunities to be had. You know, as I think I said at the, sort of, outset of our conversation, people had maybe taken a step back from some of their acquisitive activities early in the COVID-19 emergence to focus on portfolio companies and existing businesses, but I think as we start to come out the other side from some of these stay-at-home orders, you know, the private equity fund with a lot of dry powder available, those well-capitalized strategic acquirers, they’re going to come back and they're going to see opportunities, and they’re going to be looking to exploit them.

Mathieu: The pandemic is impacting sectors differently. Can you give us a sense of what you are seeing?

Rory: One of the big things that’s resulted from COVID-19 is obviously early adoption and better adoption of technology from people that may have been resistant or late adopters to begin with. Businesses are moving towards more virtual and remote working, and as a result, I think there is going to be an increased appetite by companies, you know, looking to try and, you know, get in on that game as people and businesses are changing the way that they are operating.

Similarly, I think, you know, consumer buying preferences are changing. You know, people have been using online e-commerce platforms now for a while to try and, you know, buy things during the stay-at-home orders, and so, I think, you know, all the logistics and supply chain companies that go into supporting an online platform and an e-commerce business like that, those kinds of supply-chain logistics companies can be attracting a lot more attention in M&A deals.

Health care, you know, obviously, top of mind for everybody. Growth stage companies with great ideas come into market, I think those are going to be appealing. You know, the health-care roll-up space was, you know, a boom before COVID‑19, and I don’t see any reason why after COVID-19 that’s not still going to be attractive, because I think you are going to see some of those individual practitioners that may have been resistant to be part of a larger platform deciding that maybe, you know, now is the right time to not go it alone anymore.

And, of course, you know, there’s going to be distressed deals. You know, as much as we’ve talked about winners that have come out of COVID-19, you know, there are certainly going to be companies that haven’t faired as well, you know. So, there will be distressed deals in retail, in travel, leisure, the hospitality sectors. And so, you're going to see a lot of activity there as well in a different kind of transaction.

Mathieu: Thank you, Rory. Thank you very much for your time.

Rory: Thanks for having me.

Mathieu: That’s a great segue to the impact of government decisions during the pandemic. Cassandra Brown you are a competition lawyer. Rory mentioned that certain sectors have been affected more directly than others. From a foreign investment perspective, which industries and sectors have been most disrupted?

Cassandra: Thanks very much for having me on the podcast today. To answer your question, the Government of Canada has announced enhanced scrutiny of certain investments until Canada’s economy has recovered from the effects of the global pandemic. So, this applies to foreign direct investments in Canadian businesses that are related to public health or are involved in the supply of critical goods and services to Canadians or to the government of any value whether it’s a controlling or non-controlling investment. The policy also applies to foreign investments by state-owned investors, or SOEs, again, regardless of their value.

Peggy: What’s motivating the government on this point. Is it to ensure fair market value?

Cassandra: I think the SOE part of the policy reflects concern over possible strategic or non-commercial motivations for investments in Canadian businesses whose value has dropped. This might be as much a message to buyers and sellers as it is an announcement about what the government is going to do in response to any given investment. On the public health and critical goods and services policy, sorry, part of the policy, I think that reflects concern over reliance on foreign supply chains, including those that are primarily based in the U.S. For example, I think probably everyone remembers the whole, sort of, 3M issue, and I think that is what the government is sort of trying to avoid in the future here. So, that side I would say is more about national security than valuation.

Peggy: How does the Canadian government’s response to the pandemic impact businesses that are looking to invest in Canada these days?

Cassandra: Well, the majority of foreign investments in Canada are actually not subject to any form of pre-closing review. So, for those types of investments, where for a controlling investment you just need to file a post-closing notice within 30 days of closing, the government has recommended that state-owned-enterprise investors and investors in businesses related to public health or essential goods and services file post-closing notices early in order to obtain certainty on national security reviews.

In terms of what any individual investor wants to do, I think that depends. It's fact-specific, and it’s sort of a case-by-case analysis, so I think that investors really need to be thinking hard about it in any given transaction.

For the pre-closing net benefit review transactions, that’s a minority of foreign investments in Canada. There were only nine all last year, for example. I think the government has signalled that possibly the approval process might be a little bit more extended and, in particular, fits within the targeted sectors, or there’s an SOE involved.

For what we would see very commonly, for example, like U.S. private equity firms making investments in businesses outside of these sectors, I think that it’s largely business as usual.

I do think that parties are devoting more attention towards a filing strategy and maybe putting in transaction agreements with more specificity when the purchaser will be allowed to file its post-closing notification. So, specifically, purchasers may want the comfort of being able to prepare and file their notification and wait 45 days until the time period has expired for the government being able to start a national security review. And, so, that has in the past largely been, sort of, an afterthought or people don’t really care that much about putting that in transaction agreements, and I think that people may be devoting more attention to that in light of this government policy.

Mathieu: Cassie, from a competition standpoint would it be fair to say that the M&A sector will be under more scrutiny than ever before?

Cassandra: The [Competition] Bureau has actually been more vocal about its action on non-merger matters during the pandemic, for example, misleading advertising and price-fixing matters where it’s, sort of, more uncontroversial that there is harm to consumers as a result of the conduct. Back in mid-March, the Bureau did warn the bar that merger reviews could be delayed, but in our experience that has actually not been the case to date.

The Bureau, like all government agencies, they’ve all been working from home, but sometimes we’ve seen them clearing deals faster than we expected. Anecdotally, we’ve actually heard that they have received very few merger notices in the past month. Therefore, it would appear that they have some excess capacity on the merger review front. They also indicated initially that market contacts might be more difficult in some industries. But again, overall, we haven’t seen a huge delay related to that particular issue on merger matters. They have announced that they’re prioritizing matters related to the pandemic, maybe not super obvious how a merger would be crucial to the pandemic, but if you did have a transaction where that was relevant, I suppose it could be expected to, sort of, be triaged to higher up on the Bureau’s priority list.

And the final point that I’ll say on this is that downturns often precipitate distressed M&A, often by strategics, so resulting in consolidation in an industry that could lead parties to make increased use of failing-firm type arguments. There’s strict criteria to qualify for the so-called failing-firm defence, and the Bureau will not be relaxing that criteria on account of the pandemic, but it could be very relevant and helpful to parties in the right situation.

Peggy: Thank you, Cassie and Rory. It sounds like we have interesting days ahead.

Mathieu: Listeners, if competition law in Canada interests you, please be sure to check out our next episode. We’ll be talking with partners Julie Soloway and Navin Joneja.

Peggy: Until next time, stay safe and stay well.

About the Blakes Sound Business Podcast

Our Blakes Sound Business podcast examines how changes in the Canadian legal landscape can impact businesses. Lawyers across our offices discuss the unique challenges, risks, legal developments, opportunities and government policies that you need to be aware of. We also cover diversity and inclusion and other social responsibility topics that matter to you.

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