Écrit par John Piasta, Angela Blake and Matthew Hunt
The economic landscape in Canada and around the world has changed rapidly in the second quarter of 2022. After a strong start to M&A activity in the first three months of the year, concerns about a global recession are now top of mind for companies and investors.
Russia's unprovoked invasion of Ukraine and the resulting global supply chain impact, exacerbated by COVID-19 related shutdowns in China, inflation rates at near 40-year highs and rapidly climbing interest rates, have created an economic environment fraught with uncertainty. At the same time, the record-breaking Canadian M&A activity that began in late 2020 has left many market players with strong cash reserves which could be deployed to fuel deals, most notably reflected by the amount of dry powder reported by private equity.
So what does this mean for Canada's M&A landscape?
Q2 2022 M&A Deal Activity
All numbers in this section are according to Bloomberg data (announced, completed or pending deals, excluding those that have been terminated or withdrawn) as of June 30, 2022, in US$.
Overall M&A deal volume in Canada was down in the second quarter of 2022 to $93.8 billion, from $96.2 billion in Q1. While Q2 was the fourth straight quarter with overall volume above $90 billion (Q4 2021 was over $120 billion), April to June 2022 saw slightly reduced volume each month.
2022 Monthly M&A Volume in Canada
The Canadian mid-market continued to be robust. Deals from $20 million up to $500 million totalled $12.9 billion in Q2 2022. In the first quarter of this year there were $12.5 billion worth of deals in this range.
A Soft Landing for the Canadian Economy, or Not?
The Bennett Jones Spring 2022 Economic Outlook was released on June 16 and looked at two illustrative scenarios for Canada's economy for 2023 and into 2024.
In the optimistic scenario, the Canadian and U.S. economies manage a soft landing. In the pessimistic scenario, the U.S. economy experiences a mild recession in 2023 that Canada narrowly escapes. Both scenarios require the tightening of monetary policy, albeit more aggressively in the pessimistic scenario.
Interest Rates and Inflation
Q2 2022 showed early evidence of this as central banks around the world tightened monetary policy at an accelerated pace to respond to worsening inflation. The U.S. Federal Reserve increased its benchmark interest rate by 75 basis-points on June 15, the largest increase since 1994. The Bank of Canada raised its interest rate by a full percentage point in Q2, and is widely expected to raise rates further in mid-July.
Rising interest rates could constrain financing alternatives, which may further temper M&A activity, at least in the short term. There is currently tremendous transaction uncertainty for larger deals requiring syndicated debt financing or access to the high yield debt markets. This is not the case for acquisition financing involving traditional bank single lender facilities with established relationships.
The pace at which lenders adapt to increasing rates, and the timing of when interest rates may ultimately stabilize, are also likely to affect the speed at which M&A transactions are consummated. In addition, buyers will be challenged to evaluate cost of capital and rates of return where debt is a significant component of the purchase price. By contrast, strategic acquirers who have adequate reserves and private equity funds with access to dry powder are less likely to be impacted.
Canada's Energy and Mining Sectors
As we move through 2022, we expect that current market uncertainty will have a distinct impact on M&A activity levels in the energy and mining sectors.
Opinions are divided about the extent to which the Ukraine war will impact oil supply, with the current downward price trend reflecting a belief that supply may outstrip demand and others believing Russia may turn off the taps in response to sanctions, resulting in prices potentially reaching stratospheric levels.
At the Prospectors & Developers Association of Canada (PDAC) 2022 annual convention in June, deal making, as always, was one of the main topics of discussion. Some larger producers spoke about acquiring more strategic positions with respect to critical minerals as the race to supply the burgeoning electric vehicle market continues. Consolidation in the sector, scarcity of strong gold projects and the mining industry's interplay with China were also notable themes.
Volatile commodity prices and the underlying geopolitical reasons stoking them could make it difficult for buyers and sellers to price transactions, which may ultimately impair deal making. On the other hand, macro-economic conditions appear to be conducive to strategic accretive acquisitions by companies that have done well despite cooling commodity prices and have ample capital to deploy in favour of acquiring complementary assets for long-term growth.
There is optimism that a return to stability will result in greater bid-ask certainty and encourage transactions. Overall though, M&A in Q3 will largely be between parties that believe they can achieve long-term accretive value, competitive strength or business synergies, or in circumstances where commodity price fluctuations are not expected to have a disproportionate, negative impact on the transacting parties.
The precipitous decline in digital assets in mid-May and June added to the general market instability in Q2. Hundreds of billions of dollars were lost in crypto holdings as major tokens collapsed and various crypto lenders and exchanges froze or limited user withdrawals. Bloomberg reported that Bitcoin lost 60 percent of its value in the second quarter of 2022, its worst quarterly performance since 2011. The price of Bitcoin fell from over $45,000 at the start of Q2 to under $20,000 on June 30.
While the sector has been subject to extreme volatility in recent years, a continued and sustained decline in the value of digital assets could signal a return to traditional safe havens, including gold and other precious metals, and may prompt additional M&A activity in those sectors.
What's Coming Next?
Whether the Canadian economy has a soft landing or not, today's choppy economic seas mean that companies and investors will need to take a more targeted approach to M&A deal making going forward in 2022.
We expect that valuations that increased to historic highs in recent years will soften to more normalized levels as interest rates rise, and that the frenzied transaction speed of the last 18 months will likely give way to a deeper dive into fundamentals and longer diligence periods. While the pool of capital deployed by institutional investors into private equity could decrease in favour of other asset classes, the amount of continued investment and current dry powder are likely sufficient to sustain ongoing M&A activity, particularly with respect to sectors and companies where there is a continued appetite to get deals done. Bain & Company's Global Private Equity Report 2022 says that dry powder set yet another record in 2021, rising to $3.4 trillion globally.
In many ways, we believe we are in a similar position to where we were at the onset of the pandemic, when buyers and sellers learned to navigate transactions and pivot in the midst of uncertain lockdowns and other novel restrictions. In hindsight, the learning curve was short-lived and it was not long before we were back to a very active M&A market. Once the current uncertainties have abated, a similar rebound in activity is entirely possible.
Bennett Jones' Mergers & Acquisitions practice spans all industries, and particularly those that drive the Canadian economy. To discuss the developments and opportunities shaping the Canadian M&A landscape, please contact the authors.