Canadian Capital Confidence Barometer - October 2013 - April 2014

Mergers and acquisitions

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Appetite for dealmaking holding steady

The “confidence paradox” — the gap between deal-market outlook and deal intentions identified in our April 2013 barometer — is holding steady in Canada.

For the first time in more than two years, more than 40% of US executives intend to pursue an acquisition. This confidence has now surpassed that of Canadian executives, who are holding steady at 33% since the last Barometer. US executives share their Canadian counterparts’ expectation that local deal volumes will improve — but don’t intend to wait for dealmarket growth before making a move themselves.

Dealmaking fundamentals — from credit availability to economic confidence — have all improved over the last year. As seen in their growth strategies, companies have optimized their capital structures. But Canadian executives continue to indicate their intent will remain cautious over the next 12 months, contrary to those in the US.

Deal environment in Canada is unchanged

  • Deal volumes expected to remain at current levels
    While 52% of US executives expect an improvement over the next 12 months, more Canadian executives expect global deal volumes to remain at the same level rather than show modest improvement, different from six months ago. The same expectation exists for deals in the domestic market — although 48% of Canadians expect deal volumes to improve, down from 66% in April 2013. They diverge from their US counterparts despite increased confidence in core fundamentals: economic sentiment, credit availability and job creation.
  • M&A expectations remain the same, falling behind the US for the first time in two years
    Both Canadian and US companies say they will primarily use excess cash to pay down debt — one of the remaining ways to optimize their capital structures. Additionally, a total of 46% of Canadian companies plan to use excess cash to fund growth, both organic and inorganic, with a slight bias towards organic strategies. This is also consistent with the views of US respondents.

EY - What is your expectation to pursue an acquisition and your level of confidence in the following at the local level?

Expectations on deal size and valuations both growing

  • Improved sentiment toward large deals
    We have seen improvement in the two largest categories of deals: 32% of Canadian executives say they plan to pursue deals larger than US$501 million, up from 13% six months ago. The largest increase was in deals over US$1 billion — transformational deals that tend to trigger the dealmaking environment. This expectation of larger deals is more optimistic than in the US, where 20% of whom expect deals to be in the over US$501 million range. The number of US respondents who expect deals over US$1 billion actually dropped 2% over the last six months. These shifts may indicate a more robust dealmaking environment on the horizon.
  • Valuation gaps expected to widen
    As transaction volumes accelerate, there is a natural divergence between buyers’ and sellers’ expectations on pricing. Both Canadian and US executives increasingly expect valuation gaps to widen over the next 12 months. As buyers and sellers adjust their expectations at different rates, this widening is a natural result. The recent surge in US equity markets is also indicative of a growing valuation gap.

EY - What is the expected deal size?

Increased global dealmaking likely to be driven by mature markets

  • Acquisition capital to be allocated primarily to mature markets
    Mature economies are expected to attract the majority of Canadian acquisition capital over the next 12 months, and that is consistent with US sentiment. This is largely attributable to a rebound in mature economies, as well as the perceived safety and quality of underlying opportunities.
  • Emerging market interest grows
    As they search for new strategic opportunities and portfolio diversification, Canadian executives remain cautiously optimistic regarding their emerging markets focus. Forty-four percent of Canadian executives reported a greater focus on emerging markets than a year ago, just slightly behind US respondents, at 50%.
  • Slowing-growth emerging markets require more transaction rigour
    While certain emerging markets have experienced slowing growth, executives remain largely optimistic about the opportunities they present, provided greater rigour is applied to dealmaking. US respondents indicated more optimism in these markets than respondents in Canada, and a greater proportion of Canadian respondents have also discontinued their emerging-markets strategies for the time being.

EY - How has your sentiment towards investing in emerging markets changed versus a year ago?

Divestments are fundamental to driving strategic value

  • Divestments enable corporate objectives
    Recognized for their strategic value, divestments are an effective tool to address a variety of corporate objectives. Canadian companies report continuing focus on core assets and enhancing shareholder value, while US respondents report an increased focus in shedding underperforming business units as they optimize their capital structures and focus on their core business. Fewer plan to use divestments to raise capital as credit is now more readily available both in Canada and the US.
  • Joint-venture interest has become an active divestment structure for Canadians
    At 37%, the contribution of business units to joint ventures has emerged as the primary form of divestment activity in Canada. While US executives indicate a preference for the outright sale of business units (57%), only 25% of Canadian respondents preferred this approach. In both Canada and the US, there is reduced interest in creating spinning business units off or taking them public.