Canada’s X factor: regulation

New regulatory proposals may throw a wet blanket on Canada’s red hot M&A market, which struck $157 billion worth of deals last year, up 22 percent from 2013, according to KPMG stats.

Last week, the Canadian Securities Administrators (CSA) finally unveiled their highly anticipated proposals to reform takeover bids in Canada. The proposals accomplish three main things. One, require that bids are accepted by at least 50 percent of the target shareholders; which allows them to essentially “vote” on a bid, possibly making it more difficult for GPs to gain control of the target. Two, provide shareholders that have not tendered to the bid an extra 10 days to sell after the 50 percent threshold is met – something done to mitigate the “pressure to tender”, and again, may make it more difficult to acquire control. And three, drastically extend the minimum bid period from 35 days to 120 days, which, perhaps even more so than the other two requirements, would be a real game-changer for how private equity business is done in Canada.

The law of unintended consequences helps explain why. The aim of the third proposal is to allow “white knights” more time to emerge, heat up the auction process and increase target company shareholder value. But initial bidders don’t like the idea of others coming along to snag their deals, meaning they prefer as short of a bid period as possible. Hostile bidders, who tend to be strategists, fare especially worse when rival bidders show up to the party. That’s why a short bid period is so sweet for those first to arrive at the scene: under that 35-day timeframe, only about one in four first-mover bids in Canada is met with a rival bid, according to Fasken Martineau estimates. The Canadian law firm underwent a massive study of every unsolicited takeover bid for public Canadian companies during the ten-year period ending in 2014.

Among the study’s findings: if a first-mover bid did experience any competition, it took, on average, 41 days for it to occur. So what happens when that (arguably too short) 35-day window is stretched to four months? Expect more bidders to stay on the sidelines. There’s a certain level of cost and risk that goes into the bidding process, which gives some pause when they consider the possibility of a rival scooping the deal away, making all their hard work for naught. In other words, it is likely fewer bids will be made because the chances of losing the deal go up. Again, hostile bidders especially are concerned about competition. And if they take a backseat, target management boards are less concerned about an unwelcome buyer costing them their jobs.

Then again, it’s entirely possible bidders will adapt their tactics and keep bidding even in the face of the likelihood of increased competition. If so, it stands to reason that private equity firms will enjoy higher returns while selling, and a more brutal auction process when buying (though less brutal relative to hostile bidders). It’s a situation where regulation becomes a big X-factor in the future health of Canada’s M&A market.

The CSA is giving the industry 90 days to provide feedback. Get it right, and private equity continues to flourish in one of the industry’s biggest jurisdictions. Get it wrong, and M&A activity goes south in the Great White North.