CIBC economic research note on Canadian M&A

The numbers are impressive / troubling, unless you’re a local i-banker or securities lawyer…then they’re just impressive and will ensure a happy bonus time this winter (unless your colleagues on the desk and in risk management lose it all with commodity option losses). Then you’re just working or half a bonus; but it’s probably still a better half than the “full” bonus that would have come from that job in management consulting that you turned down to go into investment banking.

The most surprising stat is the one about Canadian acquisitions surpassing outright corporate sales to foreign firms over the past 5 years by $20 billion. I’ll look into this more carefully in their complete report and get back to you on that.

“Canadian M&A activity is nearly double what it was at this point last year and has accounted for an impressive 44 per cent of the increase in the TSX Composite over the last 12 months, finds a new report by CIBC World Markets.

Canadian M&A deals have topped $175 billion so far in 2007, including $82 billion in announced transactions in the month of May alone. This comes on the heels of an 80 per cent jump in the value of M&A transactions in 2006. Globally, M&A transactions are up 60 percent over the previous year to an astounding $2 trillion.

“Investors are witnessing the greatest merger wave in history,” says Jeff Rubin, Chief Economist and Chief Strategist at CIBC World Markets. “The result is the emergence of global behemoths with GDP-like capitalization. And their creation has typically involved the payment of generous premiums, fueling stock market rallies around the globe.”

At the global level, takeover premiums have averaged 20 per cent. Premiums paid in the Canadian market over the last 12 months have averaged 30 per cent and in some cases have gone as high as 70 per cent. In the mining sector, home to many of the country’s largest deals in the last year, premiums have approached 40 per cent.

The report finds that these premiums have played a critical role in the performance of the TSX in the last year. M&A-related valuation changes have accounted for 44 per cent of the index’s overall 2,000 point increase in the last 12 months. M&A-related valuation pressures have accounted for all of the increase in the mining sector and a good deal of the gains for telecoms and consumer discretionary stocks in the last year.

Mr. Rubin notes that the key forces underpinning this unprecedented M&A wave remain in place and should lift the TSX to the 15,000 level by year end. These include low interest rates, ample cash flows, and strong commodity prices. He also notes that the growing involvement of well-financed private buyout firms, pension funds and emerging market players will continue to buoy deal volumes.

One of the key differences between this M&A cycle and those in the past is that today’s deals are mostly financed by cash. Globally, pure cash deals have been worth US$6 trillion in the last three years, accounting for more than 60 per cent of overall deal flows. Pure share exchanges, which accounted for almost half of deal volume in the late 1990s, have accounted for just 15 per cent of transactions in this timeframe.

“One key difference in this M&A wave is that firms and acquirers are playing with their own “real” money, instead of the grossly overvalued shares that some tech companies exchanged during the dot.com wave,” says Mr. Rubin.

“TSX firms have nearly 20 per cent more cash on hand these days than a year ago, a tribute in part to strong resource sector cash flows. And last year was one of the richest ever on record for cash holdings in both the Canadian and global markets.”

While the global merger wave has driven concerns over the hollowing out of corporate Canada in light of the recent disappearance of some venerable TSX listings in traditional sectors like mining, Mr. Rubin notes that over the past five years Canada has been a net acquirer of firms. The value of Canadian acqusitions of foreign companies is about $20 billion more than the value of foreign purchases of Canadian firms.

Unlike past merger waves in Canada including the recent dot.com wave, the bulk of the acquisitions are not coming at the hands of U.S. firms. Overseas players have the upper hand these days, with Europe recently eclipsing the U.S. as the top acquirer of global companies. Firms from emerging markets like Brazil, Russia and India are increasingly joining the fray. With $35 billion of deals in the last year, acquisitions by emerging market enterprises have been three to four times more important, relatively speaking, to the Canadian M&A market than the U.S. market.

The full CIBC World Markets Monthly Indicators report is available at http://research.cibcwm.com/economic_public/download/mimay07.pdf.”

MRM