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Economic winds gusting from the North: Canadian companies are finding new value in the U.S. market, and more deals are being done in a broader range of industries. But the sour U.S. economy may be keeping some Canadian buyers on the sidelines.

For much of the last decade, Canada has been informally known in cross-border merger and acquisition circles as the home of the willing acquisition target. A combination of buyer-friendly takeover laws, a strong U.S. economy and the presence of highly desirable natural resource companies has contributed to Canada's role as one of the largest net sellers in cross-border transactions worldwide.

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While there is continued global interest in acquiring Canadian companies and assets, especially from the U.S., the winds of economic change are beginning to blow in a new direction. Canadian acquirers, buoyed by a strong Canadian dollar, the weakened U.S. economy and a tight lending environment in the U.S., are more actively participating in the U.S. merger and acquisition market.

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U.S. sell-side transactions in the technology industry, which were traditionally the domain of U.S. buyers and private equity firms, are now beginning to be more vigorously shopped in Canada. In addition, Canadian companies are making more unsolicited offers for U.S.-based middle-market firms across a variety of industries.

U.S. companies considering a divestiture or outright sale should take into account a number of acquirer alternatives, including: domestic vs. international, strategic vs. financial and management buyout vs. third-party sale. Due to tightening credit markets in the U.S. and the challenges that can arise from cross-border transactions outside of North America, Canadian acquirers deserve a more careful analysis.

The key areas that U.S. businesses should explore in order to better understand the advantages and drawbacks of potentially selling to a Canadian strategic acquirer include:

* The current status of cross-border M&A activity between Canada and the U.S.;

* Factors driving Canadian buyers to explore U.S. opportunities;

* Recent examples of Canada/U.S. cross-border activity;

* Attributes of Canada/U.S. transactions versus other cross-border transactions;

* Impediments that can prevent the successful closing of a Canada/U.S. transaction; and

* Positioning of U.S. businesses for a sale to Canadian acquirers.

The U.S.-Canadian M&A Relationship

Despite being the fifth-largest set of foreign investors in the U.S., Canadian acquirers are often overlooked by many U.S. companies looking to sell their companies or assets. In 2007, there were 490 acquisitions of U.S. companies by Canadian acquirers; the deals had a total transaction value of $60.1 billion, according to Thomson Financial.

This represented a significant increase from 2005, when there were 375 transactions at a total value of $13.6 billion. While much of this activity was driven by the financial services and natural resource sectors, Canadian technology firms have increased their presence significantly.

In the first quarter of 2008, Canadian acquirer activity in the U.S. remained consistent with 2007, based on the number of transactions announced. Although the total dollar amount of transactions has declined, this trend compares very favorably to the rest of the U.S. M&A market, which has fallen off significantly.

Factors Driving Canadian Interest in the U.S.

Several factors are contributing to the rise of Canadian acquisition activity in the U.S. Principal among them is the rise of the Canadian dollar against the U.S. dollar. As little as five years ago, the "loonie," as it's known for its iconic symbol, was trading at $0.70 to the U.S. dollar. In the year ending in late April, the Canadian dollar had increased in value over 15 percent to approximately $0.99(US), a level it has been at for the last five months.

From a historical perspective, Canadian acquirers are now seeing U.S. companies at their most favorable price levels. In addition, any transactional costs, such as legal, due diligence and banking fees, can be spread to U.S. service providers at a lower net cost to Canadian acquirers.

Another factor spurring acquisition activity is the tight lending environment in the U.S. Although the Canadian debt market has encountered some of the same collateralized debt-related challenges as the U.S., the availability of debt, under reasonable terms and pricing, is significantly better in Canada in the near term. The debt meltdown in the U.S. has reduced the number of private equity buyers who would normally participate in a middle-market transaction and, in turn, has driven down valuations.

More traditional activity drivers remain in place. The strategic need to access the U.S. market continues to be the most compelling rationale for Canadian company acquisitions in the U.S. Again, where this activity was mostly limited to financial services and natural resource companies, it has now spread to the middle market and has focused on technology opportunities.

Advantages and Challenges to Canada/U.S. Cross-Border Activity

A September 2007 survey of 200 U.S. middle-market executives by the Association for Corporate Growth indicated that 72 percent of the respondents had been involved in a cross-border transaction in the past year and that 70 percent anticipated completing a transaction within the next 12 months. The three geographies of choice for U.S. executives were Europe, Canada and China.

It is important to note that in spite of its size, Canada remains a high choice among both U.S. buyers and sellers. Much of this ranking can be attributed to proximity, cultural fit and legal/accounting statutes that closely mirror those in the U.S.

With U.S.-Canadian transactions, U.S. sellers do not need to concern themselves with legal entanglements (such as dispute resolution) that come from European buyers, nor the financial or cultural issues that can arise from a Chinese acquirer. Canadian acquirers typically operate their businesses in much the same manner as their U.S. counterparts. Post-transaction integration also tends to be far less complex and time-consuming. In addition, transactions with Canadian acquirers are typically completed much faster than those with a European or Chinese acquirer.

Finally, concerns around regulatory approvals (in Europe), and protection of intellectual property (in China) tend be non-issues in Canadian transactions, due to a favorable business environment and a similar patent protection laws as those in the U.S.

Potential Challenges

Although the U.S. and Canadian economies have historically enjoyed a strong relationship, there are still issues that can trip up a potential cross-border transaction. The single largest challenge is economic uncertainty. Many Canadian acquirers believe that the U.S. economy has the potential to fall further and that valuations may continue to decline. This thought process may keep some buyers on the sideline until the second half of this year.

Another area of concern is the rapid movement of the exchange rates between the two nations. Canadian buyers, U.S. sellers and their respective advisors are wary of the transaction complexity that occurs when rates move quickly. The ability to successfully negotiate and close a transaction in a reasonable time frame is severely hampered when the underlying valuation changes.

A third potential roadblock in the minds of Canadian acquirers is the growing complexity of the U.S. market and the tightening of regulations by the U.S. government. This is highlighted by the more adversarial relationship between the U.S. and Canada over border control and "national interest" businesses.

In return, the Canadian federal government has more strenuously asserted its right to block transactions vital to its national interests. This is illustrated by the recent halt of the $1.3-billion sale of the space technology division of MacDonald, Dettwiler and Associates to Alliant Techsystems, a major U.S. defense contractor.

Positioning a U.S. Business

U.S. financial executives considering a global divestiture or sale process need to be aware of many issues that may impact the ultimate transaction. Principal among them are the cultural, economic and legal issues that may arise with a foreign acquirer. Proper positioning of the business is a key to the deal's ultimate success. Anticipating regulatory issues, due diligence roadblocks and potential legal hold-ups ahead of time will help to smooth a potentially complex process.

When considering a Canadian acquirer, many of the cross-border issues that arise in other geographies are not as prevalent. Nevertheless, attention needs to be given to the specific needs of Canadian acquirers. These may take the form of access to U.S. markets, applicability of patents in Canada and worldwide, as well as financial reporting issues.

Ultimately, the ability of U.S. sellers in the current market to recognize the potential advantages of Canadian acquirers may be the difference between a successful transaction and a costly, time-consuming and failed endeavor. As a well-known quote advises, "I can't change the direction of the wind. But I can adjust my sails." Perhaps an adjustment to the north is in order.

RELATED ARTICLE: Recent Cross-Border Activity

A study of the more than 490 transactions in 2007, as well as the transactions that have taken place to date in 2008, indicates a subtle shift in the deal landscape from the larger natural resource, energy and financial services deals to more middle-market technology transactions.

Below is a summary of selected transactions that illustrate this trend: Sierra Wireless Inc. acquisition of CradlePoint--Sierra Wireless announced on April 7 that it signed a definitive agreement to acquire CradlePoint, an Idaho-based mobile broadband networking solutions provider, for $30.2 million in total consideration. CradlePoint is expected to produce $25 million in revenue in 2008. According to its press release, Sierra Wireless believes that the transaction provides it with better access to the U.S. market, as well as a compelling product offering that can be used in numerous global markets.

EXFO Electro Optical Engineering Inc. acquisition of Brix Networks Inc.--On April 22, EXFO completed its acquisition of Brix Networks, a converged IP networks assurance provider, for up to $37.5 million, including potential earnouts. Based in Massachusetts, Brix Networks generated revenues of $15.2 million in 2007 and has been active in research and development of its technologies for more than nine years. EXFO was able to leverage the improved Canadian dollar to acquire technologies that would have cost it significantly more a year ago. EXFO intends to integrate the Brix technologies with its own offerings.

Softchoice Corp. acquisition of Optimus Solutions LLC--On January 2, Softchoice completed its acquisition of Optimus Solutions for $47.1 million, including deferred payments. Based in Georgia, Optimus Solutions is a comprehensive IT products and solutions provider to the mid-market, with revenues exceeding $140 million. According to Softchoice, the acquisition continues its implementation of a U.S. growth strategy. Among the benefits of the acquisition, according to the company's press release, are: it completes Softchoice's market coverage across all segments, extends its Microsoft Enterprise Agreement and broadens the company's customer platform.

RELATED ARTICLE: TAKE AWAYS

* Canadian acquirers, buoyed by a strong Canadian dollar, the weakened U.S. economy and a tight lending environment in the U.S., are more actively buying U.S. assets, and more of them are in non-traditional verticals.

* The dramatic rise of the Canadian dollar against the U.S. dollar in recent years has given Canadians new purchasing power, and the debt market north of the border is more receptive than it is now in the U.S.

* U.S. firms selling to Canadian buyers don't need to worry about legal entanglements (such as dispute resolution) that come from European buyers, nor the financial or cultural issues that can arise from a Chinese acquirer.

MATT MAHER is a Senior Associate in New York with Trenwith Securities LLC, a middle-market investment bank. He has more than 10 years of cross-border M&A experience, advising international companies with divestitures, acquisitions and trade finance transactions. He can be reached at mmaher@trenwith.com.
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Title Annotation:DEALS
Author:Maher, Matt
Publication:Financial Executive
Geographic Code:1USA
Date:Jun 1, 2008
Words:1938
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