While talk of globalization in the private equity market these days tends to drift toward Asia and Europe, the private equity market in Canada is quietly becoming a point of focus for a growing number of U.S. buyout firms.
During the past two years, U.S. activity in Canada has reached a soprano-like pitch. Impelled by a string of successes theremost notably the Kohlberg Kravis Roberts & Co. investments in Shoppers Drug Mart and the Bell Canada yellow pages divisionother prominent U.S. firms have set up camp to mine the Canadian landscape. Wellspring Capital and KPS Special Situations have notched similar successes, while shops such as Bain Capital, Harvest Partners, J.W. Childs Associates, Lightyear Capital, Hicks Muse Tate & Furst and Thomas H. Lee Partners are among those that have been active in the country recently.
Unlike the past, though, this border hopping is no longer as one-sided as it seems. Canadian firms have been ramping up their U.S. activity as well, and many in the industry feel their southward march has only just begun. U.S. offices are being either established or bolstered, pros are immersing themselves into Wall Streets dealflow undercurrents, and rumblings of activity from Canadian firms have already become discernible to American ears.
Consider Teachers Private Capitals $450 million purchase of Alliance Laundry, the EdgeStone Capital acquisition of Brockton, Mass.-based Specialty Catalog Corp. last March, and Onex Corp.s $1.1 billion deal to buy certain Boeing commercial aircraft plants. Market pros say Canadian interest in U.S. companies is merely a reflection of the convergence between the two North American markets.
We are indeed stepping up our interest in the U.S., Teachers Private Capital Senior Vice President James Leech tells Buyouts. The border [separating Canada and the U.S.] is now in many ways totally meaningless, at least from a capital perspective.
Tricor Pacific Capital Managing Director and Co-founder David Rowntree agrees. Were broadly seeing more Canadian firms going into the U.S. The Canadian market, as wonderful as it is, is a mile wide and an inch deep, he says. This may be different in the Ontario region, where theres a large manufacturing base, but generally speaking its not a big market up here. If youre a private equity fund, what can you do? You have to go where the deals are, and the fact is, there are more opportunities in the U.S. than in Canada.
To many, the Shoppers Drug Mart deal serves as the landmark transaction signaling the American siege on the Canadian market. Canada, however, does not have one such transaction that everybody will point to as cueing its emergence on U.S. shores. But thats not to say there isnt a slate of successes; its just that with the U.S. as large as it is, Canadian victories havent been able to stand out in the same way.
When Onex Corp. acquired American Airlines food service unit for roughly $170 million (C$240 million) in 1986, The New York Times dedicated less than 100 words in covering the sale. But despite the apparent indifference, Onex was able generate nearly $2 billion in profits, representing a return of roughly 19x its investment. The firm nearly equaled that success with its investment in Loews Cineplex, buying the company in 2001 for just over $500 million and doubling its money in a little over three years.
Others are seeing their U.S. initiatives pan out as well. Teachers investment in Denver-based Samsonite already looks to be a successful turnaround play, while HSBC Capital (Canada) Inc. scored a roughly 5x return on its investment in New York-based pool parts manufacturer Latham International.
Easing Through Customs
Not surprisingly, investment banks are doing their part to help drive the convergence between the Canadian and U.S. private equity markets. In Canada, the rigid lending community has been made molten by U.S. lenders bringing high yield and other junior debt products over the border, while in the U.S., Canadian groups such as CIBC World Markets have worked to import the Canadian Income Trust structure. The end result is that both sides are versed enough in the financial mechanisms of each country that there really isnt any dramatic initiation period.
Toronto is no different than operating in Boston or San Francisco. We just view our market as North America, Onex Managing Director Andrew Sheiner says.
From a capital perspective the U.S. banks have been operating up here for years, Leech adds, noting that there hasnt been a huge problem finding capital from a U.S. source, or vice versa, for awhile now.
Canadian Firms Bringing Their Eh Game
Rhe independent Canadian PE firmswhich generally speaking are a fund life or more behind their U.S. counterpartshave been gaining in size, and in many cases are now on equal footing with the American firms.
2003 was one of the biggest fundraising years for Canadian buyout funds, says Kirk Falconer , the director of research and analysis at Canadas Thomson Macdonald (formerly Macdonald Associates). Indeed, according to the firms most recent LBO data, the size of the Canadian buyout pool grew to $22.5 billion in 2003, up from $16.7 billion the year earlier.
Most anticipate that that number will only get larger. Onex still has the largest Canadian institutional fund, at C$2.2 billion, but recent offerings from CAI Capital Management (at C$375 million), The Richardson Financial Group (at C$325 million) and TriWest Capital Management (at C$120 million), and purported C$600 million-plus fundraising targets from EdgeStone Capital Partners and TD Capital spinout Birch Hill, suggest that Canadian firms will continue to grow in size and scope.
Every time weve gone out [fundraising], weve doubled the size of our fund, and were seeing most of our compatriots getting larger as well, Tricors Rowntree says.
However, for the most part, the independent Canadian firms are largely constrained to the small and middle markets. The public pensions, such as Teachers Private Capital, CDP Capital and Ontario Muncipal Employees Retirement System (OMERS), are still regarded as the only Canadian buyout players with the firepower to compete in the large market, although Onex is the one independent Canadian firm that is starting to emerge in that sphere. Eventually, though, if fund sizes continue to increase as expected, Canadian firms will start competing for larger transactions.
Moreover, the tax treatment on limited partnerships has served to stifle investment from Canadian LPs into indigenous Canadian funds. With new measures currently on the table to remove these limits, many expect that it could free up more money to flow into Canadian private equity partnerships (see box, page 20).
It Can Still Be Cold
But even with more capital at their disposal, some Canadian firms could find the U.S. market less than accommodating. The efficiency of the sale process, the liquidity of the financing markets and the overall competition can make the process easier, but at the same time, U.S. deals can give some Canadian buyers sticker shock. Onexs Sheiner notes, In cases where you have a bunch of firms looking to buy a company, the prices are going to be higher. Its inevitable.
But as long as it continues to make financial sense, Canadian firms can only be expected to push their way further into the States, regardless of cost. Banyan Capital Partners Managing Director David Stitt, notes, There is more competition in the U.S. and [purchase price] multiples are still lower in Canada, but our business is to back great people and grow companies. In the U.S., there are 10x more people and the market is 10x as large. Because of that, he adds that there are more opportunities to find investments, and then, due to the larger market, to grow those companies once the investments have been made.
Then there are those who dont even believe the Canadian market today is any less crowded than in the U.S.not with the Canadian income trust market going further and further downstream. We love income trusts but in the last 18 months theyve been our single largest competitor, Rowntree identifies. In terms of the valuations, none of us can really compete and the size of [income trust] deals have also come down market. It used to be that [income trust] IPOs were around $100 million in size. Then it went down to $80 million, and now were seeing IPOs of around $50 million and $40 million The U.S. market is very competitive, but no more so than the market here at home.
As Canadian firms look to build their presence in the U.S., and become a viable option for selling companies, they will need to establish a positive track record and insert themselves into the mix with the investment banks. What Canadian firms have to do is get themselves inserted into the Wall Street deal flow, Leech says. Its not easy, but were spending a lot of time doing that.
He adds, It can be an education process. It takes reaching out to a lot of the bankers, but the best way to go about it is to just do deals. When we closed our purchase of Alliance, that said to everybody in concrete terms that were here and were a viable source of capital.