Canada is hardly a new frontier for private equity, but as U.S. buyout firms look for growth opportunities outside the lower 48 states, they are finding that to their north, a robust and challenging market awaits for buyouts.
As one PE pro in Canada says, Canada used to be an environment with “one big transaction every two years.” Such was the case in 2000, when Kohlberg Kravis Roberts & Co. (KKR) led a $2.1 billion buyout of Shoppers Drug Mart Corp. and then came back in 2002 to buy the Bell Canada yellow pages division for $2.5 billion.
But since then, buyout activity led by U.S. funds has picked up, spurred partly by those very deals, which showed that there was money to be made in Canada. (as opposed to U.S. venture capital activity, which is declining; see brief on page 7).
Jim Leech, senior vice president at Teachers’ Merchant Bank, says that the returns KKR got on Shoppers and Bell Canada, “got everyone’s attention.” Leech estimates that now there are about a dozen sizeable U.S. private equity players regularly active in Canada, competing with Canada’s home-grown buyout funds.
The capital under management in Canada’s private equity market is $51 billion, with the buyout segment comprising about half that, according to a 2004 report issued by Goodman and Carr LLP and market researcher Thomson MacDonald (which is owned by Thomson Financial, publisher of PE Week).
And U.S. firms have been active in the last two years – led by The Carlyle Group, Monitor Clipper Partners, Warburg Pincus, Accel-KKR, Bain Capital, Sentinel Capital Partners and KPS Special Situations Funds, among many others.
Reasons for the increase in U.S. fund interest in Canada include: growing amounts of capital, growing numbers of funds, undiscovered Canadian management teams, and the opportunity for liquidity provided by both lower listing requirements in Toronto and Canada’s latest IPO fad, Income Trusts.
Income Trusts are financial vehicles unique to Canada that allow companies to access the public market via a trust, similar to how a REIT works. Income Trusts have emerged as ominous competitors to buyout funds because they provide a fairly easy exit for business owners at often outstanding multiples of 6x to 8x.
However, Income Trusts are a double-edged sword. “On a number of occasions we have bid on a company only to come in second to an Income Trust,” said Leech. “At the same time, it’s helped our exits.”
Rick Nathan, a managing director at Goodmans Venture Group and president of the Canadian Venture Capital Association (CVCA), says that the Income Trust market has been “a magnet of interest,” with several dozen coming to market over the last year. About two thirds of those, he estimated, had the participation of a private equity fund.
David Rowntree, a managing director and co-founder of Tricor Pacific Capital, which has offices in Chicago and Vancouver, says that an income trust IPO can generate another turn or two on a multiple. He said at least six companies Tricor has looked at have broken off talks to pursue Income Trust status.
Rowntree recalls one transaction two-and-a-half years ago, when the Income Trust market was peaking, in which Tricor had a signed letter of intent to buy a consumer products manufacturer for $90 million. The company ditched the agreement and instead went public as an income trust for $180 million. A year ago, another consumer products maker was negotating with Tricor on a $60 million deal; it went public for more than $80 million.
“They don’t even come to our doorstep anymore. They just go directly to the market,” he said.
But all is not well with income trusts. In September, Canada said it would review their taxability. The government claims it is losing hundreds of millions per year in taxes, says Nathan. The result has been the deletion of an estimated 15% of what was $180 billion in market value of Income Trusts in the last few months.
“Investors didn’t think they were buying into political risk [investing in Income Trusts]. This is a case of the government moving the goal post in the middle of the game,” said Nathan.