Financing acquisitions in Canada: keep your eye on the CAD
March 2014 | PROFESSIONAL INSIGHT | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
Companies often approach a Canadian acquisition with a reasonable degree of comfort, believing correctly that the Canadian legal and financial environment is similar to the US. While this is true in many ways, there are a number of unique aspects and one that deserves early attention is how to manage the CAD, as the Canadian dollar is aptly known. Although Canada has a relatively stable economy, the CAD has been a volatile currency in recent years. For example, between 1 July 2013 and 31 December 2013, the CAD lost 6 cents against the US dollar. Given this volatility, acquirers need to be mindful of the currency of the source of funds for an acquisition (including both debt and equity) and how those funds will translate into the currency necessary to pay the purchase price for the acquisition. Acquirers will want to ensure that they are not exposed to undue currency risk.
Do you have enough financing? Large Canadian acquisitions are commonly financed with US dollar debt financing. Where the acquisition price is denominated in US dollars, and the target generates revenue in US dollars (for example a mining company), no issue arises. Where the acquisition price is denominated in CAD, the acquirer has to consider whether it has sufficient debt commitments, and if applicable, equity commitments to fund the entire purchase price. For example, if the acquisition price is CAD$100m, to be financed as to 75 percent with debt and 25 percent with equity, an acquirer may wish to secure a debt commitment for a floating amount of US dollars sufficient to purchase CAD$75m. Alternatively, the acquirer may need to top up its equity funding to cover a shortfall in the debt financing if the CAD strengthens between signing of the transaction and closing.
How much is the equity cheque? Apart from concerns about potentially having to fund a shortfall in the debt commitment, some acquirers wish to determine the size of their equity cheque in their home currency at the time of signing the acquisition agreement and therefore explore a deal contingent hedging strategy. In a deal contingent hedging strategy, the acquirer agrees to enter into a transaction, such as a purchase of Canadian dollars at a fixed exchange rate, conditional upon the closing of the acquisition to be funded. In order to effect a deal contingent hedging strategy at a reasonable cost, the acquirer needs to have visibility on the likelihood and timing of closing which typically are most impacted by regulatory approvals. While the regulatory environment has become less predictable in Canada, given decisions such as the Canadian government blocking the acquisition of Potash Corp by BHP Biliton, experienced regulatory counsel can provide a reasonable level of guidance with respect to timing and likelihood of success. It is worthwhile to have this discussion early, so that the cost of a deal contingent hedge can be accounted for more accurately.
Can the target support US dollar debt? Many Canadian companies generate revenues in US dollars, but for those who do not, carrying US dollar debt can represent a significant risk to the business, both with respect to debt related maintenance covenants and even ability to pay debt service. The simple solution is to hedge the US dollar debt. While this is a viable strategy, there are some complexities to consider. First, in modelling debt service costs, it is important to factor in the cost of hedging. Second, the banks providing the hedging may view it as a material credit exposure, and may not be willing simply to be secured pari passu with other secured debt with no independent covenants or rights. Accordingly, if pursuing a hedging strategy, particularly for very large transactions, it is important to consider hedging as part of the overall financing package and give thought to the terms and cost of the hedging.
Is CAD financing an attractive option? For acquisitions of Canadian businesses that generate revenues primarily in Canadian dollars, a CAD denominated financing may be attractive. While syndicated bank debt is available in Canada, another alternative is high yield debt, supported by a bridge facility from a Canadian bank. Canada has a growing CAD denominated high yield market and recently high yield bonds have been used to finance or refinance acquisitions. The Canadian high yield market is similar to the US market (where the Canadian banks are also active) with the documentation based on US market standard covenant patterns. The Canadian market is smaller and less liquid resulting in more ‘bespoke’ terms that can be tailored to the particular needs of the issuer. For example, in Canada many public issuers pay a regular dividend and covenant patterns have allowed for such dividends. A smaller sized high yield issue may also be more feasible in Canada than in the larger US market. On the other hand, Canadian high yield investors tend to be more conservative than their US counterparts, and have less tolerance for permissive covenant patterns (e.g., large restricted payment and additional debt baskets). For very large transactions, the US dollar market may be the better option, although a combination is possible as some recent Canadian high yield transactions have had a US tranche and Canadian tranche. For many transactions, pursuing a Canadian debt strategy is an attractive alternative.
In summary, there are a number of effective ways to finance a Canadian acquisition and manage exposure to the CAD, but thinking about the currency early will yield the best result.
Celia Rhea is a partner at Goodmans LLP. She can be contacted on +1 (416) 597 4178 or by email: email@example.com.
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