Globe and Mail reporter Tim Kiladze.The Globe and Mail
The financial-services industry specializes in selling compelling stories. Which stocks to buy. Which fund managers to trust. Which lawyers, bankers and consultants to hire for their expertise.
When the predictions prove true, or when the concocted narratives play out, the brains behind the visions get glorified. Think of The Big Short characters who bet against the U.S. housing market right before the Great Recession. Then remember that many other money managers made the same trades, only a little too early, so they missed the massive windfalls.
Narratives are particularly widespread in the mergers and acquisitions world, because shareholders often need a persuasive story to permit one company to completely swallow another. And if a deal is going to cost billions of dollars, the CEO who's paying up has to spell out a vision. The problem with this: Sometimes the arguments are nothing but hot air.
Starting around 2014, when oil and gas prices started to plummet, there were predictions that a new wave of merger themes would guide the way business would get done. Enough time has now passed to realize many didn't pan out.
The busted myths serve as a solid reminder that even if a financial argument is logical, it can still be unfounded.
Myth #1: Corporate breakups make for smart business
In 2014, consulting firm Bain & Co. released a report on the next big thing: the "push to unlock shareholder value by refocusing on a core business." Executives were looking at their portfolios and deciding to separate – in record numbers.
Spin-outs can make sense. Companies get bloated, and when they do, shareholders can lose sight of all the moving parts. The same year as the report, Encana Corp. spun out PrairieSky Royalty, and the newly traded company has performed well.
Yet the fervour for such deals hit astronomical heights, and advisers and consultants started pushing the theme so that they could get in on the trend. Activist investors started advocating for it, too.
This year, some of the biggest deals were inked for the exact opposite reason.
In March, TransCanada Corp. spent $10.2-billion (U.S.) to acquire Columbia Pipeline Group. The driving forces behind the deal: expanding TransCanada's natural gas footprint and tapping the U.S. northeast market, where it had little exposure.
In September, Agrium and Potash Corp. of Saskatchewan tied the knot. Their rationale: to build a diversified company that had everything from potash production to retail fertilizer sales.
See the theme? Bigger, and more diversified, was better. And it's playing out everywhere, particularly in financial services. Yes, bloated companies are a problem, but multiple revenue streams usually smooth cash flows in volatile periods.
Myth #2: A weak loonie is bad for Canadian buyers
When the Canadian dollar started crashing, simple logic made it seem as though outbound M&A would be much harder to pull off. In the same way that retail shoppers buying Restoration Hardware's U.S.-dollar goods might buckle at soaring prices, Canadian companies would be similarly hamstrung.
They weren't. In 2015, the total value of all mergers and acquisitions involving Canadian companies and funds hit roughly $280-billion, according to Thomson Reuters. Of those, about 80 per cent were outbound.
The trend continued in 2016. Early in the year, Fortis Inc. paid $6.9-billion for U.S.-based ITC Holdings. Then, in September, Enbridge Inc. revealed its blockbuster $37-billion acquisition of Spectra Energy.
What the simple logic missed is that unlike retail goods, acquired companies provide continuing cash flows. Even if the buyer shells out foreign funds up front, it gets foreign revenue every quarter in return.
Myth #3: The resource crash would spring big deals
As soon as the mining supercycle collapsed, there were predictions that private equity companies would scoop up metals producers for cheap. Similar prognostications were made when energy prices took their own tumble a little later.
There were some big deals, such as Shell buying BG, and there have been individual asset sales, but for the most part it's been crickets – at least relative to expectations.
Again, it was so easy to assume that buyers would love to acquire for cheap. What this line of reasoning missed was nuance.
In mining, the biggest players – who presumably would go buying – were often those that were most troubled because they had too much debt. That meant they were preoccupied with winning back their own shareholders, not wooing a target's investors. In energy, many of the would-be buyers got gun-shy because underlying commodity prices remained incredibly volatile.
The new prediction is that frozen resource deals are thawing. This time around, there's more reason to have hope. Energy prices have stabilized somewhat, and British Columbia's Montney Formation – oh so hot right now.
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