The obvious distinguishing feature of the current Canadian recession is speed — the speed of the descent and the apparent speed of the recovery. It remains to be seen whether the recovery takes the steep “V” shape some economists predict, a long and gradual climb out, or a bumpier, up-and-down “W” path out.
Certainly, Canada’s productivity gap and lagging consumer confidence combined with a climbing dollar are trending toward a slower recovery. Canadian industry sectors relying on U.S. demand likely face a long climb ahead.
There were four key features of the Canadian recession impacting upon distressed M&A:
- No liquidity
- No bottom
- No buyers
- Patient creditors
Stage I: No Deals
Once the 2008 financial crisis had hit the U.S. and then Canada, and for many months following, virtually no distressed businesses were being sold as going concerns. Liquidation scenarios were equally grim, with traditional liquidators opting out of entire asset classes.
A decline in “healthy” M&A in both countries was expected, but the absence of a robust distressed M&A market was not. With no bottom in sight, even liquidators and buyers stayed out of the market. No liquidity meant no PE/Hedge funds were acquisitive since their models required debt to make their deals work. Many creditors took a wait-and-see position. The result: Buyers were holding out for a fire sale and lenders were not pushing assets to market.
Stage II: Bottom in Sight, Limited Liquidity, a Few Buyers and Secured Creditors Starting to Lose Patience
In this second stage, distressed acquisition funds and strategic buyers consider acquiring distressed businesses which were market leaders or niche players. Troubled entities were selling, but in relatively small numbers. Since buyers focused on businesses that complement their own, deals remained hard to close and prices remain low. Moreover, the recovery of the equity markets ahead of the grassroots economic recovery created a price expectation gap. In some cases, existing lenders to a distressed target were financing the acquisition to avoid even lower pricing.
With trouble continuing to plague creditors, insufficient liquidation values to drive “going concern” sales and few buyers, Stage II was not conducive to a high volume of distressed M&A activity.
Stage III: The Future: Exiting the Recession, Increased Liquidity, More Buyers and Impatient Secured Creditors
As mentioned, distressed M&A activity in the coming months will depend on whether the recovery tracks the “V” shape; a long, gradual incline; or the slower and bumpier “W” model. With a quick recovery, fewer businesses will be sold as increased cash flow will sustain them through the recovery. Traditional M&A activity appears to be returning but the targets remain few and far between.
If the recovery stalls or becomes a bumpy “W,” creditors who have been patient may finally start pulling triggers. With floor asset and going concern values being hit and with the return of some liquidity, the pieces are in place for increased distressed M&A activity in 2011 should the recovery stall (but not reverse).
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David F.W. Cohen is a partner with Gowling Lafleur Henderson LLP and the Leader of the firm’s National Restructuring and Insolvency Practice Group. He is also a member of the TMA Board of Directors and the incoming V.P. of Membership for 2011. His contact information can be found here.