Canadian Dealmakers Keep Their Confidence

Last month, the Bank of Canada issued its latest interest rate hike after inflation reached 4.4%—and its next rate hike could be just days away.

Like the U.S. and Europe, Canada’s high-inflationary environment is weighing on dealmakers struggling to access affordable capital to finance their investments. Market uncertainty continues to challenge investors in the middle market, yet analysts and acquirers remain cautiously optimistic.

“There’s definitely been a slowdown for sure,” said Stephanie Mooney, director of business development for Canada and the U.S. at private equity firm Trivest Partners, in a recent interview with ACG’s GrowthTV. “But we’re also comparing deal flow to record years in 2021 and 2022. So although there’s been a slowdown, it’s still a very healthy market.”

PwC Canada’s 2023 mid-year Canadian M&A update report notes inflation seems to be rising at a slower pace than this time last year, while opportunities remain for distressed investments and acquisitions of assets divested by companies pursuing leaner operations.

As sources told Middle Market Growth, in addition to taking advantage of the dealmaking opportunities that arise amid market pressures, there are unique characteristics of the Canadian dealmaking environment that are bolstering M&A investors’ positive outlook.

Banking Resiliency

There’s no denying the challenges that rising interest rates and economic uncertainty pose to middle-market dealmakers in Canada. Mike Fenton, president and CEO of ACG Toronto, says LP investors’ pullback from private equity is a common area of discussion among dealmakers at his chapter’s events. “The fundraising market has been challenging, I think everybody would agree on that,” he says.

In May, Toronto-based asset manager Onex announced plans to halt fundraising for its mid-market-focused private equity fund and restructure to cut costs, citing market conditions that make for “lengthy and time-consuming fundraising processes for many private equity funds.”

Fenton echoes the lack of speed in fundraising that has hampered deal pipelines for many private equity investors in Canada. Yet he says investors remain optimistic that conditions will improve as the year progresses. “Things aren’t happening quickly, but there is still business to be done,” he says. “It’s just taking longer.”

Rising interest rates have added to PE firms’ challenges as financing grows more expensive. But Daniel Lee, vice president at Toronto-based industrials manufacturing conglomerate Canerector, says that while both Canada and the U.S. are experiencing this credit squeeze, Canada’s banking sector doesn’t have the same risk exposures as its U.S. counterpart.

Compared to the 4,000 financial institutions operating in the U.S., Canada’s banking sector has about 80 players, and six of them account for about 80% of total bank assets. “They’re very well regulated and well capitalized,” notes Lee, adding that Canadian borrowers have been far less impacted by the U.S.’s regional banking volatility following the collapse of Silicon Valley Bank. 

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Confidence in Commodities

I definitely see a higher interest rate market working toward a strategic acquirer’s advantage

Daniel Lee

Canerector

While perhaps more readily available in Canada, credit remains expensive. Lee says this has played favorably for Canadian strategics like Canerector. “I definitely see a higher interest rate market working toward a strategic acquirer’s advantage,” he says.

Amid market volatility, the metals sector has been particularly active for M&A. Canerector, which currently holds more than 50 companies in its portfolio, recently announced that portfolio company Conrex Steel acquired manufacturer Prescor. In March, Federal Steel Supply was sold by lower middle-market private equity firm V&A Capital to Canadian private management company Westbridge Capital. The following month, PE firm MiddleGround Capital portfolio company Megatech, headquartered in Quebec, acquired Advantage Metal Products.

Commodities in general are a bright spot for dealmakers in the country, notes Lee. “Canada is primarily going to always be a resource-based country, whether it be energy, agriculture, forestry, pulp and paper,” he says.

PwC Canada’s report also points to the strength of financial services, as well as energy, utilities and mining, as sectors propping up dealmaking activity in the country. 

First Nations Step Into M&A

In addition to sector-specific opportunities, Canada’s M&A community is also growing as Indigenous investors step onto the scene.

One of them is Fort McKay, a First Nation of about 900 people of Dene, Cree and Métis descent. (First Nations are the Canadian equivalent to Native American tribes in the U.S.) Over the past several decades, Fort McKay has worked to become economically self-sufficient, funding its estimated CAD$50 million annual budget from the businesses it owns.

After initially focusing on investing in oil services companies via its holding company Fort McKay Landing LP, around 2018 Fort McKay launched a private equity fund in an effort to diversify.

The First Nation’s financial strategy represents what Fort McKay Landing Vice President Monika Wilson describes as an emerging opportunity among private equity dealmakers in Canada to acquire Indigenous businesses and partner with Indigenous investors.

There are more than 50,000 Indigenous-owned companies in Canada today, a market she says is growing yet underserved. “These are business owners who need to think about growth capital, about acquisitions, mergers—maybe they’ll go public one day. They need to think about exiting,” says Wilson. “PE firms, investment banks and advisory firms are uniquely positioned to offer these Indigenous businesses their services.”

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Indigenous investors are also expected to play a more prominent role in driving M&A across Canada in the coming years. For instance, Longhouse Capital Partners, a Vancouver-based alternative asset manager formed by a group of Indigenous business professionals, launched earlier this year with plans to raise CAD$1 billion for its flagship fund. The firm will invest in Indigenous businesses and infrastructure projects, private equity markets, private debt and real estate.

Indigenous-owned private equity firms, meanwhile, remain rare, but Wilson says that will change. “We suspect that we’ll begin to see many other Indigenous communities begin to enter the PE and venture capital industries, both as professionals and as fund managers,” she says.

We suspect that we’ll begin to see many other Indigenous communities begin to enter the PE and venture capital industries, both as professionals and as fund managers.

Monika Wilson

Fort McKay Landing

Over the Border 

With a variety of factors converging to strengthen Canada’s M&A ecosystem, ACG Toronto’s Fenton says the market is attractive to investors beyond national borders. He says he’s seen more U.S. participants in ACG Toronto chapter events, suggesting that after pandemic-era travel bans and amid a tight M&A market at home, U.S. dealmakers may be broadening their deal sourcing scope to Canada.

“Particularly for American companies that are looking for new deals or wondering about the Canadian market, it’s probably still a good opportunity for them, given that valuations usually aren’t quite as high here,” Fenton says, adding that 20% of attendees at ACG Toronto’s annual Capital Connection event typically come from the U.S.

Fenton says the strong performance of ACG events in Canada so far this year could signal growing optimism among the country’s dealmakers at home, too. “There’s definitely strong interest from private equity and investment bankers to get back and look at deal flow in Canada,” he notes.

Plenty of uncertainty remains for the nation’s middle-market M&A landscape as commodity prices fluctuate, interest rates rise and overall economic volatility persists. Yet as Canerector’s Lee notes, dealmakers’ optimism persists.

“Now the market just seems to be moving forward,” he says. “Right or wrong, there are pretty strong expectations right now.”

Carolyn Vallejo is Middle Market Growth’s digital editor.

Middle Market Growth is produced by the Association for Corporate Growth. To learn more about the organization and how to become a member, visit www.acg.org.