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Canadian M&A Market Recap: Week Ended Aug 26, 2016

  • Posted By: Louis Goldberg, Miranda Li, Michael Mazza and Paris Aden

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Market Update

Major markets were down over the week as investors eagerly await the U.S. Fed’s decision on increasing interest rates. Crude oil prices fell this week as volatility remains rampant due to rising rig counts and general macroeconomic uncertainty.

While the TSX has performed reasonably well over the course of the year, Alberta’s economy has continued to struggle. Their government’s deficit has reached nearly $10.9 billion, and private sector investment is expected to fall by 16% this year compared to the year prior. Alberta is headed towards the deepest two-year contraction since it began recording such economic data.

Valitas Insights: Canadian Private Business Landscape – Economies of Scale

The Valitas Canadian Private Business Landscape series is focused on presenting a concise summary of the Canadian business landscape. We focus primarily on the top 25 industries in Canada based on the number of companies with EBITDA greater than $3 million. This series presents various metrics, fragmentation analyses, economies of scale insights, and a discussion of which industries are the best candidates for ongoing consolidation.

In this third installment of the series, our team has conducted further analysis to determine those industries for which economies of scale are most important.  Determining where economies of scale are prevalent is a key factor in determining consolidation potential for a given industry.

Valitas has developed an economies of scale score based on the extent to which operating leverage exists in a given industry.  When there is significant operating leverage, there are greater benefits to size and hence an impetus for consolidation.  When fixed expenses are high, the profit margin on incremental revenue is much higher than a company’s overall profit margin.  For example, the income statement for a company in an industry where there is significant operating leverage would look something like this:


In this example, the company’s operating (EBIT) margin is 10%.  Because the margin on an incremental dollar of revenue is 50%, the addition of 20% more revenue doubles EBIT and increases the operating margin by almost 70%.  In many industries, such as application software, media or the telecom and cable industries, the margin on an incremental dollar of revenue can be close to 100%, as the incremental cost of adding a subscriber would be the incremental billing and customer support costs.  The cable industry consolidation of the 1970’s and 1980’s was driven by this principle.

The converse is also true.  In the 1990’s, there was a company called Pallet Pallet Inc. that executed a strategy to consolidate the fragmented wooden pallet industry.  Because of the clear lack of economies of scale in the manufacture and distribution of wooden pallets, the strategy destroyed shareholder value, as illustrated in the price chart below from the company’s last published proxy circular.

In developing a simple and objective measure of operating leverage, we chose the fixed expense ratio (where gross profit minus EBIT equals fixed expenses, which is then divided by revenue).  The higher the fixed expense ratio, the greater the operating leverage and hence importance of economies of scale.

For each industry, we studied all exchange-listed, revenue-generating North American companies.  We discarded industries, such as motorcycle manufacturing, where there were fewer than 10 companies in our sample. A normalized score from 0 to 1 was calculated, with 1 representing the greatest economies of scale, and 0 representing the absence of economies of scale.

Of 25 largest industries in Canada, only two are in the top 10 for economies of scale. These industries are Oil and Gas Exploration and Production, and Diversified Metals and Mining. It is no surprise that companies in these capital intensive industries benefit from economies of scale. However, it is interesting to note the sheer number of private and public companies in these industries at 697 and 572, respectively.  For these reasons, it is not surprising that for decades the majority of M&A activity in Canada has been in the resource extraction industries.  All indications are that this cycle “creative destruction” will continue in these industries for the foreseeable future.

Conversely, several of Canada’s 25 largest industries show up in our bottom 10 list for economies of scale. These industries include Automotive Retail, Construction and Engineering and Oil and Gas Refining and Marketing (which is primarily gas station operators). Given the thin margins on incremental revenues for these industries, and low capital intensity, it is no surprise that these industries remain highly fragmented. In these industries smaller, leaner companies focused on their local markets outperform larger, more centralized companies. 

When we revisit the top 25 list of Canadian industries by number of companies, there are a number of highly fragmented industries in Canada where scale matters.  However, several scale-driven industries in Canada (Tobacco, Home Entertainment Software and Precious Metals and Minerals) are already highly concentrated.  The fixed expense ratios for the 39 industries mentioned above are summarized below.  This is a subset of the 116 industries studied.

With both fragmentation and economies of scale measures, we have more comprehensive tools to assess consolidation potential in Canada.  In the coming weeks, we will look at economies of scale and fragmentation together. This will provide an overall consolidation score, indicating which industries are the best targets for consolidation in Canada. We will then dig deeper into a select few industries and present relevant metrics for comparison purposes.

Stay tuned.

Weekly Canadian Private Market M&A Report

Announced Deals

BRS Ventures to Acquire Minera Terra Plata

BRS Ventures Limited (TSXV:BRV), a Canadian capital pooling company, has agreed to acquire Minera Terra Plata, S.A. De C.V, a Mexican company that provides silver exploration services. The transaction value is estimated to be $2 million.

Captiva Verde Industries to Acquire TGO Organics

Captiva Verde Industries Limited (CNSX:VEG), a Cross River Capital Management backed Canadian company that engages in commercial organic farming operations in the United States, has agreed to acquire TGO Organics Limited, a Canadian organic food brokerage firm. The total transaction value is estimated to be $0.4 million.

Fantasy 6 Sports to Acquire FansUnite Media

Fantasy 6 Sports Incorporated, a Victory Square Labs backed Canadian business that operates as a sports, entertainment, and technology company worldwide, has agreed to acquire FansUnite Media, Inc., a Boomtown Accelerator backed Canadian company that operates sports prediction platforms. The transaction value is estimated to be $2 million.

Shandong Heavy Industry to Acquire Weichai Westport

Shandong Heavy Industry Group Co., Limited, a Chinese designer and manufacturer of engines for construction machinery and agricultural machinery in China, has agreed to acquire Weichai Westport Inc., a former subsidiary of Westport Fuel Systems Inc. (TSX:WPT), that offers research and development, manufacturing, and marketing of gas engines and parts used in motor vehicles, power generation, and marine vessels. The transaction value is estimated to be $9 million.

BGC Partners to Acquire Perimeter Markets

BGC Partners, Inc. (NasdaqGS:BGCP), a U.S. brokerage company servicing the financial and real estate markets worldwide, has agreed to acquire Perimeter Markets Incorporated, a Canadian company that develops and operates institutional and retail alternative marketplaces to provide electronic fixed income trading services. No transaction terms were released.

Ontario Teachers' Pension Plan to Acquire Nextgen Group Holdings

Ontario Teachers' Pension Plan, a Canadian pension fund, has agreed to acquire Nextgen Group Holdings Pty Limited, a former subsidiary of CIMIC Group Limited (ASX:CIM), that provides network connectivity, data centre facilities, and cloud services to Australian businesses, government agencies, and telecommunications service providers. The transaction value is estimated to be $207 million.

Closed Deals

Dowco Group Acquires Acuna & Asociados

Dowco Group of Companies, a Canadian company that offers steel detailing, pre-construction, and building information modeling services, has acquired Acuna & Asociados S.A., a Chilean subsidiary of Dowco Group of Companies. No transaction terms were released.

Scribble Technologies Acquires Linkdex

Scribble Technologies Incorporated, a Summerhill Venture, XDL Intervest Capital, Difference Capital Financial, XDL Capital Group, Georgian Partners, Northleaf Capital, Rogers Ventures Partners, Emerillon Capital, Blue Cloud Ventures and The OpenText Enterprise Apps Fund backed business that develops and provides content marketing and live publishing SaaS platform that helps businesses grow and expand the top of the marketing funnel using big data, has acquired Linkdex Limited, a 500 Startups backed U.K business that provides online search engine optimization (SEO) platform for agencies and in-house marketing teams. No transaction terms were released.

Constellation HomeBuilder Systems Acquires Woodland, O'Brien & Scott

Constellation HomeBuilder Systems, Incorporated, a Canadian company that provides homebuilding software and website solutions in North America, has acquired Woodland, O'Brien & Scott, Incorporated, a research and management consulting company that provides services for homebuilding companies and developers in the United States and internationally. No transaction terms were released.

Safway Group Canada Acquires Dalco

Safway Group Canada Incorporated, a company that offers experience and expertise in access, scaffolding, insulation, fireproofing, surface preparation and coatings, has acquired Dalco, a Western Canada-focused full service lining, coating and abrasive blasting solutions provider. No transaction terms were released.

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