Value Unleashed

Market Update

Last week, the S&P 500 moved into positive territory for the first time this year, while the small cap index (the Russell 2000) continued to lag, down about 3% year to date.  Also on a year-to-date basis, the TSX composite is now up almost 4% year to date and almost 11% on a U.S. dollar basis.  Despite this recent strength, the Canadian equity benchmark is still well off its levels from this time last year and far below its all-time high, particularly on a U.S. dollar basis.

Valuation multiples remain at or near 10-year highs, except for the small cap market, which unlike the large cap indices, is lower than the levels seen a year ago.

The Federal Reserve’s decision to slow its monetary tightening helped propel the equity markets for the fifth consecutive week. The U.S. dollar declined against the basket of major currencies as energy and commodity prices increased. The oil benchmark (WTI) stabilized around US$38-41 per barrel, but concerns remain as U.S. producers increase production. These factors drove the Canadian dollar up 1.2 cents last week against the U.S. dollar.  Leverage levels for middle market loans remain historically high, but the prices for the credit risk are now above levels seen over the past year.

Historical Private Equity Fund Performance and the Outlook for M&A Activity

A healthy private equity market is essential to a strong M&A market.  This has become more so as private equity has grown as an asset class and has taken ever larger shares of overall M&A activity.  Trends in private equity’s performance as an asset class have important implications for the M&A market. 

The PitchBook chart below shows private equity internal rate of return (IRR) by fund vintage year.  Clearly, it has become much more difficult for private equity fund managers to earn out-sized returns.

There have been four distinct phases in the private equity market over this period:

1.    Increasing Capital Allocation to Private Equity:  As the high returns seen by this asset class attracted billions of dollars in new private equity capital, there was a dramatic increase in private equity investment activity.  This was further fueled by a dramatic expansion of credit available for buyouts.  Together, these drove M&A valuations up.  As a result, it became increasingly difficult to generate extraordinary returns.  The median return for a 2001 vintage fund was over 20%, by 2006, this had fallen to about 8%.

2.    The Great Recession – Buy High, Sell Low: For those funds formed between 2005 and 2008, there was a perfect storm of high competition for new investments (and high entry valuations) and the Great Recession of 2008-09 impacting their holdings and their exit valuations.  As a result, many platform companies’ performance was severely impacted, while the exit window closed through much of 2009.  This resulted in longer holds, depressed exit valuations, or both.

3.    The Great Recession – Buy Low, Sell High: For those few funds fortunate enough to have dry powder at the depth of the recession, there were some excellent bargains and some great businesses available at distressed valuations.  Most of the investments made during this time (including those made in the public equity markets) have performed very well by participating in both a cyclical upturn and more liquidity in the system to underpin high exit valuations.  As a result, 2009 vintage funds had the best performance seen since the 2003 vintage funds.

4.    The New Normal: Since the recession, the private equity market is characterized by the following:

a.       Unprecedented Capital Overhang – There is currently more than US$500 billion of private equity capital in North America that is available for investment.

b.       Accommodative Credit Markets – While credit markets have moderated in the latter part of 2015, the market for mid-market credits remains very robust by historical standards.

c.       Ever-Increasing Competition – In addition to the growth in the dollars allocated to private equity, there has been a rapid expansion in the number of private equity funds, particularly in the mid-market.  This has made it increasingly difficult to compete for platform investments.

d.       Record M&A Valuations – As a result of the unprecedented buyout capital in the system (about US$1.5 TRILLION, when both equity and debt are considered), sustained quantitative easing and slow but steady economic growth driving growth through acquisitions, M&A valuations are likely to remain high.

e.       Slower Deployment – These factors in combination make it very difficult to deploy private equity capital, particularly at reasonable valuations.  This slower deployment will drag fund IRR performance down.

Median returns are settling in somewhere between 10% and 12%.  As time goes on, there will be many winners and losers.  Those funds that have been kept on the sidelines by high valuations in recent years are now unable to participate in the record valuations seen through 2015.  Soon they will be required to return their un-deployed capital to their investors.  Many funds with weak performance will be wound down and the stronger performers will develop sustainable competitive advantages in attracting capital and in developing deep domain expertise.  Those more successful funds will be able to deploy capital in ever-more specialized strategies, further driving their IRR performance.

For business owners considering their exit and liquidity options, the markets have never been more receptive than they have been over the last couple of years and we expect this to continue.  This market is being driven by unprecedented liquidity and structural factors that are unlikely to change and in any case, not quickly.

Weekly Canadian Private Market M&A Report

Announced Deals

Birch Communications confirms buy of PE-backed Primus Canada

Birch Communications Inc. has confirmed a previously announced agreement to acquire select assets and customers of Primus Telecommunications Canada Inc., a full-service telecommunications services provider. No financial terms were released. The deal will help the Atlanta, GA-based Birch expand its services footprint to include all of the major cities in Canada. Vincent Oddo, President and CEO at Birch said, “… With the addition of the Primus assets, Birch expects that a significant portion of its revenue in 2016 will come from its fast-growing fiber and managed services segments.”

Australia’s Asciano bows to $6.8 billion break-up bid

Australia’s Asciano Ltd. (AIO.AX) on Tuesday agreed to a A$9.1 billion (US$6.8 billion) buyout by two global consortia after a seven-month bidding war for the port and rail giant, although doubts persist over anti-trust and foreign ownership issues. Australia’s largest ports and rail operator said it now supported a joint bid from local rival Qube Holdings Ltd. (QUB.AX), Canada’s Brookfield Asset Management (BAMa.TO) and a host of backers from China to Qatar. The deal would cement Sydney-based Qube’s position as Australia’s biggest stand-alone ports company.

PE-backed VersaCold to acquire Coastal Pacific Xpress

VersaCold Logistic Services has agreed to acquire Coastal Pacific Xpress, a British Columbia based refrigerated carrier specializing in the shipping of perishable and ambient products across North America. No financial terms were disclosed. Douglas Harrison, President  & CEO of VersaCold said, “This exciting acquisition is a major step towards reaching our goal of being Canada’s premiere, fully integrated, total supply chain solutions provider. Through partnerships with exceptional companies like CPX, we live our vision of being our customer’s most trusted and reliable long-term partner by providing new and innovative solutions and services that provide stability and peace of mind, allowing them to focus on what matters most – the satisfaction, health and wellness of their valued consumers.”

VC-backed Solegear to acquire Ex-Tech’s bioplastics division

Solegear Bioplastic Technologies Inc. (TSX-V: SGB) has agreed to acquire the bioplastics division of Ex-Tech Plastics Inc. for $1.33 million in common shares of the company at a price of $0.20 per share. Vancouver-based Solegear, a developer of bioplastics from renewable plant-based sources, said the deal will provide it with annualized revenues of about US$2 million and accelerate product commercialization.

Closed Deals

Alaris-backed LMS Reinforcing Steel acquires Johasee Rebar Inc.

LMS Reinforcing Steel Group, a portfolio company of Alaris Royalty Corp., has acquired Johasee Rebar Inc. for an undisclosed sum. Based in Bakersfield, California, Johasee is a provider of rebar fabrication and installation for industrial, commercial and residential projects. LMS commented on this deal, “With the addition of another fabrication yard to our operations and local, experienced installation crew, LMS is positioned to service residential and commercial clients’ needs for rebar and post tensioning fabrication and placing needs for projects in southern California.”

Birch Hill’s Terrapure acquires Consolidated Giroux Environment Inc.

Terrapure Environmental, an Ontario based environmental services and recycling solutions specialist has acquired Consolidated Giroux Environment Inc., an industrial dredging services company based in Charlo, New Brunswick. No financial terms were disclosed. Todd Smith, Vice President, Environmental Solutions – Onsite at Terrapure commented on the deal, “This acquisition significantly bolsters our capacity to provide onsite dredging services to customers in our key target industry sectors across Canada. By gaining access to Giroux’s customer base, particularly in the mining sector, we can also expand the suite of services we offer these companies to assist them with a broad range of environmental challenges, including dewatering and recovering metals and other resources from their waste streams.”

Tandem and CDPQ back Averna’s acquisition of T&M Solutions

Averna has acquired Belgium’s Test & Measurement Solutions Group (T&M Solutions), a provider of technology solutions for the quality control of diverse products and production processes. No financial terms were released. André Gareau, Averna’s President and CEO and François Rainville, Vice-President of Sales & Marketing for Averna commented on the deal, “This major expansion into Europe signals Averna’s strategic positioning to accelerate growth and become a truly global Test Engineering powerhouse. We are proud to welcome T&M Solutions’ customers and employees while providing all our customers with additional expertise and increased worldwide presence. We’re building a strong track record of successful acquisitions and are motivated by our robust pipeline of opportunities in Europe and around the world.”