Market Insight – Q4 2015 FX Impact on Cross-Border M&A

Loonie losing ground against the Greenback

In October 2015, the Canadian dollar (CAD) was hovering near an 11-year low against the USD driven in part by the decline in price of oil and other resources, and by the worsening economic outlook. Further headwinds for the CAD on the US interest rate front: on the strength of the recent jobs data out of the US, over 70% of traders now believe the Fed will raise interest rates during its December 2015 meeting, which is up from 37% in October, according to a recent Bloomberg survey.

In this issue of FirePower’s Market Insights, we investigate the impact of the CAD/USD exchange rate (FX) on cross-border M&A, especially in light of the growing importance of FX adjustments as part of an acquirer’s due diligence.

Impact of FX on operating profitability and an acquirer’s due diligence

A change in FX can materially affect a company’s financial performance depending on the level of currency exposure. For example, a Canadian business that sells to US clients and has costs in CAD would have seen profitability increase over the past year as the USD gained strength relative to the CAD. However, it goes both ways: the opposite is true for a Canadian company that sells to Canadian customers but has some level of costs and expenses in USD.

When US buyers evaluate Canadian acquisition targets (which they are doing at an accelerating pace – see below), changing FX adds another layer of complexity to the already challenging task of due diligence. Some of their investigation will focus on understanding what drove movements in financial performance in recent years. With FX moving that much, the question then becomes, were moves in profitability caused by fundamental changes to operations, merely by FX rate differences or a combination of both?

It follows that companies with robust financial reporting and management systems that are able to isolate and report on the impact of FX will be significantly more attractive to buyers. We have strong evidence of this in our recent deals, and PwC corroborates our view in a recent report.

Moving forward, most sellers and buyers acknowledge a ~0.75 CAD/USD rate is a new normal, which should simplify FX-focused due diligence efforts in the coming years. For parties looking to transact in the near-term, though now more than ever, FX is a critical component of due diligence.

What should owners of private companies with material FX exposure, who are looking to maximize the value of their business in an M&A process, do? We recommend two changes:

  1. Get your accountants to add a note relating to FX in your annual financial statements which shows how your sales, COGS and fixed expenses were impacted by FX. In other words, have them provide more clarity into the single FX adjustment they typically make at the bottom of the Income Statement. This is not a standard request so anticipate some push-back from your accountants.
  2. Improve your internal reporting and systems such that the monthly or quarterly financial reports you produce are insightful with respect to FX exposure.

US acquirers looking north of the border

From a transactional perspective, financial and strategic buyers that use USD to make acquisitions have seen Canadian companies become significantly less expensive compared to pre-2014. This is solely due to the CAD’s decline as valuation multiples have not changed appreciably. It has resulted in more US-based buyers looking north of the border for acquisition opportunities; this theme was prominent during the November 2015 ACG Capital Connection conference held in Toronto. We estimate that, of all the private equity attendees, 50%-60% were US-based firms looking for Canadian targets.

While there are other factors at play, it is likely FX has had an impact and explains some of this infatuation for Canadian targets by US firms.

As we expect US buyers to continue scouring Canada for M&A opportunities, the accuracy and management of FX reporting has become and will continue to be a key factor during due diligence. In turn, for those sellers who do it well, it will be a significant driver of enterprise value.

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