This week’s rerun comes from April 2007. Foreign buyers were on the hunt for Canadian assets, which was stirring emotions and politics at home. Tom weighed in with some unique perspective on the issue. With Potash Corp. now in play, it’s timely to revisit the topic.

The Flip-side of the Foreign Takeover Binge
Originally published in The Globe and Mail on April 20, 2007
By Tom Bradley

Like everyone else, I don’t like seeing corporate Canada get gutted by foreign buyers. I’ve thought for years that we were getting hollowed out, even if study after study claimed otherwise. I say that because I had a front row seat through the 90’s as a pension fund manager at Phillips, Hager & North. Instead of meeting with pension committees in a Canadian city, my partners and I increasingly found ourselves servicing the same Canadian plans in places such as Dallas, New York, Connecticut and New Jersey. The parent companies had taken as many white-collar jobs out of Canada as they could and that included the pension department.

But as we beat ourselves and the Finance minister up about our northern passivity and lack of guts, I think there is a need for some perspective on the foreign takeovers. To date, the commentary has been very emotional and increasingly political.

So, under the heading of perspective, I add three comments to the dialogue.

First, there is an underlying assumption in all the commentary that the foreigners are making wise purchases. Perhaps Canada is grossly undervalued and guys like me are missing it, but there’s plenty of evidence that paying premiums to buy public companies at the end of a business cycle (or somewhere near the end) usually turns out badly. How much value was there in Inco, Dofasco or Four Seasons at the takeout price? Did that price represent an outstanding opportunity to generate an above-average return? Only time will tell.

Right now the hyper-aggressive acquirers and empire builders are the heroes. That’s typical of every cycle. But I think it’s far too early to make that judgment. Certainly as the cycle goes on, the buyers from 2006 or before are looking better and better, but a few tough years might change the jury’s mind. By 2008, shareholders in the acquiring companies may want to reclaim some of the bonuses that were paid to executives in 2005-2007.

As for private equity, we don’t know how well these funds are going to do this cycle. Buying public companies at a premium has played a much bigger role in their strategy. We may find that their returns aren’t so great this time around because of it.

Second, throughout my business career I’ve found that the foreign buyer, in any industry, has been predictably fickle. In the business I’m most familiar with, investments, foreign firms are well known for jumping on and off the bandwagon with great regularity. When the world wants what Canada has to sell, every self respecting brokerage firm must have a top-tier investment banking and M&A operation in the snowy north. When Canada moves back into the ‘forgotten’ category, hidden in the shadow of the U.S., foreigners are quick to downsize or completely pull out. Industry veterans know that Merrill Lynch is famous for buying into the market when things are hot and then bailing out when the executives at the mothership need to refocus or cut costs. They’ve had lots of company.

There was a period in the energy business when the big multinationals were only too happy to offload their Canadian subsidiaries. There were a number of terrific companies that came out of that purging. A sale by Occidental created what is now Nexen, while BP’s sale became Talisman and Sun Oil’s is now Suncor.

Which brings me to my third point. If my first two comments have a speck of truth to them, Canadians will have a great opportunity to buy back many of these assets at reduced prices a few years from now.

I accept the fact that many of the acquired companies are gone for good. Some of the foreign buyers operate like Warren Buffet or Ontario Teachers, meaning they buy companies to hold them. That is so they can benefit from a continuing, and perhaps growing, flow of cash.

The companies bought by “strategic, in-industry” buyers are also less likely to come back to us. But there will still be lots of situations where the new owner will change its mind and deem Canada to be ‘non-strategic’ a few years from now. Those companies will likely come back on the market.

And private equity funds have a much shorter fuse. Eventually they have to liquefy their hard assets so they can return capital to their investors. For every headline we see today about a private equity purchase, there will be an offsetting headline in two to seven years announcing the sale of the same asset. There will be a flip-side to the huge buildup of capital at the private equity firms that’s influencing our market so significantly today.

With every announcement of another Canadian firm being bought, a little of me gets hollowed out. The industries that were solidly Canadian ten years ago now have little or no Canadian ownership today. Steel is in the news right now, but think about beer, hotels, technology and forest products.

We’re not going back to where we were before, but we should be aware that the dialogue about this topic right now is pretty one-sided and focused on the short term. Hopefully, our big pension funds and opportunity-starved equity managers will be ready and waiting to buy back the Canadian assets when they find their way back across the border.