Overview of M&A Activity in December 2004
The aggregate disclosed value of announced M&A transactions involving Canadian companies in the first nine months of 2004 was C$86.5 billion, up 38% from C$62.7 billion for the first nine months of 2003. Included in this total is C$44.0 billion of acquisitions or sales of foreign companies by Canadian companies (as compared to C$36.5 billion of such acquisitions or sales of foreign companies in the corresponding period of 2003). The aggregate disclosed value of acquisitions of Canadian targets announced in the first nine months of 2004 was C$42.5 billion, a 62% increase over the C$26.2 billion disclosed value of such transactions announced in the first nine months of 2003. Of 473 transactions in the first nine months of 2004 for which the deal value was publicly disclosed, 134 transactions were valued at over C$100 million, and 19 of those were valued at over C$1 billion. By comparison, in the same period in 2003, 94 of the 428 transactions for which the deal value was publicly disclosed were valued at over C$100 million, and nine of those were valued at over C$1 billion. (Source: Mergers & Acquisitions in Canada , published by investment banking firm Crosbie & Co. Inc.)
The oil and gas and utilities sectors have led the pack in 2004 in terms of value of announced transactions. Significant oil and gas transactions have included EnCana Corp.'s C$3.6 billion acquisition of Tom Brown, Inc., Petro-Canada's estimated C$1.2 billion acquisition of Intrepid Energy North Sea Ltd. and the C$1.1 billion acquisition by Acclaim Energy Trust and Enerplus Resources Fund of certain oil and gas assets of ChevronTexaco Corp. Notable transactions in the utilities sector have included TransCanada Corp.'s C$2.3 billion purchase of Gas Transmission Northwest Corp. and the C$1.7 billion acquisition of Allstream Inc. by Manitoba Telecom Services Inc.
Although proxy contests are relatively rare in Canada, the past 12 months have seen two such contests and the announcement of an intent to proceed with a third. In the case of Leitch Technology Corp., a dissident group led by two former officers was defeated in its attempt to appoint a new slate of directors following the adjournment of the annual shareholders' meeting and the appointment of a new CEO. A dissident group was successful in establishing its slate at the annual meeting of Dimethaid Research Inc. in September 2004. Less than one month later, following the pattern of contesting the board in the wake of disappointing stock market performance, holders of approximately 6% of the shares of Creo Inc. advised the company that they were seeking to replace the board of directors and CEO through a proxy contest unless the individuals resigned.
Two of the most-watched transactions announced in 2004 were the proposed merger of Molson Inc. and Adolph Coors Co., and the unsuccessful proposed merger of IAMGold Corp. and Wheaton River Materials Ltd. Both of these transactions are discussed below.
The merger of Molson Inc. and Adolph Coors Co., both of which were controlled by descendants of their respective founders, was announced on July 19, 2004, with the objective of creating the world's fifth-largest brewer. By the time of filing of the parties' joint proxy statement with the SEC on September 17, 2004, concerns had been raised that the interests of the nonvoting shareholders of Molson would not be fully served by those members of the Molson family who control a majority of the voting shares of Molson. In addition, there was speculation that Ian Molson, a former director of Molson, was pursuing a possible alternative transaction. In this context, a number of Canadian institutional investors expressed concerns with respect to certain terms of the transaction disclosed in the proxy statement, reflecting an increasing willingness of institutional investors to exert their influence in M&A transactions.
The institutions had two principal objections. The first was the treatment of Molson optionholders. Under the terms of the merger, the vesting of options was to be accelerated, performance-based vesting conditions were to be waived, and optionholders were to be entitled to vote with shareholders on an "as if exercised" basis. The extension of voting rights to Molson optionholders was considered particularly contentious given the prospect that the shareholder vote might be close and that optionholders, most of which were members of Molson management, would be expected to vote in favour of the merger. The second concern of the institutions related to payments to be made to the Molson CEO and another senior Molson executive upon completion of the merger in an amount equal to their severance entitlement (being three years' salary in the case of the CEO) despite the fact that these individuals were slated to continue to hold senior positions in the merged company.
The transaction was structured as a plan of arrangement under the Canada Business Corporations Act (the "CBCA"). While voting rights have been extended to optionholders in M&A transactions completed by way of plan of arrangement, it is not typical that plans of arrangement provide such voting rights. Under the CBCA, it is necessary to obtain a court order approving the arrangement following a hearing to consider the procedural and substantive fairness of the transaction. While the CBCA establishes the court's jurisdiction to permit optionholders to attend and vote at a meeting as it thinks fit, no conclusive view respecting the treatment of optionholders has emerged. Although guidance published by the Director under the CBCA respecting the voting entitlement of securityholders under plans of arrangement does not specifically address voting rights of optionholders, the Director's interpretation of "securityholder" relies on the CBCA definition of "security," which does not include options or other rights to acquire shares.
Against this backdrop, Molson's board determined, following meetings with the concerned institutional shareholders, the CBCA director and Coors, to amend its securityholder approval process such that optionholders would not vote on the merits of the merger and as a result would not affect whether or not it proceeded. Instead, optionholders would vote as a separate class on whether to exchange their Molson options for options of the merged company, thereby addressing the issue that the arrangement would modify the rights of optionholders. Molson also announced that the change of control payments to be made to Molson's executives would not be made, while preserving each executive's severance entitlement in the event of termination. In addition, Molson announced that the options, as well as restricted share units to be issued to the Molson CEO on the exchange of his existing Molson options and restricted share units, would be subject to similar performance-based vesting conditions as in effect under his existing arrangements.
The Molson family and the Coors family contemplated entering into voting trust and other arrangements in connection with the merger. As these arrangements would constitute a collateral benefit to the Molson family under the recently amended Ontario Securities Commission Rule 61-501, that rule would require the merger to be approved by a majority of the Molson voting shares, excluding the shares held by the Molson family. As this requirement would result in holders of less than 5% of the Molson voting shares having the ability to potentially veto the merger, the OSC agreed to issue a ruling providing exemption from this minority vote requirement.
Based on the Molson-Coors experience, it is likely that parties to M&A transactions proceeding by plan of arrangement will carefully consider the question of extending voting rights to optionholders on a basis that would affect the rights of shareholders to determine whether or not the transaction will proceed. The transaction highlights the need for issuers to establish provisions in their option plans that clearly address optionholder rights and their voting entitlement in the context of an M&A transaction. To the extent that merging parties determine that an optionholder vote is not required, the merits of obtaining a fairness opinion that addresses the terms on which optionholders participate in the transaction in order to assist in establishing the fairness of the transaction should be considered.
Income Fund Activity Continues
The first nine months of 2004 have witnessed continued significant activity in the Canadian capital markets in initial public offerings by income funds. This IPO activity is relevant in the M&A context, because in an income fund IPO the proceeds of the offering are generally used to acquire an operating business or income-producing assets from a vendor, who is usually also the promoter of the income fund. The continued popularity of income fund IPOs in 2004 indicates that, for many business owners, the sale of the business through an income fund offering continues to represent an attractive exit alternative as compared to a more conventional sale to a strategic or financial buyer. It is an approach being taken by a variety of vendors, including private equity funds (such as KKR in the C$1 billion initial public offering of Yellow Pages Income Fund), merchant banks and owner-managers, as well as public companies that have sold divisions or discrete income-producing operations to income funds.
Broadly speaking, an income fund is a trust that is listed on the Toronto Stock Exchange (and in some cases the New York Stock Exchange) and indirectly owns an operating business or other income-producing assets. The cash generated by the business or assets is distributed on a regular periodic basis (typically monthly) to the income fund which, in turn, distributes the cash to holders of the income fund's units. As income funds are designed to offer their unitholders a stable, long-term source of cash distributions rather than prospects for significant capital gains, a typical candidate for sale through an income fund offering is a business that has stable, sustainable cash flows and predictable ongoing capital expenditure requirements.
Although a number of cross-border income trusts were established in 2002 and 2003 to hold U.S.-based businesses, a significant development in 2004 in the income fund area has been the sale of U.S. businesses through initial public offerings of "income securities" of corporate issuers that are, in essence, corporate income funds. These income security structures are generally seen as being superior to many cross-border income trust structures from a U.S. tax perspective and have been used to sell, through IPOs in the United States and Canada, U.S. businesses that might formerly have been sold through a conventional income trust offering.
Referred to variously as income deposit securities ("IDSs"), enhanced income securities ("EISs") and income participating securities ("IPSs"), the securities offered by these corporate income funds are essentially "clipped" units consisting of subordinated notes and common shares. Like a conventional income trust, the corporation that issues the units pays regular distributions to its securityholders, in the form of interest on the subordinated notes and dividends on the common shares. The notes and common shares are considered to be "clipped," because they are initially issued together as a unit but may be subsequently separated at the option of the holder into their underlying components.
Although registration statements for over 15 IDS and EIS IPOs have been filed with the SEC, only two of these offerings have been completed to date, and significant delays have been experienced with SEC review. While a number of these U.S. offerings are also being made concurrently to the public in Canada, there have also been two completed IPS offerings, made publicly only in Canada, by Canadian companies established to acquire U.S. businesses. In March 2004, Medical Facilities Corp. completed the first Canadian-only IPO of income participating securities by a Canadian corporation established to acquire a U.S.-based business, and a second such IPO was recently completed by Atlantic Power Corp., a Canadian corporation established to acquire and hold interests in 15 power-generation projects located primarily in the United States.
Pension Surplus Obligations
In July 2004, the Supreme Court of Canada ruled in the case of Monsanto Canada Inc. v. Ontario (Superintendent of Financial Services) that Ontario pension legislation requires the distribution of a proportional share of actuarial surplus from a defined benefit pension plan at the time of a partial wind-up of the plan. The Court did not decide who owns the surplus, but merely that it must be distributed.
The Monsanto decision has far-reaching implications to the acquisition of companies that sponsor defined benefit pension plans, due in part to the potential for it to be applied retroactively. Given that Ontario pension legislation has contained wording similar to the provision at issue in Monsanto since 1969, and that there is no limitation period that restricts the ability of the pension regulator to order a partial wind-up retroactively, it is possible that partial wind-ups that require a distribution of surplus could be ordered in respect of events (such as plant closures or downsizings) that occurred as far back as 1969. The Monsanto decision could conceivably affect most pension plans in Canada that currently or have ever contained surplus assets, as federal pension legislation and that of a number of provinces contains language similar to that in Ontario 's pension legislation.
In view of the Monsanto decision, a potential purchaser of a business that sponsors or has sponsored a defined benefit pension plan will need to assess whether there is potential liability relating to a prior partial wind-up or events that could give rise to an order for a retroactive partial wind-up where surplus should have been distributed from the plan. In a negotiated M&A transaction, a purchaser should, as part of its due diligence, attempt to assess the risk of such liability by (i) reviewing historical plan and funding documents as well as actuarial reports and annual returns for the plan, and (ii) attempting to identify prior partial wind-ups where surplus was not distributed, as well as significant changes in plan membership that indicate an event or events that could give rise to a partial wind-up order. In this context, a purchaser will also want to obtain appropriate representations and warranties and, to the extent practicable, indemnities from the vendor addressing this risk. In the case of an unsolicited take-over bid, the bidder will have limited ability to assess undisclosed pension liabilities generally and the risk of liability for a distribution of surplus in particular.
On March 30, 2004, IAMGold Corp. and Wheaton River Minerals Ltd. announced a proposed combination to create one of the world's top ten gold producers. The transaction raised a number of interesting issues as a result of the concurrent announcements by Golden Star Resources Ltd. and Coeur d'Alene Mines Corp. of unsolicited tender offers to acquire IAMGold and Wheaton, respectively, just 11 days before the scheduled meetings at which shareholders of IAMGold and Wheaton would be asked to approve the merger. Prior to announcing their bids, Golden Star and Coeur d'Alene had entered into an agreement under which they had agreed to net the potential break fees payable if both Golden Star and Coeur d'Alene completed their proposed bids.
Golden Star had previously held merger discussions with IAMGold in late 2003, and was subject to a standstill obligation under its confidentiality agreement with IAMGold. Following the announcement of Golden Star's bid, IAMGold advised Golden Star that the standstill obligation precluded Golden Star from commencing a bid. Golden Star brought an application to the Ontario Superior Court to obtain an order declaring that, as a result of the proposed IAMGold-Wheaton merger, its standstill obligation did not preclude it making a bid for IAMGold. The court agreed to issue such an order, rejecting IAMGold's position that because its proposed merger with Wheaton would not result in a change of control of the shareholders or the board of IAMGold, the standstill remained operative. With the support of certain IAMGold shareholders, Golden Star also succeeded in its application to the court for an order requiring IAMGold to adjourn the date for the meeting of its shareholders in order to provide them with additional time to consider the Golden Star bid, given that the proxy cut-off for the IAMGold shareholders meeting was approximately one week after the announcement of the Golden Star bid and that there appeared to be minimal prejudice resulting from a short adjournment.
In the face of the unsolicited bids, one particularly interesting aspect of the IAMGold-Wheaton combination agreement was the "superior proposal" definition used in the non-solicitation covenant. In their March 30, 2004 letter agreement, IAMGold and Wheaton defined a superior proposal to require that the consideration offered in a competing transaction represent, in the case of IAMGold, 105% of the closing price of IAMGold's stock on March 30, 2004, and in the case of Wheaton, 105% of the value ascribed to Wheaton's stock by the parties on March 30, 2004. At the time of the parties' letter agreement, gold prices were near their peak for the year. By the time of announcement of the Golden Star and Coeur d'Alene bids on May 27, 2004, there had been a significant decline in the price of gold and in IAMGold's stock price. As a result, the premium that a competing transaction would have to have offered to the prevailing stock price on May 27, 2004 in order to qualify as a superior proposal had become substantial, being 33% in the case of a bid for IAMGold and 27% in the case of a bid for Wheaton. Accordingly, the IAMGold-Wheaton non-solicitation covenant may have provided considerably greater deal protection than would have been available under the usual approach in which a superior proposal requires only that a competing bid provide greater financial value to shareholders.
The use of a static benchmark in the superior proposal definition raises issues respecting a board's ability to fully assess whether an alternative transaction may be in the best interests of shareholders. While the non-solicitation covenant was not contested, in granting Golden Star's application to obtain an adjournment of the IAMGold shareholder meeting, the court commented that the IAMGold board "might also be seen as somewhat hamstrung by…the definition of 'superior proposal'." Perhaps not surprisingly, in the subsequently announced combination transaction between IAMGold and Gold Fields Ltd., the parties' agreement followed the usual format, requiring only that an alternative transaction be superior from a financial point of view to IAMGold shareholders in order to qualify as a superior proposal.
New Merger Enforcement Guidelines
On September 21, 2004, the Canadian Competition Bureau released Canada 's new Merger Enforcement Guidelines. The new Merger Enforcement Guidelines provide guidance on the factors to be considered, and the analytical approach to be taken, by the Competition Bureau in determining the competitive impact of mergers on the Canadian economy. The new guidelines are generally consistent with the 1992 U.S. Merger Guidelines and the recently amended European merger guidelines. The guidelines contain several significant changes, including those discussed below.
The new guidelines reduce the certainty of relying on market share safe harbours in mergers between competitors. Both the old and new guidelines provide that a merger between companies with a combined market share below certain thresholds will not normally require further analysis. However, under the new guidelines it is no longer a necessary condition that a merger result in a high level of market concentration for the Competition Bureau to challenge the merger, suggesting that mergers even at low levels of market concentration may be subject to additional scrutiny or challenge in certain circumstances.
While the price effects of a merger continue to be a primary indicator of the competitive landscape, the new guidelines provide an increased focus on non-price effects, such as quality, service and choice.
The guidelines set out the approach of the Competition Bureau in connection with transactions that are anticompetitive, but also generate efficiencies—the "efficiency exception." Among other things, the new guidelines provide that the merging parties are not required to establish that efficiencies will be passed on to consumers.
The guidelines provide a considerable discussion on the circumstances in which the Competition Bureau may find that a merger prevents or lessens competition. These circumstances include an acquisition of an increasingly vigorous competitor or potential entrant into the subject market; an acquisition by the market leader that pre-empts such acquisition by another competitor; and the acquisition of an existing business by a firm that would likely have otherwise entered the market in the absence of the acquisition.