Big year on the horizon for big pharma

DLW_blog_pillsGlobal M&A activity in the biopharmaceutical industry skyrocketed in 2014 and 2015, eclipsing US$200 billion in deal value each year and prompting EY to declare such elevated activity to be the “new normal” in the industry. After another strong year in 2016, big pharma companies now appear poised to carry this trend into 2017. In fact, according to EY’s M&A Outlook and Firepower Report 2017 (the Firepower Report), both the pressures on big pharmaceutical companies to pursue inorganic growth, and the ability of these companies to execute strategic acquisitions, are higher than they have been at any point over the past several years.

Findings in Firepower Report

The Firepower Report predicts that pricing pressure will be a key driver of M&A activity as payers around the world push for lower drug costs. This pressure, enhanced by the establishment of biosimilars in developed markets and overcrowding in increasingly competitive therapeutic fields, is steadily eroding the pricing power of big pharma companies and threatening to erode future revenue streams. As a result, analysts’ revenue forecasts for both legacy and new drugs have been trending downwards, creating a “growth gap” for many big pharma companies as compared to overall drug market sales. Efforts to counteract the effects of these dampened growth trajectories have focused on M&A activity in what EY calls a “race for inorganic growth”.

Fortunately, according to the Firepower Report, a convergence of political and industry factors has the potential to create favourable M&A conditions for big pharma in the coming year. First, EY has identified that there is significant unspent “firepower” among big pharma companies. “Firepower” is a metric derived from the strength of companies’ balance sheets that is used by EY to approximate a company’s ability to engage in M&A activity. While “firepower” is down overall among big pharma companies, EY reports that for the first time in several years, big pharma “firepower” is beginning to exceed target company valuations, putting larger growth targets within reach.

Relatedly, target company valuations have sharply declined, which could increase buyers’ appetites for M&A. In this regard, there is historical precedent: a similar decline in biopharmaceutical company valuations in 2008 was followed closely by a slew of “mega-deals” in 2009.

Impact of geopolitical developments on M&A

Finally, the past year’s geopolitical developments may also spur M&A activity. This is particularly true in the United States, where optimism about favourable future regulatory and tax environments, coupled with the possible repatriation of up to US$100B in cash into the target-rich country, could significantly drive dealmaking. EY further suggests that any anticipated benefits in the United States may induce companies in other jurisdictions to accelerate their own M&A agendas.

All considered, the biopharmaceutical industry seems poised to equal, or even eclipse, the elevated dealmaking levels achieved in the recent past. Indeed, in mid-October, 2016, 43% of executives in the life science industry said that they had five or more deals in the works. With big pharma in the driver’s seat, it appears likely that a big year is on the horizon.

The author would like to thank Geoff Mens, Articling Student, for his assistance in preparing this legal update.

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Supreme Court of Canada clarifies law of rectification

Deals often come together very quickly. In all that rush, it’s easy for the parties to forget to think about all of the long term implications of the deal. Perhaps the parties simply didn’t realize that the deal would have certain consequences that frustrated their original intentions. Maybe the parties intended to avoid particular tax consequences but carried out the steps of the transaction in the wrong order. Whatever the issue, the remedy of rectification offers the parties a second chance; a chance to go back and fix their mistakes. Two recent decisions of the Supreme Court of Canada have provided new clarity the law of rectification.

Recent Supreme Court of Canada decisions

In Canada (Attorney General) v Fairmont Hotels Inc (“Fairmont”)[1] and Jean Coutu Group (PJC) Inc v Canada (Attorney General) (“PJC”),[2] the Supreme Court of Canada considered two separate transactions that were intended to be tax-neutral. In Fairmont, the Court considered common law related to rectification; in PJC, the question was to be resolved under a provision of the Quebec Civil Code. In Fairmont, Fairmont was party to a cross-border financing arrangement. When Fairmont was subsequently acquired, a proposal was developed to ensure that there were no negative tax consequences when certain shares were redeemed to unwind the arrangement. However, the proposal was never implemented. The shares were redeemed in the mistaken belief that the proposal steps had been undertaken, resulting in unanticipated tax consequences. In PJC, PJC invested in a chain of pharmacies in the United States. PJC developed a plan to manage the currency fluctuations of its US investment without adverse tax consequences; however, PJC’s objective of avoiding tax was unsuccessful, and PJC was required to pay tax. In both cases the taxpayer sought to rectify the transaction that it implemented in order to avoid the unintended tax consequences. In both case, the Supreme Court denied rectification.

In Fairmont, the majority of the Supreme Court held that the mere intention for a transaction to be tax neutral is not sufficient to allow rectification when that intention is not achieved, overruling the previous law of rectification. The majority held that rectification will generally only be available when a written legal instrument has incorrectly recorded the parties’ actual agreement. The majority held that four criteria must be met for rectification to be available:

  • The parties had reached a prior agreement whose terms were definite and ascertainable;
  • The agreement was still in effect when the instrument was executed;
  • The instrument fails to record accurately the prior agreement; and
  • If rectified as proposed, the instrument would carry out the prior agreement.

In Fairmont, the parties had a general intention that the redemption result in no tax payable, but there had been no specific agreement with ascertainable terms, and no failure to properly record the agreement in writing. Accordingly, rectification was denied.

Similarly, in PJC, the majority of the Supreme Court held, for civil law purposes, that the mere intention to avoid adverse tax consequences was not enough to allow the court to grant rectification in the absence of any error in recording the agreement, and therefore denied rectification. The majority, however, held that rectification may be available where (i) the parties specifically sought to avoid the unintended tax consequences by giving specific consideration to, and agreeing on, how such consequences could be avoided, and (ii) the agreement, if properly expressed and implemented, would have succeeded in avoiding those unintended tax consequences.[3] The majority even went so far as to state that rectification can include the insertion of new transactions where the criteria for rectification are fulfilled.[4]

Law of rectification

These two decisions provide much-needed clarity to the law of rectification. It is clear from these decisions that parties should turn their minds to the specific means of achieving their intentions through the agreement. Parties should know, not just that they want to do a deal tax-free, but specifically what steps they have agreed to take to accomplish it. Parties should obtain tax advice before entering into an agreement to ensure that they know how to accomplish their tax objectives. If they do that, even if the parties make a mistake implementing their deal, they stand a good chance of having their objectives fulfilled.

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[1] 2016 SCC 56.

[2] 2016 SCC 55.

[3] PJC at para 24.

[4] PJC at para 34.

Canada punches above its weight-class in cross-border deals and works on attracting greenfield and other private investment

Over the past few months, the Canadian government has been working to establish a source of financing for several infrastructure projects across the country. These projects include public transit initiatives, green infrastructure, social infrastructure, and smaller tailored projects for our rural and northern communities. What makes this interesting is how Canada is sourcing the money.

Infrastructure bank to be established

The government is in the process of establishing an infrastructure bank, wherein $35 billion in public funds will be used to get the projects off the ground. The hope is that the private sector will respond with around $140 billion. Much of this is expected to come from abroad.

Private investment needed

It has never been more true that attracting private investment from abroad is crucial to ensuring Canada’s economic growth. In late 2016, a report by the Advisory Council on Economic Growth specifically addressed that Canada may be falling behind its peers in bringing in foreign cash. Interestingly, it was not long ago that foreign direct investment (FDI) in Canada was viewed with reservation. Studies have shown that many of the fears, such as the “hollowing out” of Canadian management when a Canadian corporation is acquired, is in fact misplaced and overstated. On the contrary, investment brings with it increased competition at home and technology transfer, among other benefits to all Canadians.

Canada attractive cross border target

What is clear from the Advisory Council report is that the government is less concerned with Canada’s cross border M&A activity than it is with greenfield investment. The report refers to the fact that Canada lags what it calls “best practice” FDI nations in the ratio of greenfield to M&A investment. The countries it uses as benchmarks include France, Hong Kong, Ireland, Mexico, Singapore, and the United States. That trend, however, may be the result of Canada punching above its weight class in M&A activity. The 2016 Deloitte Year-end report on M&A Trends showed that Canada is currently positioned as the most attractive target market for US companies, with 40% of firms citing it as such. By comparison, the UK and China are the second and third most desirable markets with only 31% and 25% of responding firms citing them as target markets, respectively. While greenfield investment brings with it compelling benefits such as the promise of new jobs, Canada should not discount its comparative advantage in cross-border M&A.

The author would like to thank Peter Georgas, Articling Student, for his assistance in preparing this legal update.

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Back to the basics: the business value in keeping human interaction

coffee-680x220In today’s market, there is significant buzz around phrases such as automation, artificial intelligence, cloud computing, robotics and the like. Many businesses are investing in the fast-paced technology sector and innovating outdated systems for customer engagement. For example, earlier this year, the first U.S.-based robotic café opened its (figurative) doors to patrons in San Francisco, serving reasonably priced espresso drinks with a robotic arm behind a large pane of glass. Only one human is present to administer the machine and assist customers with orders. With the changing face of consumer interaction, it is demanded of businesses to act progressively, so as to not fall behind in the realm of innovation.

According to an EY study from July 2016, early adopters of digitization appear to have gained a first-mover’s advantage and companies are looking for solutions to “bridge the gap” with their competitors. To that end, 68% of corporate respondents believe that investing in M&A is more efficient than pursuing organic growth. 67% of respondents plan to use M&A to build on digital capabilities in the next 2-3 years. Companies believe digitalization is “accelerating sector dynamics”, requiring a rapid response. More information on the growing appetite for digital M&A can be found in this previous post.

Increased access to digital technologies has given rise to more “human-less” customer services. However, Accenture’s 11th Annual Global Consumer Pulse Survey encourages companies to prioritize humans over digital channels, even in the “digital age”. The report indicates that over 80% of consumers prefer dealing with humans over digital channels to get advice or to obtain customer service. And, should a customer be lost from a poor experience, 68% indicate that they will not go back once they have left a provider. Although there is appeal in servicing customers with digital and automated platforms, investment in human interaction with customers offers significant value for companies that should not be overlooked as digital M&A advances forward.

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Technology M&A outlook

Deal Law Wire - Norton Rose FulbrightKPMG LLP’s survey predicts M&A deal levels in 2017 will be steady from 2016, with the technology industry leading expectations for high activity. This follows from 2016’s profile for tech M&A deals, which had EY’s Global technology M&A report for Q3 2016 highlighting digital technologies as driving tech M&A deals for both tech and non-tech companies. Digital technologies that drove deals include internet of things (IoT), smart mobility, cloud/SaaS, big data, security, advertising and marketing technologies, connected cars, payment and financial technologies, gaming, and health care IT.

Deal value

In Q3 2016, the average value per tech M&A deal was US$789 million, compared to US$273 million in the same quarter the previous year, and the aggregate deal value was US$155.5 billion, compared to US$65.4 billion in the same quarter the previous year. This was the third highest recorded aggregate quarterly deal value for tech M&A, falling behind only to Q4 2015 and Q1 2000, which had aggregate deal values of US$189.8 billion and US$228.4 billion, respectively.

Deal volume

In terms of deal volume, Q3 2016 had 911 deals, a decrease of 15% from the same quarter in the previous year.  Thirty-two deals equaled or exceeded US$1 billion, with 13 from corporate tech buyers, 12 from private equity, and 7 from non-tech buyers.

The author would like to thank Larissa Leong, Articling Student, for her assistance in preparing this legal update.

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Asset sale and shareholder approval

In the context of an asset acquisition, both the seller and the buyer need to consider whether the proposed transaction triggers shareholder approval requirements under corporate legislation.

Legislative requirements

Subsection 189(3) of the Canada Business Corporations Act (the CBCA) states that “a sale, lease or exchange of all or substantially all the property of a corporation other than in the ordinary course of business of the corporation” requires special resolution of shareholders, being not less than two-thirds of the votes cast by shareholders who voted in respect of the resolution. The Ontario Business Corporations Act has similar provision.

It should also be noted that minority shareholders who were entitled to vote on the special resolution have dissent right which entitles them to be paid “fair value” for their shares if the asset sale proceeds.

“All or substantially all”

So what constitutes “all or substantially all” of the property of a corporation? The Canadian courts conduct both the quantitative and the qualitative analysis when interpreting the phrase, with the qualitative test being ultimately determinative.

The quantitative analysis is mathematical and it involves determining what percentage of the total assets of the corporation is being sold. Courts will examine all relevant factors to establish corporate value, including book value, net asset value, market value, EBITDA, and gross and net earnings. If the value of the assets being sold exceeds 75% of the corporation’s consolidated assets, then it is presumed that the sale is “all or substantially all” of the corporations’ property. The presumption can be rebutted under the qualitative analysis described below.

The qualitative analysis looks at whether the transaction would “transform the fundamental nature of the corporation” while taking the purpose of the statutory provision (to protect shareholders from fundamental changes occurring without their consent) into account. The court will consider, among other things, whether the transaction:

  • is tantamount to a liquidation or winding up of the corporation;
  • constitutes a significant change to the line of business historically carried on by the corporation; or
  • divests the corporation of its key resources of revenue thus putting the future viability of the corporation in question.

Given that obtaining shareholder approval can be a time consuming and costly process, both parties should conduct analysis to determine whether the proposed asset acquisition triggers shareholder approval under corporate legislation as early as possible.

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Sweet deals: M&A in the “indulgence” food and beverage category

2015 and, to a lesser extent 2016, were bumper years for M&A in the food and beverage industry, with 2016 deal activity accelerating considerably as the calendar year reached its close. As we reported back in August, though consumer demand in certain staple food and beverage categories has declined in the past half-decade, emerging trends such as demand for “natural” and organic products has recently led to a sizable number of deals. According to consumer strategists in the industry, organic and “natural” food demand will continue to boost M&A into 2017.

However, amidst the growing movement towards healthier food options, there has also been deal activity on the decidedly less healthy side of the industry. Affectionately referred to as the “indulgence” category, continued consumer interest in less healthy foods could perhaps signal a backlash to the health food trend or a way for consumers to return to the days before they learned of hydrogenated oils and high-fructose corn syrup. Some suggest that the “indulgence” category, with its time-tested but slow-to-no growth companies, is ripe for the entrance of private-equity buyers – perhaps to streamline certain successful brands.

Within the indulgence category, an area of particular growth exists in the premium and so-called “super-premium” and “ultra-premium” food and beverage brands, which produce creative new takes on classic foods and drinks using higher-quality ingredients. While consumer demand for run-of-the-mill indulgence products may arguably have waned, demand for premium products has increased dramatically. A report produced by management consulting firm Kurt Salmon shows that the total market growth of the US ice cream category, for example, rounded out at only 1% between 2010 and 2013. However, in the same period, “super-premium” ice cream brands grew by 5.7% and “ultra-premium” by 41.7%. A similar phenomenon can be seen in terms of beer, a classic indulgence beverage. Sales of US domestic and import brands have experienced negative growth in recent years, but craft beer sales have grown by around 20%. The Kurt Salmon report suggests that these indulgence subcategories present numerous targets for private-equity buyers and are helping revive deal activity in the industry as a whole.

It is yet to be seen how the recent campaigns to curtail junk food advertising in countries like Canada and the UK, particularly with respect to children, might affect the future of both the classic and newcomer indulgence brands.

The author would like to thank Peter Charbonneau, Articling Student, for his assistance in preparing this legal update.

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Doggone?: the ascent (and potential decline) of pet M&A

dog-bite680x220Due to the ubiquitous status of pets in North America, it is likely that most would expect the industry built around pets to be quite a profitable space for business. The level of success this industry has shown over the past several years, however, might still come as a surprise. Since the early 2010s, a surge of M&A activity has taken place in the pet industry, involving a sizable number of deals each year. 2016 was no different, witnessing around 50 transactions completed by Q4, which is especially impressive considering that the industry is relatively fragmented. While most agree that the surge is fueled by the rise of “natural” pet products and emerging “pet tech”, some believe that the recent fervour is soon to give way to dog days in the industry.

Developments in the industry

What is the driving force behind the increased level of transactions? Many speculate that the trend towards “humanizing” pets and the resulting increase in consumer spending is at least partly to blame. More than ever, Canadians and Americans view their pets as part of their families. As such, they are becoming more willing to pay a premium for products and services that they perceive as more beneficial for their pets, such as “natural” health treatments and food and treats produced without grains. A rapidly developing area of the industry is “pet tech” (wearable cameras, GPS devices, etc.), which is projected to evolve into a billion-dollar field within the next decade. The numbers tell the story – total 2016 consumer spending in the pet industry was estimated at $7 billion in Canada and a whopping $62.7 billion in the United States. The US number has been growing year by year at a steady rate of around 4%, largely unaffected even by the financial crisis.

Profiling pet M&A

Considering the shifting consumer demands, the most successful buyers during the pet M&A surge have unsurprisingly been those focused on acquiring pets retailers and pet lifestyle product manufacturers that market “natural” alternatives to the big-box names. Some buyers have set their sights on consolidating chains of pet groomers, boarding facilities, and veterinary hospitals across the United States and Canada – businesses that were traditionally locally, or at most, regionally owned. Nascent “pet tech” start-ups have proven attractive to major players in the technology sector, no doubt eager to take advantage of emerging trends, such as millennials’ desire to showcase their pets via social media. In fact, Q3 of 2016 saw almost as many transactions in “pet-tech” as in the rest of the pet industry combined.

Stagnating or continuing growth?

Some in the industry cite factors such as reliable growth in consumer spending and emergence of “pet tech” as indicators that the recent surge of M&A activity is far from over. Others, however, have hinted at consumer realization that higher price does not always equal higher quality. Further, it has been pointed out that as the pet industry becomes more consolidated with each major transaction, the number of viable targets decreases.

One can safely say at least, that in the past few years pet companies have proven to be the cat’s pyjamas of the middle-market.

The author would like to thank Peter Charbonneau, Articling Student, for his assistance in preparing this legal update.

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Power and utilities: ongoing attraction for investors

EY’s review of Q3 2016 deal activity within the power and utilities (P&U) sector shows ongoing stability to be expected into 2017. Highlights from the quarter include ongoing premiums on prices for regulated assets, increased investment in renewables and diversification into disruptive technologies.

Regulated network assets (i.e., transmission and distribution assets) are described as “safe havens” for investment, translating into transactions worth US $23.6 billion in Q3 2016. EY reports that this sum accounted for more than half of the quarter’s overall deal value. Investors view regulated network assets as stable with long-term returns in a relatively volatile market.

Renewable energy assets continue to record strong valuation multiples. Q3 2016 saw 23 deals worth US $2 billion in the renewables segment, with offshore wind assets in particular receiving spotlight attention from investors.

EY notes that investors are expected to look for opportunities in emerging markets with growing energy demands, and disruptive assets (such as battery storage, micro-grids and virtual power plants) due to the falling costs of PV panels and energy storage batteries.

EY’s regional snapshots provide a more detailed breakdown of trends and predictions in the P&U sector:

  • The Americas were the “hot spot” for deal activity in Q3, representing 66% of total global deal value. More than half of the deals in renewable energy and regulated assets in Brazil, Canada, Chile and Mexico involved acquisitions by foreign buyers worth US $3.3 billion.
  • Deal value in Europe decreased slightly in comparison to Q2. Diversification and investment in renewables and disruptive technologies are highlighted as key priorities for this region. Utilities are changing their energy mix with a policy shift towards lower-carbon energy sources. Coal-fired power plants will pave the way for increased renewable and gas-powered energy capabilities.
  • Similarly, EY reports that focus on renewable energy deals was a driving factor in the Asia-Pacific China and India alone contributed 77% of deal value in the region.
  • EY highlighted areas of opportunity in Africa and the Middle East as residing in new conventional power and renewable energy. Foreign investment from China has driven growth in the P&U sector in this region, in addition to an increased presence from European utilities.

EY concludes that, despite economic challenges at the global level, M&A markets should remain stable in the P&U sector.

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M&A trends for 2017: Canada a likely target

According to a year-end report on M&A Trends published by Deloitte, corporate and private equity executives surveyed in the last quarter of 2016 anticipated significant M&A activity in 2017. Indeed, three quarters of survey respondents expect deal activity to increase in 2017 relative to 2016, and almost 65% expect deal size to increase. Aside from strategic reasons, the expected increase in the pace and size of transactions may be linked to high stock prices, continued low interest rates, and availability of cash held in reserve by large companies.

In the Canadian context, the Deloitte report suggests that U.S.-based investors are looking at M&A opportunities abroad, with Canada ranking first among foreign markets, particularly among corporate respondents. Forty percent of respondents to the Deloitte survey cited Canada as a target market, with the UK (31%), China (25%), Japan (34%) and Europe (22%) lagging behind.

U.S. interest in Canadian-based businesses may be attributed, at least in part, to the enthusiasm shown by the survey respondents for M&A transactions in the energy and resources sector. In that category alone, more than half of respondents identified Canada as the geographic region where deals were anticipated.

Increased acquisition interest from abroad naturally means opportunity for strategic review and the potential divestiture of Canadian businesses. Canadian business owners and executives looking to capitalize on the expected trend should consider how best to position themselves for success in 2017.

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