Capital abounds in Canada’s mid-market

Well-capitalised commercial banks and pensions in Canada have contributed to a spike in buyout activity, says Birch Hill’s Steve Dent.

For Canadian private equity managers searching for quality mid-market businesses, there’s no time like the present.

Canadian investment activity during the second quarter of 2011 shot up to levels not seen since late 2008, according to Canada’s Venture Capital & Private Equity Association. The 49 private equity deals recorded in Canada last quarter represented a 40 percent increase compared to the same period last year, and the C$5.7 billion (€4.3 billion; $5.8 billion) put to work exceeds the total amount invested in 2010.

One factor that has contributed to the heightened activity in Canada has been the availability of financing for mid-market transactions, a lifeline that never disappeared even during the worst of the global financial crisis in 2008 and 2009.

“Canadian banks have been pretty steady suppliers of capital through that period of time,” said Steve Dent, a partner at Birch Hill Equity Partners. “Their balance sheets are even better now, and I think they were pretty solid then, so we view the banks as being a sort of a constant right now.”

In the US, meanwhile, volatility from issues such as the Standard & Poor’s downgrade of the country’s triple A credit rating have been disruptive events for private equity groups and businesses in need of financing.

“The slight difference between the Canadian market and US market on this front is the Canadian [commercial bank] market is still quite strong,” said Glenn Gibson, head of credit capital markets at TD Securities in Toronto. “The US market clearly is clammed up at the moment.”

Financing without banks

Canadian pensions such as the Ontario Teachers’ Pension Plan, Canada Pension Plan Investment Board and Ontario Municipal Employees’ Retirement System have also established themselves as a second level of capacity for financing.

“Each one of those [pensions] has a debt capital markets group that in one way, shape or form has participated in the leveraged market in Canada,” Gibson said. “Those guys have stuck their noses in once in a while.”

Canadian insurance companies such as Manulife Financial and Sun Life Financial are a third source of financing, according to vice chairman of Scotia Capital John Sherrington.

“They have a plentiful supply of funding and are looking to put out money in quality situations,” Sherrington said.

Tougher terms

While there has been no shortage of available financing as of late for quality businesses in Canada’s mid-market, lending has recently become more conservative in Canada, according to Sherrington.

“We’ve seen over the last few months a great deal more caution. Conservatism has come into the marketplace,” he said. “I would say for quality deals, funds are definitely available on reasonable, not excessively aggressive terms, but for other deals that might have gotten done 12 or 18 months ago, I think they’re more challenged.”

Asset-based lending is also present in Canada on a more limited basis, according to Sherrington, from traditional sources such as GE and Wells Fargo.

High yield falls flat

In the last month or so, Canada’s high-yield market, which was becoming “a big source of funding in Canada”, according to Birch Hill’s Dent, dried up in response to investors shifting interest into lower risk assets, a result of the recent volatility in both Europe and the US.

The disappearance of high-yield debt, Dent says, will likely have an impact on private equity groups’ ability to finance the larger deals in the mid-market. The minimum size for a deal in the Canadian high-yield market, according to Sherrington, is approximately $100 million to $125 million.

“For a lot of mid-market companies, that might be a bit of a stretch,” he said. “A company that’s got EBITDA in the $35 million range is just about there on the margin, but anything less than that would be a challenge to access in the Canadian high-yield market.”

Uncertain future

While Canada’s thriving buyout sector appears to have all the ingredients in place for a continued forecast of robust deal flow, managers on the ground are not declaring victory just yet.

“I think the interesting factor right now in the market is just the amount of volatility you’re seeing in capital markets. I think that will show up in the private markets in the next quarter,” Dent said.

“In our experience there’s usually a bit of a lag and depending on which way things go there’ll be an impact on valuations, higher or lower…that’s what we’re watching more than anything right now.”