Canadian convenience store giant Alimentation Couche-Tard Inc. is among the top 20 Canadian companies punctuated by other growth-by-acquisition stocks.Ryan Remiorz/The Canadian Press
Gone are the days when the strategic acquisition was a sure path to stock market glory.
After feasting on cheap and abundant capital for the past decade, companies in the habit of gobbling up their competitors are facing a new set of circumstances revolving around inflation and higher interest rates.
Fast-rising borrowing costs are changing the math governing mergers and acquisitions, making it more difficult for any given deal to make financial sense. Meanwhile, financial conditions are tightening around the world and lenders are getting more cautious.
“Everyone is going to find it harder to meet the new standards,” said Brad Cherniak, co-founder of Sapient Capital Partners in Toronto. “The more aggressive the strategy is, the more the bar will be raised.”
Canadian investors ought to take note, since aggressive acquisition strategies have dominated the TSX leaderboard for years.
In the years after the global financial crisis, easy money policies became an immutable force. A low-growth economic backdrop and the lack of an inflation threat made for a decade-plus of minuscule interest rates.
A wave of corporate deal-making ensued. These were boom times for businesses relying on a steady flow of acquisitions to generate growth.
Consider the stretch of time bookended by the global financial crisis and the COVID-19 pandemic. In the bull market that roughly spanned that 11 years, serial acquirers account for roughly half of the best-performing stocks in the S&P/TSX Composite Index.
In the top two spots are Boyd Group Services Inc. BYD-T, which posted share price gains of about 8,100 per cent (meaning its stock rose more than 80-fold), and Constellation Software Inc. CSU-T, which rose by 5,500 per cent.
Both companies are predicated on the relentless pursuit of smaller competitors and complementary businesses. Each year, Boyd scoops up dozens of collision repair locations in Canada and the U.S., while Constellation has built up a roster of hundreds of smaller software companies mostly serving niche industries.
The rest of the list of top 20 Canadian performers over that time is punctuated by other growth-by-acquisition stocks: information technology names CGI Inc. GIB-A-T, Descartes Systems Group Inc. DSG-T, and Enghouse Systems Ltd. ENGH-T; convenience store chain Alimentation Couche-Tard Inc. ATD-T; trucking company TFI International Inc. TFII-T; food manufacturer and distributor Premium Brands Holdings Corp. PBH-T; and label maker CCL Industries Inc CCL-A-T.
Growth-by-acquisition has been so powerful an investing theme, it could be considered the “flavour of the decade” for the TSX – the previous decade, that is – according to Ian de Verteuil, head of portfolio strategy for CIBC World Markets.
The trend was also supported by Canada’s corporate tax regime, which made the TSX a destination for U.S. consolidators who could effectively relocate their profits to the lower-tax jurisdiction. But that advantage was largely eliminated by U.S. tax reform in 2017.
And now the strategic acquisition is being dealt another blow, as capital becomes more expensive and less available. “Very few of these companies generate enough capital to continue to grow and do 10 or 20 deals a year, or whatever it is,” Mr. de Verteuil said.
There are exceptions. Constellation Software, for example, doesn’t rely on debt to sustain its acquisition program. That might help to explain why its stock is down by only 17 per cent this year – a strong showing compared with the dramatic losses inflicted across the software space.
But the market is unlikely to reward acquisitions to the same extent as in recent years. “It’s been a pretty simple strategy,” said Craig Basinger, chief market strategist at Purpose Investments. “Bond markets would lend to anybody with a heartbeat at super-low yields. You go out to buy a business and then de-lever over the next couple years. Rinse and repeat.”
In the face of higher interest rates for the indefinite future, serial acquirers will need to be more disciplined and selective with the deals they pursue.
In that environment, perhaps investors turn their attention to companies that grow the old-fashioned way, Mr. Basinger said.
“The boring, plain vanilla operators will become increasingly more valuable, just because they’re not beholden to cheap capital.”
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