‘Classic rotation’ into less risky sectors to define M&A in 2015

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This year, bet on the boring stuff to deliver the best deal flow.

Six months ago, when billion-dollar energy deals were selling swiftly, talk of Canadian consumer stocks, industrial companies and utilities barely elevated any heartbeats. But in the midst of a gut-wrenching oil and gas slump, stable, conservative sectors are suddenly generating the biggest buzz on Bay Street.

In some respects, the fervour for these industries stems from investment bankers' eternal optimism – something they openly joke about. The S&P/TSX Composite Index could halve in value, causing panic for investors of all stripes, but many deal-makers would argue the slump simply allows buyers to find assets on the cheap.

This time, though, there's more to it. Canada is in the midst of a fundamental shift, and it's expected to be a powerful force for deals. "It's a classic rotation," said Roman Dubczak, head of equities at CIBC World Markets.

TSX Sectors

Because mining stocks are still suffering and energy shares remain volatile, portfolio managers have been plowing money into Canada's traditionally stable sectors. By the end of February, for instance, the S&P/TSX consumer staples sub-index was up 28 per cent over the previous six months. This is the sector that is supposed to be the least volatile and that does best in bad markets – not when the stock market is hovering around its record high.

"Resources tend to get a lot of the headlines, oil and gas in particular," said TD Securities vice-chair Pat Meneley. "But if you look at the non-resource sectors – consumer [stocks], industrials, etc. – they've shown extremely strong performance."

Recent history shows there's no shortage of investor appetite for non-resource deals. On the same day in February, Bombardier Inc. and Fairfax Financial Holdings Corp. collectively issued $1.6-billion worth of new common shares, and both offerings were gobbled up.

The demand for Fairfax's deal, which was launched to help fund its $2.3-billion purchase of Brit PLC, also shows that Canadian investors continue to support acquisitions. In 2014, roughly 40 per cent of equity issues were connected to financing corporate purchases, and that theme is expected to dominate this year.

Although such deals are good for big banks – many non-resource clients name underwriters based on who lends money to them – they aren't much help for boutique investment bankers and law firms that specialize in mining and energy deals.

That doesn't mean resource advisers are left twiddling their thumbs. By the end of February, mining companies had already raised roughly $1-billion through equity financings. Energy companies have also tested the waters too, looking to raise cash to shore up their balance sheets.

Human nature looms large, however. Save for select situations, buyers would much rather do deals during a market upswing because uncertainty makes both managers and directors nervous. That's why share price performance matters – and in every sector, not just energy.

"The single biggest driver of M&A activity is confidence," said Peter Buzzi, head of M&A at RBC Dominion Securities.

The wild card is that no one knows what activists will dream up this year. Even if energy companies want to hunker down, some may be asked to shake things up by opportunistic investors.

Historically, activists were viewed as long-term shareholders who saw the need to remove bad managers or directors. But a new breed is rewriting the rules. Today, many so-called activists are simply event-driven investors looking to make a quick buck – forcing companies to evaluate spinoffs and asset sales in the process, something TransCanada Corp. just endured.

"Any shareholder that agitates for change could in some sense be considered an activist," said Jeremy Fraiberg, a partner at Osler, Hoskin & Harcourt LLP, "but what we're seeing more of these days are specialized investors that use activism as an investment strategy."

Investment banks who work with corporate clients on strategies to defend against activists have had to adapt as a result. BMO Nesbitt Burns has gone so far as to redefine the activist label, breaking the category down into a number of different strategies.

When talking to clients, "we don't use the word 'activism,'" said Dan Barclay, head of the dealer's Canadian and international investment banking group. "We talk about the different [tactics] and what they mean for company change."