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Canada's M&A boom a nightmare for regulators

Date: Monday, July 24, 2006
Author: David Clarke, Investmentnews.com

OTTAWA - The torrid Canadian mergers-and-acquisitions sector has gone international, making it a dream for U.S. and European hedge funds, which have the resources and the market knowledge needed to make plays, and a nightmare for Canadian regulators who have to referee the deals.

Following a near-record year in 2005, when $166 billion (Canadian) worth of deals were announced, 2006 has continued the heady pace.

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And there is a new twist to the Canadian M&A scene, which traditionally has been dominated by U.S. companies taking over Canadian ones.

Now Canada is making its mark internationally.

"Canada is on the cusp of becoming a net foreign creditor, likely for the first time since the fur trade was the nation's dominant industry," Doug Porter, deputy chief economist at Toronto-based BMO Capital Markets, wrote in a report issued July 12.

Rising dollar cited

The country has recorded net direct investment outflows in each of the past five years, he wrote, hitting a peak for a moment in 2004 when Toronto-based Manulife Financial Corp. completed its $10.8 billion (Canadian) acquisition of Boston insurer John Hancock Financial Services Inc.

Mr. Porter cited the rising Canadian dollar plus the fact that Canadian investors have been buying more foreign stocks since the government scrapped a foreign-content limit on tax-deferred retirement savings plans (InvestmentNews, March 14, 2005). He said he believes that the situation is likely to exist for a while.

"In general, a country with a current-account surplus/capital-account deficit will be a hunter, acquiring foreign assets, which will provide a future stream of interest and dividend income," Mr. Porter wrote. "This is now Canada's position, as will become clear in coming quarters."

M&A deals by Canadian acquirers, in general, are of little interest to Canadian securities regulators. But a couple of deals with Canadian targets are of interest to those regulators.

On July 4, a lawyer for investor William Ackman told an Ontario Securities Commission panel that Sears Holding Corp. of Hoffmann Estates, Ill., had offered two Canadian banks benefits not available to other shareholders in its attempt to buy out its Canadian unit, Toronto-based Sears Canada Inc.

It's the "quintessential coercive bid," Kent Thomson, a lawyer for Mr. Ackman's New York-based firm, Pershing Square Capital Management LP, said at a hearing into Sears Holdings' $812 million (U.S.) bid for Sears Canada.

Mr. Thomson said that Bank of Nova Scotia, Scotia Capital Inc. and Royal Bank of Canada, all of Toronto, struck a deal with Sears - which he termed a "vote-buying arrangement" - the details of which were not divulged to other shareholders.

The minority shareholders opposed to the takeover are primarily hedge funds, responded Mark Gelowitz, a lawyer for Sears Holdings. They are "an organized, collusive group that's seeking a blocking position,'' he said.

On July 6, OSC recommended that Sears Canada shares held by the two Canadian banks shouldn't be counted in a takeover bid.

That brought an end to one facet of the takeover bid. But what to make of the hedge fund role?

"We were not involved," said James McGovern, managing director and chief executive of Toronto-based Arrow Hedge Partners Inc. and founding chairman of the Toronto-based Canadian chapter of the Alternative Investment Management Association Ltd. in London.

Why not?

"It would take a special knowledge of the situation, of the business, and of the personalities and companies involved to really attract us," said Mr. McGovern.

The other M&A deal of interest to regulators involves Zug, Switzerland-based Xstrata PLC's bid for Toronto-based Falconbridge Ltd. - the biggest takeover attempt in Canadian history.

The bid - intended to thwart the proposed $40 billion combination of Falconbridge, Toronto-based Inco Ltd. and Phoenix-based Phelps Dodge Corp. - was preceded by Vancouver, British Columbia-based Teck Cominco Ltd.'s bid for Inco, the world's second-biggest nickel producer. Teck, the world's biggest zinc miner, filed an application with the OSC asking to have Inco's shareholder rights plan, or poison pill, tossed out.

Teck's bid is conditional on the poison pill being eliminated. It was surpassed last month by Phelps Dodge, which struck a deal with Inco.

In its application to the OSC, Teck suggests it's hoping to take advantage of the uncertainty surrounding Phelps' offer, which still requires approval from shareholders, regulators and the courts.

"Inco shareholders will never have the opportunity to decide for themselves whether they prefer the Teck offer now to the uncertain Phelps Dodge transaction later," the Teck application to the OSC states.

A shareholder protection plan at Falconbridge expires July 28. When that happens, Xstrata will be able to increase its Falconbridge stake by buying small lots of stock.

A condition of the poison pill is that once a bidder has met its tender requirements it has to extend its offer by 10 business days.

Teck's bid, launched in May, initially could not meet that requirement. More than 40% of Inco's shareholders are in the United States, and under U.S. securities laws, Teck's bid could not have more than one takeup date.

On June 21, the Securities and Exchange Commission gave Teck permission to have multiple takeup dates.

Meanwhile, Xstrata's bid for Falconbridge was cleared unconditionally by the European Commission and awaits only approval under the Investment Canada Act.

Meanwhile, the Xstrata and Phelps Dodge bids still need approval under the act, and Phelps Dodge's bid also needs clear-

ance from the European Union and the potential acquirer's own shareholders.

An article by lawyers Mark A.A. Warner, Anthony F. Baldanza and Aaron J. Stefan of the Toronto law firm Fasken Martineau DuMoulin LLP, "A New Conservative Government in Canada: Implications for Competition Law and Foreign Investment Review," said that "The election of a new minority government in Canada led by Stephen Harper of the Conservative Party comes at a time of considerable debate about the future directions for competition law and policy in Canada.

"In order to establish new Canadian businesses or acquire control of an existing Canadian business, a non-Canadian must provide either a notification or, in rarer circumstances, an application for review under the Investment Canada Act. The minister appointed under the ICA can only prevent and/or impose conditions on the non-Canadian purchaser of a Canadian business in the event such acquisition is subject to an application for review. The ICA already provides for consideration of "the effect of the investment on competition within any industry or industries in Canada" in section 20(d) of the ICA for determining whether a reviewable investment by a non-Canadian is of "net benefit to Canada" in the case of reviewable transactions. In this regard, it has been our experience that such evaluations are generally left to the expertise of the bureau."

In other words, the bureaucrats decide.

Not interested

Mr. McGovern of Arrow Hedge is not interested in the Inco deal, either.

"This is a play for the superstars of the international hedge fund community," he said. "They have the financial clout to get involved as shareholders, the technical knowledge of the industries involved, and the appetite to become involved in what is to be a variety of arbitrage opportunities resulting from the ripple effects from this mega merger.

And, Mr. McGovern said, "This is an event-driven deal in that it involves speculating on what a whole lot of regulators are going to do or not do."

"The big opportunity for the smaller hedge funds and investors is in the fallout from whatever deal is not done - i.e., the 'losers' along with a great deal of mid[size] and smaller nickel and copper producers will become targets - a sort of 'pre-arb' situation where value has yet to be realized. That looks far more interesting to our hedge fund managers than gambling in what may be a highly political and litigious mega-type deal."