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Thawing the freeze

|Written By Kelly Harris

Private equity markets are slow moving, but like a hockey team on the verge of the trade deadline, for the right price, there are deals to be had.

Every year Canadian hockey fans ?glue themselves to their television screens to see the moves their favourite team makes on trade deadline day. For some fans the moves are to bolster an already strong lineup to make a run for glory. For other, less fortunate fans, their team’s goal is to trim, move assets for prospects or futures, with the goal of decreasing the bottom line, and shoring up the core group of players to be competitive in the future.

It usually starts slowly, little deals a week or so before the deadline and then one team jumps in with a blockbuster, forcing the other leaders to follow suit. The rule is simple. If you have money to spend you can really make some hay.

Much the same can be said for private equity markets in Canada today. Except, when it comes to private equity, there are no drop-dead dates to make deals to bolster the bottom line. So the lucky fund managers with cash on hand are left to seek out deals from companies desperate for capital, or desperate to get their house in order.

Still, much like hockey teams, there are those who overvalue their assets, running the risk of having nothing when the getting is good, or holding out until they are forced into deeper holes, or hopefully, the market rebounds. “Things are relatively quiet now,” says Gary Solway, Bennett Jones LLP partner and co-chairman of the firm’s commercial transactions group. “I don’t think it can stay that way, the status quo, there are too many companies marching toward the brink and they have to do something.”

Solway, a director of Canada’s Venture Capital & Private Equity Association, describes today’s market in an almost macabre way; equating those with cash on hand looking for deals, buying dying companies or non-core business units. “There are a lot of private equity firms out there that feast on corpses that are out there, the vultures of private equity funds, this is the sort of environment they like, where they go out and try to buy debt for pennies and try to make it worth more than that, or buy cast-off divisions of companies. . . . There will be private equity in the counter-cyclical market, where things are not going well as opposed to the private equity we had before, where guys were paying top dollar and buying things at the top of the market.”

There are deals getting done with companies having an eye on the future. Solway points out that the recently announced move by Kitchener’s Research In Motion to buy Certicom Inc., one of the company’s suppliers, is an example of a company taking advantage of the market to build. For every Certicom buyout there are many more deals companies and clients ponder, but don’t happen, Solway says. “There is a lot of uncertainty about everything. You can’t count on anything happening the way you thought it would, you can’t be sure you can borrow money, you can’t be sure you can do equity financing, you can’t be sure that your business is going to continue to generate the type of cash it is generating today, it just makes it very difficult to do anything.

“I spend a lot of time helping clients to look at things, but not a lot of time actually executing transactions, because there are not that many transactions moving forward,” says Solway.

Ogilvy Renault LLP senior partner Andrew Fleming, says while private equity isn’t rolling along as it has in the past few years, there are still deals getting done, “it’s still alive, it’s just not breathing very loudly. It’s strategic, it’s being done with companies that are either flush with cash or stable in this environment, which is hard to find, and two which have a far-out strategy as to where they want to be in 10 or 20 years.”

Forward-looking companies need to be careful. Companies struggle for reasons, often too much debt or liabilities. Fleming says even though the front-end cost of acquiring such a company can be low, the risk on the back-end is important to look out for. “You don’t want to pick up any overhang in terms of liabilities, things like huge tails on pension liabilities, retiree health benefits liabilities. It used to be what you did is you relied on an indemnity coming from the other side, ‘if someone comes after you for this, then I’ll indemnify you,’ nowadays you have to look at the strength of the indemnity.”

Fleming points out indemnity protection, is only as strong as the company that is providing it. This is also contributing to the slowing of the private equity market.

“It does change the dynamic of what is going on at the table. A willing seller, and as a matter of fact a frantic seller, and a cautious buyer, so you have got a dynamic there that wasn’t around three years ago.”

This has contributed to the slowing of the market “and why things are falling apart,” says Fleming. “People are saying ‘I’m not going to step up to the plate unless it is absolutely squeaky clean, because I don’t have to.’”

Deloitte partner and co-chairman of the group’s Canadian private equity practice Mark Jamrozinski, says one positive note in Canada's private equity funds are being afforded more time to turn things around. He points out Canada’s banks are working with the funds to allow for time to effect changes and help stabilize the funds.

“There is a level of co-operation between the banks and the private equity firms. You are not seeing the drastic measures being taken by the banks, you are seeing a significant level of co-operation that is driven from two perspectives. One is there is value in those relationships with those funds and there is a mutual respect between the fund and the bank.

“So they are not looking at it just on a portfolio company basis and I think that the banks realize the best strategy is not just to go and take over and try and effect change.”

One reason the Canadian banks may be more willing to work with the funds is because many of the acquisitions were through club deals, and not the large syndicated deals that are more common in the United States. A club deal pools private equity funds allowing for several firms to acquire a more expensive company collectively, while limiting the overall risk to each individual fund because their overall stake in the company is lower.

While working with banks is important, looking for strategic opportunities is also part of what funds are doing right now. Much in the same way the RIM purchase of Certicom allows the company to take over a supplier and build efficiencies, Jamrozinski believes private equity funds could be used in similar ways to build efficiencies. And deals providing “strategic value” are the ones the funds are looking to do. The companies being forced to pare off assets are often the ones that got away from their core competency and are being forced to “sell off divisions that take away from that." This could mean there is an opportunity to buy up a competitor, if its larger parent company decides the business unit is not part of what will make it successful in the future. One place these opportunities can be found is in Canadian subsidiaries that are not part of the parent company’s overall core business.

Still Jamrozinski notes there are issues facing even those types of deals and they can be found in the valuation of assets and companies can price themselves out of the market.

Companies are trying to hold on through the bad times, and wait until the market begins to rebound before they look to sell. And others are “forced to deal with the current market ?circumstances.”