Why, with a relatively tiny number of banks and investment dealers, are Canadian capital markets among the world’s most efficient? Those whose business it is to design and sell made-in-Canada ‘bought deals’ think they know the answer.
Until 1982, equity offerings were ‘fully marketed’, with management going on roadshows and telling their story to investors. That year, Gordon Capital sparked a sea change in Canadian capital raising by introducing the ‘bought deal’, which lets companies raise money within hours rather than weeks.
A bought deal is what purists might call an ‘underwritten’ deal. Investment dealers buy all the offered shares outright J usually (but not always) at a discount J then sell them quickly to institutions who already know the company. Securities rules make these quick deals tough to do in the States but they flourished in Canada.
In 1993, when equity financing in Canada hit its recent peak of some C$22 bn, about 80 percent of transactions by value were bought deals. Several factors have combined to lead more and more companies to choose the fully marketed route. Today, the number has largely reversed, with fully marketed deals taking the lion’s share.
The rising stockmarket has helped prompt the trend toward fully marketed deals because it makes management less jittery about their stock price falling off during a lengthy marketing period. Indeed, they usually expect it to rise. At the same time a spate of IPOs riding the hot market has, by definition, required the marketed route.
Another catalyst has been the growing use of US financing by Canadian companies. Besides broadening the shareholder base, this offers a chance at US analyst coverage. But tapping the US market with a bought deal is all but ruled out because US investors are used to buying issues on a fully marketed basis.
Indeed, Canadian companies searching for finely-tailored financing vehicles are finding an increasingly broad and flexible range of options. Hybrids between fully-marketed and fully-bought deals have arisen. Here, management and underwriter agree on a price, but management still goes on a mini-roadshow for a day or two.
Bounce Back
But don’t count the bought deal out just yet. ‘In a rising market, companies are less concerned about market risk during their marketing period,’ notes Susan Monteith, head of equity syndication for CIBC Wood Gundy Securities. ‘In more volatile markets, expect more bought deals.’
For now, bought deals remain a key weapon in Canadian companies’ financing arsenal. Specific company and market conditions can make taking a firm offer without committing weeks of management time a significant advantage for issuers.
A number of oil patch companies, for instance, took advantage this year of a market keen on oil and gas stocks. ‘They saw an opportunity to raise money immediately at an attractive rate without the need for roadshows and without market risk,’ says Monteith. ‘If you have been out telling your story to investors all year, there’s little reason to tell them again.’
‘You can’t do a bought deal unless you have done continuous IR and disclosure throughout the year,’ adds Jean-Guy Brunelle, senior vice president and director at Montreal-based securities dealer Levesque Beaubien Geoffrion. ‘The market has to know what you are doing. Otherwise, if you have changed your company upside down or there is no research coverage, brokers won’t sell the stock.’
Bought deals can also be used as a marvelous marketing tonic. If a group of major underwriters commit their money to a company whose credibility is in question, the market may not want to bet against them.
Nation of Risk-Takers
Bought deals mean the investment dealer puts its capital at stake and bears the risk of selling the issue. While a variation is slowly catching on south of the border in the form of ‘superblock trades’, Canadian dealers are proud of their risk-taking tradition. ‘Block deals are exceptionally efficient ways to raise capital when you know how to price them properly,’ comments Monteith. ‘And the Canadian market has figured out how to price these things.’
Not that there haven’t been a few major jolts along the way. Wood Gundy itself hit dire straits a decade ago when it bought a large offering from BP of Canada only to hit the crash of 1987 before it could market the deal. Two years ago, Nesbitt Burns led a syndicate that miscalculated investor appetite for Air Canada and is said to have sold a significant portion at a loss.
‘Canadians are more entrepreneurial,’ concludes Levesque Beaubien’s Brunelle, who believes US markets are inefficient because the amount of money sloshing around means dealers simply don’t have to risk their capital to do deals.
‘The willingness of underwriters to buy a deal is a key strength of the Canadian market,’ agrees Denys Calvin, managing director and head of Equity Capital Markets at TD Securities. ‘It requires an exceptionally good understanding of the buy side. Major US underwriters are relatively more powerful regarding their clients than are their Canadian counterparts. They just say to issuers, This is how it works.’
The decision to do a bought or fully marketed deal was weighed carefully by Paul Wagler, chief financial officer of the Vancouver-based Loewen Group. He turned down a bought deal in favor of a fully marketed cross-border transaction in May that raised C$545 mn.
It was a bold move. ‘There are some carcasses littering the US financial landscape of Canadians who jumped over the wall and fell into an empty swimming pool,’ wryly comments Wagler. ‘It worked beautifully for us, but it’s not necessarily the strategy which will suit everyone.’
Stampeder Exploration, for example, pulled out of a fully marketed C$150 mn deal in June. In March, Merrill Lynch led a US syndicate hoping to raise C$93 mn for Vancouver-based resort operator Intrawest Corp. In the end, US appetite was misjudged, while Intrawest’s roadshow came during the March market correction, and 60 percent of the issue had to be unloaded back home in Canada.
Meanwhile, Toronto-based real estate giant TrizecHahn had to reduce a cross border offering this summer because its stock hit a 52 week low during the marketing period. In April, ten months after first approaching the US market, Co-Steel Inc ultimately succeeded with a C$125 mn bought deal in Canada. Co-Steel had ‘deferred’ its fully marketed offer as steel stocks moved into disarray during the marketing period.
‘US or other markets need to have a reason why they think it legitimate for you to be there,’ comments Wagler. ‘Most of our income comes from the US and we are large enough to have a natural purchasing audience. But if you are a regional Canadian company who thinks Hey I’ll try the US market, you may be in for a rude shock.’
For its part, Loewen exceeded its 60 percent US content target by two percentage points. It wasn’t the first IR splash Loewen made in the US. Last year, in the midst of a lawsuit in Mississippi, Loewen successfully sold C$302 mn in convertible preferred shares after fireproofing the stock issue and going on the road to explain the structure.
Yet Wagler, with two large marketed deals in the US under his belt, is far from achieving his full objective in the US. Loewen recently brought in an IR director, Chris Hunter, to help in the effort. ‘Lots of big US companies have been around for 30 years and you can’t think that being out there for a month means you have joined their ranks.’ Wagler says that although he believed the Canadian market remained supportive, he was after the maximum market for Loewen stock.
‘By broadening demand – and telling investors that was our strategy – we pushed up the stock,’ says Wagler, who roadshowed in 30 cities and seven countries. ‘At the end, the price had risen three bucks. The nice thing about the US is that you get a lot of coverage. Even to be a small success in that market is already a big benefit.’
Still, Wagler doesn’t exclude doing another bought deal. ‘There are many cases when doing a quick bought deal without spending management time is a good thing.’
Superblock Trades South of the Border
Wall Street underwriters have used ‘superblock’ trades to sell over $10 bn in equity this year. Like a Canadian bought deal, an underwriter buys stock from an issuer and re-sells it to investors.
Unlike a Canadian block deal, however, a block trade requires no prospectus. The stock market surge has undoubtedly made it much easier to avoid lengthy roadshows. Most block trades are secondary issues. Seagram, for example, sold its $1.4 bn stake in Time Warner in less than 24 hours.
