Top Stocks in Canada Find Buying Their Way to Growth Pays Offby and
Weak economy, low corporate taxes set to stoke more acquirers
What happens when the dealmaking stops, some investors wonder
Canada’s best-performing stocks are finding it’s better to buy growth abroad than expand at home.
Nine of the 10 top gainers in the Standard & Poor’s/TSX Composite Index in the past two years have used deals to help propel growth, including drugmaker Concordia Healthcare Corp., technology company Constellation Software Inc. and convenience-store operator Alimentation Couche-Tard Inc. Returns have ranged from more than double to almost seven-fold, outstripping the 5.4 percent advance of the Standard & Poor’s/TSX Composite Index, which came in 17th out of 24 developed equity markets over that time.
Companies that do deals to advance growth are expected to double to about a 20 percent share of the S&P/TSX, from about 10 percent to 12 percent currently, spurred in part by Canada’s low corporate tax rate, said Ian de Verteuil, portfolio strategist at Canadian Imperial Bank of Commerce.
“They want to be based in Canada and they are not just selling out to the next guy who comes along at a higher price,” de Verteuil said by phone last week. “They would say: ‘There’s no reason we can’t be predator rather than prey.”’
The model has proved a bright spot for investors as the collapse in commodity prices stunts economic growth along with shares of corporate stalwarts such as Suncor Energy Inc. and Royal Bank of Canada. It’s also come under increasing scrutiny as investors question what happens when the deals slow and whether they’re paying too much for their targets.
“It works until it doesn’t,” said Som Seif, chief executive officer at Purpose Investments Inc. in Toronto, which manages about C$1.4 billion ($1.1 billion). “You don’t have a sustainable business model if you can’t grow the assets themselves.”
Jamal Baksh, chief financial officer at Constellation Software, declined to comment on the Toronto-based company’s business strategy. Mark Thompson, chief executive officer of Concordia, said in an e-mail the company’s mergers and acquisitions model is tried and true, and stands the test of time. Couche-Tard CEO Brian Hannasch, said his company is happy to be known for doing “smart” acquisitions.
A top example of the growth-by-acquisition model is Valeant Pharmaceuticals International Inc., which briefly eclipsed Royal Bank of Canada to become the biggest stock in the country earlier this year. The Laval, Quebec-based company announced 18 pending and completed acquisitions over the past two years worth $15.8 billion, according to data compiled by Bloomberg.
"Supplementing our organic growth with strategic M&A has led to great success across our global platform and generated significant value for shareholders,” Laurie Little, a Valeant spokeswoman, said in an e-mail. The company recently had its fifth consecutive quarter of same-store organic growth topping 10 percent, she said.
Valeant’s stock has slumped 56 percent in Toronto from an Aug. 5 high amid increasing scrutiny by lawmakers on the industry’s pricing practices and after stock-commentary site Citron Research accused it of using its relationship with Philidor RX Services, a mail-order pharmacy, to falsify prescription drug sales in the U.S. Valeant has called the allegations “erroneous.”
CIBC’s de Verteuil counts 14 growth-by-acquisition firms in the S&P/TSX, including tech company CGI Group Inc. Buttressed by a corporate tax rate of about 26.5 percent compared with 40 percent for the U.S., the companies have looked outside Canada for growth.
In the process, they’ve returned 14 percent on average this year, compared with a decline of 2.8 percent for the S&P/TSX Index, according to a note dated Oct. 22. On a three-year basis, the companies averaged a 33 percent gain versus 7 percent on the S&P/TSX and a 15 percent advance for the S&P 500.
“Growth is in our DNA,” Couche-Tard’s Hannasch said in an e-mail. “We are happy to be known for making smart acquisitions and for being an effective integrator, but we are never going to favor store count over profitability.”
Couche-Tard’s recent M&A includes a $860 million deal for The Pantry Inc., closed in March, that added about 1,500 stores in the U.S. Including debt, the transaction had an enterprise value of $1.7 billion.
Both organic growth and acquisitions are important, Lorne Gorber, a Montreal-based spokesman at CGI Group said in a phone interview. “It’s not one or the other. The reason you do M&A is to make a broader, deeper platform you continue to grow organically, so they work hand-in-hand.”
Returns at Concordia, whose shares have come under pressure amid lawmakers’ focus on drug pricing, have still surged 584 percent in the two years until Oct. 23, making it Canada’s top-performing stock, according to Bloomberg data. The company completed five deals worth $5.6 billion including its purchase of Amdipharm Mercury Ltd. on Oct. 21.
Concordia’s mergers and acquisition model has focused on buying well-established products, not companies it strips down to find synergies, CEO Thompson said in the e-mail. With the acquisition of Amdipharm, “we have an incredible platform for growth and will continue to use this model to deliver greater value for all our stakeholders.”
Brandon Osten, chief executive officer at Venator Capital Management Ltd., said the issue with some of the acquirers, which are sometimes called rollups, is valuations.
“I can buy rollups in the U.S. for half the valuation of ones in Canada," said Osten in an Oct. 14 interview in Bloomberg’s Toronto office. His firm manages about C$300 million. "What happens if Constellation goes two years they can’t find anything they want to buy? Will it go to C$260 because it should only trade 10 times earnings?”’
Constellation Software, which closed yesterday at C$555 share in Toronto, trades at about 54 times earnings, compared with about 20 times earnings for Spectrum Brands Holdings Inc., a consumer products company Osten owns and considers an example of a U.S. rollup. He’s shorting Constellation.
Dany Assaf, co-chairman of the competition and foreign-investment group at law firm Torys LLP, said there’s nothing inherently wrong with rollups.
“If your home market isn’t growing, you have to get creative,” Assaf said in a phone interview. “It’s a strategy that’s been long overdue for Canadian companies, not only to be strong in your home market, but to also grow your geographic footprint.”