Written by David A. Dodge
As a year of increased economic uncertainty approaches, Bennett Jones provides its forecast for Canadian business in 2009.
Short Term Economic Outlook Grim
Despite stimulative efforts of governments and central banks worldwide, global growth in 2009 is likely to be less than 2% and 2010 only a little better. Real recovery should take hold in 2011. Commodity prices are likely to be weak through 2011 but recover strongly thereafter. Canadian and U.S. growth will be negative in 2009 with very weak private investment and household consumption. Assuming significant fiscal stimulus in both countries, growth should begin to pick up in 2010 although the level of output in Canada is not likely to recover to the mid-2008 level until end of 2010. Outlook for 2011 is much brighter in Canada and the U.S. although unemployment will remain elevated.
Credit Crisis Continues, Cash Still King
The current credit crisis should begin to ease by mid-2009 as a result of massive infusions of liquidity by central banks and infusions of capital by governments. Frozen capital markets should begin to thaw later in the year although credit spreads will remain wide and credit conditions tough. Debt will remain expensive and equity dilutive. Challenges in renewing credit facilities, replacing bridge facilities and financing acquisitions or projects will necessitate creativity with alternative sources of capital and the structuring or restructuring of investments.
Insolvencies Up, Restructurings Down
2009 will bring more corporate insolvencies and restructurings. Increasingly, however, troubled companies well-deserving of restructuring will likely face break-up due to the dearth of liquidity, coupled with an extremely competitive business environment. Even those restructurings that do proceed will likely do so with less committed or DIP (debtor-in-possession) financing and more of a lock-in for those already invested.
Renewed Focus on Risk Management
The financial sector meltdown and the global economic crisis have moved risk management to the top of corporate and regulatory agendas. Companies must carefully assess their financial exposure and exposure to third-party providers, such as lenders, hedging counterparties, suppliers and technology licensors who may themselves face financial crises. Businesses must be prepared for all eventualities that could arise quickly: a liquidity crisis, sale or reorganization, significant litigation or regulatory or internal investigation. Data rooms, document retention programs, disclosure committees and multi-disciplinary teams must be operational, or available quickly.
Challenging Disclosure Issues
Publicly-traded companies will be increasingly challenged in managing disclosure of a broader range of risks, including liquidity problems, declining revenues and counterparty credit risks. Issuers face the double-edged sword of avoiding premature disclosure, which could result in undue loss or negative market impact, and tardy, incomplete or misleading disclosure that could result in regulatory or civil liability. New rules on executive compensation disclosure will also apply and reporting will be required on transitioning to IFRS rules.
Increasing Pressure on Directors
Boards of directors and management will work at developing improved processes to identify and assess risk. This will involve recognition that the task is not for the audit committee alone, but involves full board and deep corporate commitment. Boards will also look to ensure that adequate processes are in place to support new requirements for CEO and CFO certifications of internal financial controls. Watch for increased use of special committees to address related-party and conflict transactions expected as a means of survival in a world of limited options. Expect directors to insist on contractual indemnification. And, look for increased pressure on insurance procurement processes with the anticipated hardening in D&O insurance markets.
Bad times have illustrated that targets cannot rely on a buyer's reputation to use best efforts to complete an acquisition. Expect targets to focus on Material Adverse Change/Effect clauses and to draft more detailed specific performance and damage remedy clauses. More attention will also be given to how to secure completion obligations where the buyer is outside the jurisdiction or without financial resources.
Market Meltdown Means More Litigation
Any market meltdown brings with it disappointed investors who will look to their investment advisor for redress. Expect a huge increase in litigation against brokers and dealers as investors come to fully appreciate the extent of investment losses. Watch for more accounting manipulations and fraudulent schemes to be discovered and ensuing litigation. Also look for more Securities Act secondary market class action claims, which emerged in earnest in 2008, to flourish in 2009.
Oil and Gas Sector Challenges
With wildly fluctuating commodity prices, the lack of liquidity available to fund growth and increased uncertainty surrounding the environmental obligations of energy project developers, expect 2009 to pose a multitude of challenges for oil and gas companies. Major oil sands projects will continue to be delayed or downsized as proponents await the return of $100 oil and easy credit, necessitating the renegotiation of supply arrangements. Junior developers may well have to look for a way out. On the conventional side, buyers and sellers will begin the year watching and waiting for the first movers, but when the "new normal" arrives, look for significant consolidation at the junior end of the market. And what about the larger Canadian independents about whom take-over rumours persist? We'll have to wait and see.
Green Economy not to be Delayed
The arrival of the green economy will not be delayed by the economic downturn. Increasingly, market-based solutions to environmental and social issues will be sought, found and implemented. For example, the great experiment with greenhouse gas emissions trading as a key element in the climate change solution will finally get traction in 2009 and be ready to roll in 2010. Beware potential new climate change rules in the U.S. which will make life difficult for a number of Canadian businesses producing both primary and manufactured products.
Increased Focus on Renewable Energy
Fossil fuels will continue to be critically important and in short supply despite the economic slowdown, accelerating the pressures to move to renewable energy and low carbon alternatives. Government-owned utilities will seek additional renewable power sources and the need will be met by new private renewable power developments. Geothermal, biomass and biogas based power will gain momentum, augmenting the Canadian wind and solar power development industries.
Income Trusts – Converts or Targets?
There will be more conversions announced of the approximately 200 income trusts ahead of the 2010 tax "deadline". Conversion at today's depressed market prices will help ease the churn in units which inevitably takes place following conversion announcements, when yield oriented investors sell and value-oriented investors buy. However, with more than half of the income funds having a market capitalization of less than $150 million, declining distributable income and the costs and risks associated with being a publicly-traded vehicle, expect to see more income funds acquired.
REITs - Real Estate in Trouble?
The market value of REITs has plummeted as the property market has fallen, capitalization rates have risen for many property types, credit spreads have increased and leverage has declined. Existing strategies regarding financing and acquisitions and dispositions of properties may no longer be feasible. As REITs rethink their strategies, expect to see divestitures of assets and significant consolidation.
Attractive Technology Opportunities
Innovative technology start-up companies will find it difficult to obtain private investment. Some promising technologies will therefore become available at favourable prices through acquisitions, licensing or other transactions. Private placement investment at the seed capital and venture capital stages, where available, will be able to extract more value in exchange for investment.
More "User Friendly" Competition Law
On the heels of this year's report of the Competition Policy Review Panel, look for the government to streamline the merger review process to include greater convergence with the timing of U.S. antitrust review, allowing most transactions to be cleared in a 30-day preliminary phase. Pricing practices like price maintenance, predatory pricing and price discrimination will likely be de-criminalized. A weakened economy may also result in more flexible review of mergers that increase efficiency and allow industries to undertake necessary consolidation.
Less Red Tape for Foreign Investors?
Also in response to the Competition Policy Review Panel, watch for the government to increase the general review threshold for foreign acquisitions of Canadian businesses, likely from $295 million to $1 billion. However, the cultural sector will probably be excluded. The government may also shift the onus from the foreign investor to the Minister of Industry to establish that a proposed acquisition is not in Canada's interest.
Trade Diversification: the New Mantra
Recession will lead to more international trade disputes as demand and pricing decline and international competition intensifies. Chinese exports in particular will be targeted. Expect more WTO and NAFTA complaints by Canada as the government seeks to protect Canadian companies' access to foreign markets in a more protectionist international environment. Weakened U.S. demand and retrenchment in Canada's manufacturing sector will give increased focus and urgency to bilateral and multilateral trade initiatives.
More Interest in Islamic Finance
Expect the Islamic financial sector, which still enjoys relatively high-liquidity, to play a larger role in international finance. Some portion of that sector's excess liquidity should find a home in Canada, as a result of Islamic investors diversifying their investment portfolios and capital-hungry Canadian businesses making greater attempts to tap into this available pool of funds.
Pension Underfunding Concerns
Concern over deficits in defined benefit pension plans will continue to be front and centre, as many businesses deal with crippling funding costs resulting from the market meltdown. There will be continued pressure on governments to provide relief from solvency funding requirements. Expect pension governance and disclosure to emerge as a key area of focus.
"New Deal" for Infrastructure
Canada has evolved into one of the world's most vibrant markets for public-private partnerships (PPP) in infrastructure. Mature provincial agencies are tackling an infrastructure deficit of over $125 billion, domestic and international proponents have committed to the market, and PPP is now recognized as a viable alternative for many projects. As governments announce fiscal stimulus packages with infrastructure as a key component, the pipeline for PPP activity promises to be robust, although financing structures may evolve in response to tighter credit markets.