Stay connected

Get the latest insights into Canadian business

Toggle

The FX factor

By Brooke Valentine | December 2, 2015
The FX factor
Brooke Valentine

The decline of the loonie over the past year makes Canadian companies attractive to U.S. acquirers, and that’s bound to be on the minds of business owners who might want to sell, as well as potential foreign buyers 

Although currency-driven bargains may seem harder to resist, mergers and acquisitions (M&A) shouldn’t hinge on foreign exchange (FX) considerations alone. Exchange rates can be a factor in M&A, but a company is making a mistake if it bases its rationale for an acquisition primarily on an FX advantage.

It’s tempting to believe otherwise right now. Canadian businesses look attractive to prospective buyers, given that in August our currency hit an 11-year low against the greenback. The Canadian dollar has recovered slightly since then, but it continues to be dragged down by weak energy prices and widespread expectations that the U.S. Federal Reserve Board will hike interest rates this fall and the Bank of Canada won’t, widening the gulf still further.

Fundamental truths

The exchange gap is something to consider when contemplating a Canadian target company, but let’s put it in perspective.

For M&A, the fundamentals still apply: the quality of the acquisition target, its brand, market position, intellectual property, customer base and more. Acquirers will also want to analyze how the target’s location fits in with their existing business and whether there are other possible synergies between the two.   

Obviously, FX rates can affect valuation; Canadian companies appear relatively cheap to U.S. buyers right now, while potential U.S. acquisitions look expensive to those north of the border. Buyers can gain a deeper perspective through sensitivity analysis, looking at how foreign currency movements affect the target company as a whole.

This might sound straightforward, but it can be complex. The acquirer will want to look at targets that have robust financial reporting and management systems, because determining the real effects of FX on a company calls for examining issues in isolation.

For example, a Canadian business with a high percentage of U.S. customers might have seen revenue climb over the past year as the U.S. dollar’s relative value rose. The challenge is to determine how much of that jump was driven by FX shifts and how much by other forces, such as increases in sales volume, changes in pricing or a new product mix. Isolating all of these factors is no easy task, but it’s worth the effort.

Perform such an exercise on the cost side, as well as on the revenue side. Are some costs influenced by foreign exchange? Do changes in costs mitigate changes in revenue? Only by dissecting a target company’s income statement can a buyer understand its exposure to FX.

Good times, bad times

In the past year, we’ve seen both sides of the impact of foreign exchange on Canadian companies. Those with sizable U.S. customer bases – 50 per cent or more of total sales – are thriving as the Canadian dollar declines and the robust U.S. economy gives them an extra boost.

By contrast, businesses that need to make significant U.S. dollar purchases but sell mostly to Canadians are struggling, unless they can find ways to hedge or to pass on the FX impacts to customers.

Companies can mitigate their FX exposure in the context of an M&A transaction. One way is to use U.S. dollar debt financing as part of the purchase. If the greenback strengthens, the acquisition target’s value will increase, but so will the value of the debt, and vice versa, if the Canadian dollar rises.

Companies can also use FX contracts, but these require considerable management expertise and attention. By locking in an exchange rate for, say, six months, a corporation can protect itself. On the downside, such contracts come at a cost, and the business could find itself on the wrong side of an FX bet.

The key to any analysis of how FX affects a target company is to remember that it needs expert review and focus on detail – the kind of work that should be undertaken with a trusted professional. Due diligence really is key.

The content of this field is kept private and will not be shown publicly.
About PwC Canada Hide Footer