Feds raise foreign takeover threshold – but there’s a catch

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The Federal Government is raising the threshold at which foreign takeovers of Canadian firms will trigger a review under the Investment Canada Act. But because of a change in how a target company's size will be calculated, it could lead to an increase in the number of deals being scrutinized, not a reduction.

In addition to extending the length of time devoted to reviews of such takeovers, as reported by the Globe and Mail Wednesday, the government announced that on April 26 the size limit for target companies exempt from review will increase to $600-million from the current $369-million. In 2017 the figure will climb to $800-million and in 2019 it will rise to $1-billion. These numbers apply to takeovers by World Trade Organization member countries only, among other restrictions.

Sounds like the deep freeze on foreign investment ushered in by new guidelines in 2012 is thawing, right? Not so fast. Crucially, the government will use a target company's enterprise value instead of book value when it is figuring out how much a deal is worth. Book is the value of a company's assets minus its liabilities. Enterprise value is market capitalization plus debt, and is almost always higher than book value. Sometimes, dramatically higher.

"If they kept the limit at $369-million [book value] but moved it to enterprise value, for sure, more companies would fall under review. No question about that," said Dimitry Khmelnitsky, analyst with Veritas Investment Research in a telephone interview.

"Generally, companies are traded at more than their book values. There is future expectations of earnings, there is fair value of the assets, which are generally higher than their book value."

Mr. Khmelnitsky believes that, thanks to the change in valuation metric, increasing the threshold to $600-million could result in more deals being scrutinized than under the present $369-million rule. And even when the trigger goes to $1-billion he expects it will be "a wash" – i.e. the same number of deals will still be getting yellow flagged.

The government is also keeping in place its existing stringent rules regarding proposed takeovers of Canadian firms by foreign state-owned enterprises (SOEs).

"Reflecting the greater scrutiny accorded investments from SOEs (announced by the Prime Minister himself in 2012), those investors from WTO countries will continue to be subject to the current lower threshold, based on book value and adjusted annually," wrote Michael Koch and Joel Schachter, partners with Goodmans LLP wrote in a note published Thursday.

Canada already has a more stringent takeover review process than our neighbours to the south.

"The U.S. does not have a net benefit review, but it does have a national security review. In Canada we have national security and net benefit [review]," said Mr. Koch in a telephone interview.

Ultimately, the change in the rules that appears to make Canada a more takeover friendly jurisdiction may end up being no more than smoke and mirrors.