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Normandin Beaudry

The impact of mergers and acquisitions on the S&P/TSX Composite Index

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There, in black and white

NB Bulletin Vol. 10 N. 11, August 2007

Over the last few years, a growing number of Canadian companies have undergone mergers or acquisitions. This trend recently culminated with the acquisitions of BCE by Teachers and Alcan by Rio Tinto, both slated for completion within the next six months. These mergers and acquisitions have changed the content of the Canadian stock market and, in turn, its benchmark, the S&P/TSX Composite Index.

The global economy was and continues to be marked by the strong growth of emerging countries, including China and India, which supports a demand for raw materials. In addition, in recent years, central banks in industrialized countries have maintained relatively low interest rates in spite of recent increases. These conditions promote the financial health of businesses and the creation of significant liquidity.

This context set the stage for the series of mergers and acquisitions that have permeated the Canadian stock market in the last few quarters. The acquirers are primarily foreign companies and private equity funds. This wave drove up Canadian stock market prices, causing acquiring companies to offer premiums for stocks in companies targeted by the transactions. According to some analysts, merger and acquisition activities accounted for more than 40% of the increase in the S&P/TSX Composite Index for the one year period ending on May 31, 2007.

This new reality also decreased the number of Canadian large cap stocks. Once all of the transactions have been completed (as presented in the table below), eleven of the one hundred largest companies in terms of market capitalization within the S&P/TSX Composite Index will have been removed from the Canadian market. 

MAIN TAKEOVERS IN RECENT MONTHS

Acquiring companyTarget CompanySectorIndex
Rank(*)
Index
Weighting(*)

Royal dutch shellShell Canada Energy   9 3.2%
Teachers BCE Telecomm. 19 2.3%
Rio Tinto Alcan Materials 22 2.0%
Xstrata Falconbridge Materials 26 1.5%
CVRD Inco Materials 38 1.1%
Barrick GoldPlacer Dome Materials 40 1.0%
Advanced Micro DevicesATI Technologies Technology 53 0.4%
Kinder Morgan Terasen Energy 69 0.3%
Marathon OilWestern Oil Sand Energy 80 0.3%
Svendkt Stal AB Ipsco Materials 83 0.2%
Arcelor Dofasco Materials 89 0.2%

(*)Index market capitalization data for May 2006.

 The impact of the takeovers of these eleven companies on the S&P/TSX Composite Index is estimated at 12.5%. Only the transaction involving Barrick Gold and Placer Dome remains capitalized on the Canadian market.

The decreasing number of available large cap stocks is negatively impacting the importance of the Canadian market globally, as Canadian large cap stocks account for less than 3% of global market capitalization. Although the majority of transactions target the Energy and Materials sectors, the S&P/TSX Composite Index remains very concentrated in three sectors: Energy, Materials and Financial Services. These three sectors accounted for 75% of the S&P/TSX Composite Index as at June 30, 2007.

A number of factors are prompting institutional investors to support increased foreign diversification of assets: the decrease in the number of large cap stocks, the composite index’s concentration in three key sectors, the Canadian dollar’s strength in recent years and the excellent returns generated by the Canadian market.

 

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