Prepare for the 'Canada Discount' Bogeyman

by: Mark McQueen

News item: Industry Minister Tony Clement turns down BHP bid for Potash (NYSE:POT)

Get ready for the onslaught. The naive, yet well-meaning, free-marketers among us will unleash a series of seemingly irrefutable, cogent arguments over the coming days. They’ll focus on two sound tracks, and will dazzle members of the media with their economic sophism.

The first argument will be the “Canada Discount” one.

Under the “Canada Discount” scenario, claims will be made that the Potash decision will put a pox on the house of every Canadian public company. Without the inherent takeover spec that most large public companies enjoy, Canadian firms will be at a disadvantage. Let’s stand back and look at the macro picture, before taking that point of view as gospel.

Dozens of large Canadian public companies are already protected from the very takeover that Potash is dealing with. You’ll recognize many of the names:

Astral (OTC:AAIAF)
Bank of Montreal (NYSE:BMO)
Bank of Nova Scotia (NYSE:BNS)
Cameco (NYSE:CCJ)
Manulife (NYSE:MFC)
Rogers Communications (NYSE:RCI)
TD Bank
The Royal Bank of Canada (NYSE:RY)

Pull up the valuations of these firms on Bloomberg or Yahoo Finance, and compare them to similar players elsewhere in the U.S., U.K. or Australia, for example. Do you see much of a discount by virtue of the fact that none of these Canadian household names can be easily acquired, if at all? And these are the Big Daddies — the ones that attract international investing attention due to their size, market position and liquidity.

But most of Canada’s public companies are smaller than $5 billion, even $2 billion. None of them is likely impacted by the “economic nationalism” that has allegedly taken hold here in the Great White North. There’s nothing particularly “strategic” about Magna International (NYSE:MGA), even with a $10B market cap., despite the financial success that Frank Stronach has created for shareholders, and the jobs he’s created for Canadians. That’s why a Magna takeover deal would sail through Ottawa if it were announced tomorrow.

The second strain will be along the lines of: “this decision will increase the cost of capital for Canadian firms."

My naive freemarket friends will tell you that when Canadian firms go to New York or Zurich to raise equity capital, their valuation and the appetite for their story will be impacted as a result of Canada’s Potash decision.

Such hogwash. Name me the investors who bought Potash shares a year or three ago on the basis that, someday, a takeover might occur. While that may always be in the back of a portfolio manager’s mind, the truth is the analysis is more basic than that. Commodity stocks were flying, whether it be copper, potash or gold. Increasing population levels, and ramping industrialization in India and China, meant that fertilizer and the food chain in general was a focus of media attention. Potash had plenty of opportunity for growth, and was well-positioned within the cartel. And, the deposits were in jurisdictions that were transparent, and not Russia or China…where the sheer sense of private ownership of mining rights may be in doubt at some point down the road.

Most PMs buy stocks based on a combination of sectoral choice, earnings growth, relative valuation, momentum, yield, etc. The idea that Magna or Encana (NYSE:ECA) won’t be able to raise capital at the same price they could have last week relies on the existence of an unprovable element in the international stock selection process.

Disclosure: I own POT puts; we own BCE, BMO, BNS, RY, TD in our household.