‘New NAFTA’ impact on M&A seen as minimal, with US benefitting most, experts say

17 October 2019

• US auto sector could draw foreign buyers
• All eyes on US in wait for ratification

M&A is down noticeably this year in Canada and Mexico, two of the three parties to the new NAFTA.


And that makes it tempting to assign blame to new provisions in the United States-Mexico-Canada Agreement (USMCA) treaty, which after all has its origins in the desire of President Donald Trump and US organized labor to reverse decades of manufacturing job loss to Mexico primarily, courtesy of NAFTA. In blowing up the tri-lateral trade treaty, Trump’s stated goal was to make America great again for industrial investment.


Tempting, but not entirely accurate, according to experts who study international trade agreements.


While they agree that NAFTA’s replacement will alter the rules for North American M&A, the changes will not be dramatic or sweeping. To the extent that there will be winners and losers, the US is likely to benefit the most, they say.


“Yes, M&A is down in Canada,” observed Patricia Olasker, a partner with the Toronto-based law firm Davies Ward Phillips & Vineberg. “We blame trade wars, Trump, tariffs, interest rate jitters and the waning cannabis trade, but not the USMCA.”

Likewise, in Mexico, where the export of goods and services represents nearly 40% of the country’s economy, the fate of the USMCA has become a “non-issue,” said Sebastian Miralles, managing partner at the Mexico City-based private equity firm Tempest Capital. He said the difference between USMCA and NAFTA “is for all practical purposes minimal.”


Mexico just wants a deal


Mexico has not always been so blasé about the new trade deal. In the spring of 2017, when the US government formally announced it would renegotiate NAFTA, the Mexican peso lost close to 6% of its value against the US dollar on fears it could lose its preferential access to the US and Canadian markets — which account for nearly 80% of its exports.


Today, however, Mexico has gotten “used to the noise” associated with the uncertain future of the revised trade agreement, said Sergio Garcia, managing director at M&A boutique firm Seale & Associates.


M&A activity in Mexico has declined from 57 deals between January and September 2018 to 47 during the same period this year, according to Mergermarket data. The drop is more likely the result of uncertainty surrounding local policy decisions rather than the delayed passage of USMCA, said Martin Plettner, partner at Mexican investment bank RIoN.


Moises Zabaleta of trade consultancy Ansley Consultores added that domestic issues coupled with a possibly looming global recession and ongoing US-China trade tension have “pushed investors to take a standby approach, … which certainly affects deal making.”


And yet Mexico, which is the only country whose Congress has ratified the new trade agreement, continues to lobby for full passage. Earlier this month, Mexican President Andres Manuel Lopez Obrador sent a letter to US House Speaker Nancy Pelosi urging her to approve USMCA.


US auto sector could draw foreign investment


Clifford Sosnow, a Toronto-based partner and co-chairman of Fasken’s International Trade and Investment Group, said the US comes out ahead in USMCA in several ways. The biggest driver of change, he predicted, will be the new provision that requires at least 40% of a vehicle manufactured in Mexico, the US or Canada be made by workers earning at least USD 16 an hour. Vehicles that do not meet the target will be subject to a 2.5% tariff. The requirement also applies to expenditures on automotive R&D, which may comprise up to 10% of a vehicle’s labor value.


So, if a hypothetical Japanese investor wanted to be a player in the North American electric vehicle R&D and production market, the US would be a lot more attractive than before, when Mexico had a significant advantage in labor costs. The lawyer called the provision “a big invitation for the Canadians and Japanese to invest in the US market.”


The USMCA will also change the equation for companies like Deshler Group, a Livonia, Michigan-based automotive parts and logistics company with 98% of its workforce based in Michigan and Ohio, according to Robert Gruschow, owner and president of the near USD 160m revenue company.


“If we were previously considering an investment in Mexico, we may reevaluate that and say it makes more sense to continue to invest in the US,” Gruschow said. Asked if the terms of USMCA would make Deshler more attractive to a potential Japanese or other acquirer, he said, “Sure.”


“Foreign investors will be taking a harder look at the automotive sector in the US,” said Gruschow.


Canadian outlook generally positive


For Canada, not much is changing. As a higher wage country, Canada like the US will benefit from the 40% content provision as it relates to wages in the automotive sector, the experts said.


Fasken’s Sosnow said another win for Canadian deal makers comes from something that is unchanged: USMCA retains the CAD 1.6bn threshold before the Canadian government can trigger a “net benefit to Canada” ministerial review for US-based acquirers of Canadian companies.


For China and other “government-controlled or influenced entities,” the threshold is approximately CAD 416m. Therefore, US buyers will continue to face much less government or regulatory risk than many other buyers.


“If I’m a US investor looking to invest in Canada, it’s generally a good news story,” Sosnow said of the provision and new treaty overall.


Outlook for passage: murky


All three parties to the 1,809-page trade deal signed off on a draft agreement in November 2018. With Mexican final approval in hand and the prospect for Canadian ratification strong, all eyes have turned to the US, where impeachment proceedings have muddied the waters.


“If it passes in Congress, Canada will pass it,” Sosnow said. “Everybody is looking at Congress right now, and that is the bottleneck.”


Majority Democrats in the US House are reportedly seeking changes on certain provisions before a vote. Speaker Nancy Pelosi has said in recent weeks that “we are on a path to yes,” giving USMCA supporters hope.


“The general consensus right now is that Congress had better pass this thing; we don’t want to end up like the UK with no agreement” on Brexit, said Gruschow of Deshler Group. He said a “no-deal” would throw the automotive supply chain “into turmoil if that happened.”