The net losses test [CNOOC takeover of Nexen] – by Steven Globerman (National Post – August 1, 2012)

The National Post is Canada’s second largest national paper.

Steven Globerman is Kaiser Professor of International Business, Western Washington University College of Business and Economics, and adjunct professor, Simon Fraser University, Beedie School of Business.

Imposing conditions on foreign takeovers has costs

he recent announcement that CNOOC, China’s large multinational oil company, is bidding $15.1-billion for Canadian energy producer Nexen brings into focus the Canadian government’s vetting process. Under the Investment Canada Act, foreign takeovers of large Canadian companies must pass a “net benefit” test. That is, a foreign takeover of a Canadian company must convey additional economic benefits to the Canadian economy over and above those currently being realized under domestic ownership.

Over the past 20 years, the Canadian government has blocked only two proposed takeovers. The most recent was the attempted takeover of Potash Corp. of Saskatchewan by BHP Billiton, a large Australian mining company — the “strategic value” of retaining domestic ownership of Saskatchewan’s large potash mines was seen as exceeding any advantages that would be created by BHP Billiton operating the mines.

It is obviously desirable for a foreign takeover of a domestically owned company to contribute additional wealth to the Canadian economy. What is not obvious is why requiring federal government approval of the takeover makes achieving this objective more likely. Indeed, a strong argument can be made that requiring approval of large takeovers reduces the economic benefits to Canada of inward foreign direct investment.
The basis for skepticism about the use of a net benefits test is the reality that equity valuations of companies are set in competitive and relatively efficient global capital markets. Thus, the stock prices of publicly traded companies should more or less reflect the discounted future expected profits of those companies. A foreign acquisitor should therefore only be willing to pay a premium over the existing stock price to acquire a company if it believes that it can earn more than the discounted future profit stream currently built into the market price of the target company.

While potential acquisitors may have different reasons for being relatively optimistic, one plausible reason is that acquisitors believe they can operate the existing assets of target companies more efficiently than the latter are currently being operated. In this case, an acquisitor should be willing to bid a higher price for the target company’s common shares than are other investors. An acquisitor should be willing to bid up the price of the target’s common shares until virtually all of the expected increases in future profits from the change of ownership are captured by the current shareholders in the form of capital gains. As such, competition in equity markets will ensure that there are net benefits arising from foreign takeovers, and that domestic shareholders receive a substantial portion of the expected net benefits in the form of capital gains.

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