Let’s Buy Canada!
The Merger of the Century
A Well-Valued Canadian Stock
Patriots Day is not a federal holiday in the U.S., but it is a state holiday in both Massachusetts and Maine. However, because the stock market is open, I’ve always worked on this day, even while most Massachusetts residents take the day off-and many people run in the Boston Marathon.
So every year for decades, I’ve spent my lunch hour watching the finish of the marathon.
Last year I was watching as two losers who did not share the American Dream sowed death and destruction near the finish line.
Since then, the community has rallied about the phrase Boston Strong, coming together in a shared healing process, and this is a good thing.
But it’s been an emotional process, rather than an intellectual process. And aside from stepping up security, little has been done from an intellectual standpoint to actually change the conditions that created that awful situation in the first place.
So, as a counterpoint to the Boston Strong movement (which experience tells me likely peaked today as I watched the marathon’s finish), I want to share a big intellectual idea-a big National Idea-that is not at all widespread, never mind popular, but that I think deserves consideration.
The root of the idea is the book, Merger of the Century, by Diane Francis, an American-born Canadian journalist who’s authored nine books on Canadian socio-economic topics.
The central idea of the book is simply this: that the United States and Canada should merge, to create a continent-wide superpower with excellent growth potential.
Many Canadians, of course, will laugh at this. They don’t want to see their lovely country absorbed into the blankety-blank U.S.
And many U.S. citizens simply don’t see much to gain. They seldom think about Canada, except when our sports teams play each other.
But every big idea starts as a small idea, and I think this one deserves further exploration.
So here, in brief, are the bullet points that lay out what would be “The most audacious initiative since the Louisiana Purchase.”
The biggest challenge in the U.S. today is slowing economic growth. We have workers, but we don’t have enough jobs.
The biggest challenge in Canada is developing its huge landmass, as it lacks capital, workers and technology.
So on the simplest level, this idea is about making it easier to get U.S. money, workers and technology into Canada to develop its resources.
But there’s more, and perhaps the biggest outside factor is China, which is currently growing its economy at a 7.4% rate and is projected to top the U.S. economy somewhere between 2016 and 2028 (mainly it depends on what you measure).
China is also our biggest creditor. So far the Chinese have played nice, but the global history of credit says we’d be much more secure if we had less debt, and if it were held by friendlier entities.
And China is a threat to Canada, too. In 2012, China oil company CNOOC bought big Canadian oil company NEXEN for $15 billion, despite opposition, and there’s no doubt China will buy more as opportunities arise.
Also troubling is Russia, particularly since the opening of the Arctic Ocean gives Russia greater access to the top of North America-and since Canada is largely dependent on the U.S. for its defense. Yes, Canada has an army, but it’s only effective because the U.S. stands behind it.
So in one sense, Francis’s proposal is defensive. It’s about proactively countering the threats of China and Russia-and the longer we wait, the harder the Chinese threat in particular will be to deal with. But it’s also offensive, because a merger would enable great synergies that would keep the new entity a superpower for decades-even centuries- to come.
THE BARE FACTS
Canada has 35 million people, while the U.S. has 318 million.
Canada has 3,854,085 sq. miles, while the U.S. has a little less, 3,794,101 sq. miles.
Thus Canada has 8.3 people/sq. mile, while the U.S. has 88.6 people/sq. mile.
Both countries embrace democracy, free enterprise, the rule of law and pluralism.
The biggest difference in culture is the roughly 25% of Canadians who claim French Heritage.
Beyond them, Canada is decidedly Anglo-Saxon, as it separated from the U.K. much later, while the U.S. is more multicultural, with a notably higher weighting of Germanic culture than Canada.
Canada is more socially liberal, but so are the people who live in the states closer to Canada, where’s there’s already plenty of cross-border trade.
In fact, the two countries are already each other’s largest customers. 73% of Canada’s exports come to the U.S., while 19% of all U.S. exports go to Canada. But that border adds a lot of friction to trade between the countries, even after the passage of NAFTA.
Remember how hotly debated NAFTA was? It’s been 20 years since it was implemented, and I don’t hear anyone arguing that we should go back. So in one sense, this idea is more of the same. Removing the border totally would enable more commerce.
America’s greatest assets, in addition to its technology and labor force, are its culture of risk-taking and entrepreneurship.
Canada’s greatest assets are its resources, its stable banking system, and its educated, law-abiding people.
But the great white north remains largely untapped. While the U.S. has developed Alaska, building a pipeline that’s carried more than 17 billion barrels of oil, and Russia has developed Siberia, building seven cities that each hold more than 500,000 people, Canada has done little.
With a merger, the new entity, whatever it’s called, can remain a technological superpower. It can become an energy superpower. It can have the world’s strongest currency. And as synergies bring growth, debt will shrink as a percentage of the whole. Also shrinking, on a relative scale, should be defense budgets.
To get there, Ms. Francis proposes five options, just to get the conversation started.
Option 1: Merger Model a.k.a. Project Great Lakes
Structured like any corporate merger of unequals, this model relies on an initial valuation of each country’s assets: GDP, land, oil production, oil reserves, crops, water resources, public debt and more. With the assistance of a merger expert, Francis valued the Canadian contribution to the merged entity at 18%. Given that Canada has just 10% of the population of the merged entity, that reflects an “over-contribution” of roughly $17 trillion by Canada, which would have to be paid by the U.S. to Canada, and which works out to $492,529 for every Canadian citizen (to be paid over time).
Option 2: A Mining Merger Model
This model uses techniques common to mergers of mining companies, valuing cash flow to the government from royalties and taxes as well as land value. Francis calculates these at $1.1 trillion and $6.6 trillion. Add in an earn-out agreement, which would reward Canada for the increase in productivity from Canada’s previously underutilized resources and $5 trillion for a “health-care “top-up” and you get to $12.6 trillion.
The financing possibilities for both these options, which Francis investigates, would be accomplished over decades-20-year and 30-year bonds are possible-and would reward Canadians in the first few decades. But in the long run, assuming all works out, everyone would win.
Option 3: The World’s Biggest Farm-In
Farm-in is oil industry jargon for a business arrangement between an oil company and a landowner, and it could work in this case because most land in Canada (roughly 89%) is owned by the government. Much of this land is already staked or leased by companies, but a right of second refusal (after Canadians) could be granted to the U.S. for the remainder (and current deals that expire), and the result would be a flood of new capital into the Canadian economy. The resulting new jobs would be filled in the majority of cases by workers from the U.S., as Canada expects manpower shortages for decades to come. If all goes well, expanding the arrangement to Option 1 or Option 2 would then appear more palatable.
Option 4: A Farm-In with Other Countries
If the U.S. were unwilling to shoulder the entire burden, other countries could join in. Asians could team up-after making large up-front payments-on deals that brought oil and gas out of the McKenzie Delta. Europeans could buy rights to minerals in the Northwest Territories. And American technology companies might target lands where rare earths are found. Again, there would be potential for further collaboration in the future.
Option 5: Carve-outs
Also known as a partial spin-off, this would transform Canada’s current passive land ownership system, run by bureaucrats, into an active system run by profit-seeking public-private partnerships. Canada would retain majority control of the land, but partners would reap the benefits of profitable growth made possible by their investments of capital, manpower and technology.
As we all know, politics can-and frequently does-trump business. And the partisan factions that dominate discussion in the U.S. today (not to mention Canada) would certainly find plenty to object to in any U.S.-Canada merger plan.
So what could make a merger (or a lesser deal) happen? In my opinion, it almost certainly won’t be a rational analysis of the potential for synergistic growth from here. That requires too much open-mindedness and optimism.
Instead, it would only happen (after much discussion) if the outlook gets substantially bleaker for the U.S. Furthermore, the first move would probably have to come from the weaker party, Canada (which is how NAFTA got started).
Today, about 48% of U.S. citizens support a merger with Canada, while only 20% of Canadians support a merger, so I’m not holding my breath. But I would like to see the conversation started.
So feel free to pass the idea on to your friends. And while you wait for the discussion to get rolling, you can have fun by thinking up names for the new entity.
United States of Canada? Canmerica? North America?
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Sticking with the Canadian theme, today I bring you a Canadian stock, selected by Roy Ward, our value investing expert and longtime editor of Cabot Benjamin Graham Value Investor.
It’s Magna International (MGA), with headquarters in Aurora, Ontario. Here’s what Roy wrote about the stock in his February issue.
“Magna International is an independent supplier of original equipment components, assemblies, modules and systems and related tooling for cars and light trucks. The company designs, develops and manufactures products for North American, European and Asian car and truck manufacturers. The world’s major automakers are progressively outsourcing complete vehicle systems to large parts makers. Magna’s vast size and capabilities are beating out smaller rivals, a trend that will likely continue in the future. The company is also actively acquiring companies that are immediately adding growth, profitability and earnings.
“For the 12 months ended 12/31/13, sales increased 12% and EPS climbed 18%. Cost control and better efficiency are producing bigger profits. Also, Magna is clearly taking market share from competitors at a time when car and truck sales are robust in North America. In addition, the company’s revamped European operations are producing better-than-expected results. I expect sales to increase 7% and EPS to rise 19% for the next 12 months ending 12/31/14.
“At 13.6 times current EPS and with a dividend yield of 1.5%, MGA shares are attractive. Magna’s balance sheet is strong with minimal debt. Buy MGA at the current price. I expect the stock to rise to my 102.24 Min Sell Price within one year.”
That was written in February, when the stock was trading at 87. It did climb to a high of 101 in early April, nearly reaching Roy’s goal, but by then Roy had raised his goal! Or I should say his model had raised his goal, because there’s no judgment in Roy’s analysis-everything is quantified; Roy enters the numbers and the computer spits out the target valuation.
So what should you do today, as the stock sits just under 100 and yielding 1.6%?
If you own it, hold on (even Citigroup recently upgraded the stock from Sell-a very rare rating for a brokerage-to Neutral).
And if you don’t own it?
Well, you could certainly jump on board here. The stock has held up very well through the market’s selling pressures in recent weeks, telling me it has strong institutional support.
But even wiser would be to take a trial subscription to Cabot Benjamin Graham Value Investor, so you can get Roy’s regular updates on the stock, and, most importantly, be advised of the new target price, so you know when to sell.
Yours in pursuit of wisdom and wealth,
Chief Analyst, Cabot Stock of the Month
Publisher, Cabot Wealth Advisory