Australia buyouts: Patience is a virtue

OzForex has come a long way from its humble beginnings 16 years ago, when the company was run out of a spare room in a house in Sydney's northern suburbs. It is now one of the world's largest online foreign exchange platforms, with 170 staff, offices on four continents, partnerships with Moneygram and Travelex, and A$9.1 billion ($8.2 billion) in transfers last year.

In October 2013, OzForex went public on the Australian Securities Exchange (ASX), raising A$440 million through its IPO and providing exits for The Carlyle Group, Macquarie and Accel Partners. The offering was priced at 12.7x the company's forecast earnings for 2014.

A number of potential acquirers were circling the company ahead of the offering, say people familiar with the situation. None of these groups was willing to pay anything like the multiple OzForex thought it could obtain via the public markets.

It is a familiar refrain. While Australia's record year for private equity-backed IPOs in 2013 has presented managers with much-needed liquidity events, it has pushed up the valuations being asked of those looking to buy.

"People see businesses out there at 10.5x EBITDA or more and they think their companies are worth the same amount," says David Willis, head of private equity at KPMG Australia. "I know of several forthcoming IPOs that also have a trade sale mandate and, even at the low end of the bankers' book range, it is still a way off what trade and secondary PE buyers are willing to pay."

The view is echoed by a regional buyout manager who claims to have seen a number of deals fall through because the sellers are looking for higher valuations at IPO. "The investment banks tell them 12x is possible and the sellers believe what they want to believe," he adds. "In some of those cases the companies have yet to go public."

Mixed feelings

According to Thomson Reuters, 44 offerings between them generated A$9.6 billion in 2013, the largest annual total since before the global financial crisis. More than one third of these IPOs and close to two thirds of the total proceeds came in December alone. According to AVCJ Research, nine PE-backed offerings raised a record $2.5 billion, up from $156 million from three IPOs the previous year.

The headline PE investment numbers also look impressive, with $12 billion deployed, a 25% gain on 2012, although more than half came from two infrastructure deals. Mega transactions in this area are not uncommon - indeed, they accounted for a sizeable portion of the previous year's deal flow. But the more telling difference between the two periods is the drop in activity in the middle market.

In 2012, 14 deals were completed with an enterprise value of more than $150 million; four were in excess of $750 million and five were below $300 million. Last year, the deal count fell to 12, of which three came to more than $750 million and six were below $300 million. The number of deals in the $300-500 million range dropped from four in 2012 to zero last year.

Both Pacific Equity Partners (PEP) and CHAMP Private Equity, having each deployed in excess of $1 billion in 2012, were far less active last year. Quadrant Private Equity saw a less substantial drop - from $856 million to $420 million - while Archer Capital's increase came after a relatively quiet 2012.

For PEP and CHAMP, the last 12 months have been spent digesting the earlier glut of deals. John Haddock, managing director at CHAMP, admits that in 2013 the firm was "more portfolio company focused," after completing three buyouts and one substantial bolt-on acquisition the previous year. PEP's annual average deployment is A$550 million equity; in 2012 it invested double that amount. Similarly, Archer's slow 2012 followed a year in which it also committed more than $1 billion.

"You are given 5-6 years to invest the money it doesn't always work out as two companies a year for 10 in total," Haddock explains. "There are ups and downs, and then once you've made investments there is work to be done. It's the job of the manager to take into account all those constraints - getting the money deployed and how quickly you deploy it."

Of course, this doesn't mean private equity firms stopped looking for potential deals.

PEP estimates there are 1,700 companies or entities in Australia and New Zealand of A$250 million to A$1 billion in enterprise value that meet its broad investment criteria. On average, the GP will look at 80 per year or less than 5%, of which 14-15 are taken forward for deep due diligence. The number of deals presented in 2013 was down slightly, but the standard 14-15 were attractive enough to warrant closer consideration.

"We saw the same number of quality deals that we liked - many more in the second half than the first half, but in line with the 10-year average - but the number of those deals that actually traded by calendar year end was significantly down," says Tim Sims, co-founder and managing director at PEP. "They were put into the market, entered a process or we bid on them and the vendor has not yet dealt the asset."

Industry participants offer numerous reasons for deals failing to transact, and not all agree that the public markets revival had a debilitating impact. CHAMP's Haddock observes that, although IPOs present another option to business owners who might otherwise sell to private equity, an active market is also an optimistic one and this can facilitate deal flow.

Indeed, the general upward trajectory of the S&P ASX 200 mirrors feedback on business sentiment and conditions in National Australia Bank's latest monthly business survey. Conditions - an average of the indexes on trading conditions, profitability and employment - swung from a multi-year low in the second half of 2013 to a three-year high in December. Business confidence subsequently improved for the first time in four months in January.

NAB said that "confidence may continue its run of surprising (post-election) resilience for a while longer," perhaps a nod to its assertion made in August of last year that elections historically haven't delivered an immediate improvement in business sentiment.

However, Sims argues that the long nine-month run up the announced election contributed to a period of uncertainty and temporary lull in PE investment, in line with well established precedents in other markets. Uncertainty in terms of the crucial future of carbon pricing, to name but one example, was a factor in the reduced deal flow.

In addition, domestic corporates in particular were reluctant to bring divestments to a head in the second half of the year because in a climate of low cash rates and appreciating stock markets, they were not under pressure to act. Some prefer to wait until the end of the financial year in June and take the full consolidated earnings of a business before selling; others hang on because they think the valuation tide is rising.

"If you have a buyer that has done the work and is interested and engaged and you think you know what their walk-away position is, then you may take the chance and hold out a bit longer," Sims says.

Silver lining

With UGL weighing up offers for its property services unit DTZ, Transpacific Industries looking to sell its New Zealand waste management unit, and Orica mulling an exit from the chemicals business, there is evidence to suggest that corporates are now examining their portfolios with a view to focusing on core operations.

More M&A activity is expected in the mining sector, where large players are considering asset sales and their smaller counterparts are struggling to raise capital required to stay in operation. It is hoped this will result in a few more sizeable leveraged buyouts come onto the traditionally lumpy Australian market, but even if assets are put on the block, there is no guarantee PE firms will be interested or able to execute.

Just last week, Shell offloaded its Australian refineries and service stations to Vitol for $2.6 billion. Further down the scale, Catalyst Investment Managers has exited broadcaster Global Television and refrigeration systems supplier Actrol Group in the last two months, to an international trade buyer and a domestic trade buyer, respectively.

"We have seen the reemergence of the trade buyer," says Russell Sinclair, head of the acquisition finance division at Westpac. "Australian corporates have enjoyed a rise in their stock prices rise but that natural lift is slowing. As a result, they are re-leveraging, with a focus on growing their businesses, leading them to examine capital expenditure opportunities and acquisitions. This means more competition for PE firms, which has the potential to increase prices."

For many private equity investors with assets in Australia, the first half of 2013 was also a period of re-leveraging as deals were refinanced. In some cases, terms were improved, allowing for dividend recaps. Term Loan B was the flavor of the month for a while, as managers made the most of the opportunity to secure competitively priced financing out of the US. Since mid-2013 the industry has been preoccupied with IPOs.

With most of the refinancing efforts now completed and local banks recognizing borrowers' capacity to leverage earnings - plus a return of subordinated or mezzanine debt layered on top of the senior tranche - Sinclair believes there stage is set for more investment activity in 2014. This confidence is shared by CHAMP's Haddock, who expects to complete a couple of acquisitions in the next 6-12 months based on the deal flow he is seeing.

The unknown factor is the public markets and whether strong liquidity will continue to present business owners with an alternative to PE.

While the window remains open, investor appetite is not unlimited and the recent pricing of CHAMP Ventures-backed SG Fleet's offering towards the low end of its indicative range might be a harbinger of things to come. KPMG's Willis warns that the next four months will be a telling period, with institutional investors likely to become pickier about the IPOs in which they participate and how these offerings are priced.

"There are groups aiming for a first half IPO and my guess is that they are trying to get there as quickly as they can," says Mark McNamara, global head of private equity at King & Wood Mallesons. "There will some that fail to go public and look at other options."

If and when these groups stop playing the waiting game, a raft of transactions may open up for trade and private equity buyers. "When vendors decide to sell businesses they tend to get sold and if not in one window then in the next, you can see this in the data over nearly 15 years" says PEP's Sims. "These deals don't disappear; they simply take longer to conclude."

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• Topics
• Australasia
• Buyouts
• Exits
• Australia
• buyout
• Exit
• IPO
• CHAMP Private Equity
• Pacific Equity Partners
• Archer Capital
• Quadrant Private Equity