Australia IPOs: Suspicious minds

Pepper Group represents KKR's third attempt in six months to test Australian public market investor appetite for a financial sponsor-backed IPO. The previous two forays, consumer lending business Latitude Financial and Southeast Asian online real estate platform PropertyGuru, were pulled at the book-building stage due to concerns that they would see volatile post-IPO trading. 

A mortgage lending business, Pepper was privatized by KKR's credit unit – the other two are private equity portfolio companies, with KKR one of several investors – in 2017 at a valuation of A$676 million ($446 million). The European operation was offloaded to Link Group last month for A$322 million. Now the remaining Australian assets are supposed to list in May at a valuation of up to A$1 billion, or about 12x forward earnings.

Success could mean more than just a liquidity event for KKR. Australia hasn't seen a sizeable PE-backed IPO in over three years when the last wave of listings met its scandal-tinged end, underlining investor wariness of financial sponsors. A strong offering by Pepper could reopen the door.

"We have been largely dormant for nearly four years, but if we get some good news stories from the offerings currently in the pipeline, confidence is likely to build," says Mark McNamara, a partner a King & Wood Mallesons. "If they trade up post-IPO, bankers will find it easier to convince people that the market is there. It's a difficult conversation right now. The bankers are trying to sell to people who know the markets and aren't necessarily convinced that they can spend a lot of money and get a result on an IPO."

Ups and downs

Private equity-backed IPOs in Australia go in cycles: a strong performer rekindles retail investor interest in private equity-owned companies, a wave of offerings hit the bourse, and then one or two notable failures snuff out the flame. "The window stays open for a year or so, then pricing goes too far, a couple fail, the market gets tired of IPOs and it's all over for another year," says one GP. 

Between 2003 and 2007, 70 IPOs – including those by companies not domiciled in Australia – raised a combined $5.4 billion on the domestic bourse before the global financial crisis brought activity to a halt. There were only 19 IPOs, with total proceeds of $3.5 billion during the five years ended 2012. The magic returned in 2013 with $12.3 billion raised from 52 offerings during a three-year period.

That mini golden age was easy to bookend: Quadrant Private Equity opened the window with the well-received Virtus Health offering; then Dick Smith Electronics abruptly shut it by sliding into bankruptcy within two years of its IPO and just over one year after former owner Anchorage Capital Partners sold the last of its shares. Local media laid into private equity and investor trust in PE-backed offerings largely evaporated. 

From late 2013 to late 2015, 13 companies completed offerings of $300 million or more. This was followed by TPG Capital-owned Inghams Group raising $586 million in mid-2016. Since then, only two private equity-backed offerings have managed to cross the $100 million threshold. The market isn't closed to financial sponsors, but it appears to prefer a certain kind: Of the 26 post-Inghams IPOs, 19 could be described as new economy plays and only eight have raised more than $25 million.

Whispir, a Melbourne and Singapore-headquartered cloud-based platform that automates interaction between businesses and customers was one of three software-as-a-service (SaaS) start-ups to list in Australia last year. Another three – out of eight PE-backed offerings in total – were financial technology businesses. The Whispir IPO raised A$47 million, which included a partial exit of A$20 million for early-stage investors MDI Ventures, Openspace Ventures and Telstra Ventures.

"Australia is a legitimate channel for mid-cap tech companies. There were about a dozen quality enterprise SaaS businesses close enough to Whispir to be comped and trading at decent valuations, with okay liquidity," says Shane Chesson, a managing partner at Openspace, while noting that post-IPO trading has been solid but not spectacular. "There are some great companies, but like any market, some companies that don't get it right – wrong sector, wrong timing, wrong price."

Start-ups can take advantage of a disclosure-based system that is open to pre-profit companies provided they meet certain criteria. It was originally designed for mining businesses, which sometimes raise development capital years before entering full production, but it is well-suited to SaaS players looking to emulate local success stories like Atlassian, Xero, and WiseTech Global.

Pressure points 

However, investor goodwill is not inexhaustible. One of the reasons given for PropertyGuru's failure to get traction is that the market has become more critical of start-ups with no discernable Australia connection coming to list simply because the perceived risk tolerance is higher and there are retail and superannuation investors sitting on piles of cash. 

Another reason is that PropertyGuru was too richly priced. Had the IPO priced at the top end of the indicative range, the company would have raised A$380.2 million at an indicative market capitalization of A$1.36 billion, or 10.9x pro forma 2020 forecast revenue. Major external shareholders TPG and KKR were not planning to sell any shares in the offering, but the terms were widely seen as too aggressive for a pre-profit business in a competitive market.

This is not an isolated case of overambition. Industry participants note that a dozen financial sponsor-backed IPOs were pulled in 2019, among them Funlab, Retail Zoo, GFG Alliance, Pepper Group (its first attempt), Fineos, ECA, Onsite Rental Group, MPC Kinetic, and DDH1 Drilling, as well as Latitude and PropertyGuru. They coincided with a 12-month period in which the ASX200 Index reached highs not seen since before the global financial crisis, ending the year up 21%.

Latitude also tested investor forbearance with plans to raise as much as A$1.4 billion at a market capitalization of A$4 billion, or 13.9x forward earnings. In this instance, existing investors were targeting partial exits. Concerns about the prospects for a personal finance business at a time when the consumer sector is giving indications of weakness were a consideration as well.

There is a sense that more defensive industries, unlinked to consumer activity, are likely to produce reliable listing candidates – if priced appropriately. Indeed, it is argued that smaller offerings of this nature, typically in the A$150-300 million market capitalization range where retail brokers can be relied on for distribution, should still get done.

"We try to invest in businesses that we think can be sustainable over the long term and at some point, maybe it makes sense to take them public. The IPO market comes and goes, but the for the right business at the right price and with the right financial sponsor, the market should be open. Our approach is pretty simple: we want well managed businesses, good opportunities, fair prices," says Jeremy Samuel, a managing director at lower middle-market buyout firm Anacacia Capital.

Unjustly maligned?

Several industry participants observe that IPOs are not necessarily the most desirable outcome for private equity investors. As one manager describes it, the market is structured – through the roles played by regulators, non-executive directors and large mutual fund buyers – to ensure IPOs are priced at a discount to fair value. On top of that, there is a sense that public ownership is not suited to all companies, especially those that are too small to get the attention of analysts or those looking to make long-term investments that will come at the expense of short-term returns.

The shift from public to private may represent a structural realignment of the market, with large financial sponsors increasingly buying assets from their smaller peers. But it doesn't address the broader issue of the negative perception of private equity, even though several historical studies have shown that, on average, financial sponsor-backed IPOs outperform the rest.

"When the market was strong, people made a reasonable clip on the retained equity post-IPO and sold out via a block trade. However, some institutional capital providers got burned in 2014-2016 when there was a significant volume of floats and this created a degree of skepticism about PE," says David Willis, head of private equity at KPMG Australia. "Now, if managers can find a good buyer and get a 100% exit to a trade buyer, they are happy to take that. The uncertainty around IPOs has prompted people to avoid those processes. I don't see that changing in the near term."

At the same time, there is plenty of anecdotal evidence of brokers avoiding certain financial sponsors that have reputations for rushing businesses to market before they are ready. Several managers observe that brokers constantly remind them of situations like Dick Smith and name GPs they no longer want to work with. The caveat is "they all have short memories, so in a year they might have a different view."

There remains a general acknowledgment that, regardless of the quality of the company or the financial discipline of the offering, private equity involvement means greater market scrutiny. "There is a history of that, of suspicion of private equity, but if it's a good business it's a good business," says Justin Ryan, a managing partner at Quadrant. "It's a hard market right now, but not impossible."

Some industry participants are resigned to the episodic nature of IPOs, noting that the market is not deep and listings coming through disclosure-based regimes must be judged on their individual merits. Moreover, there have been more than three times as many trades in the past 20 years as exits via IPO or subsequent public market sell-down. The pattern is clear.

From the perspective of the Australian Investment Council (AIC), though, skepticism of private equity among various stakeholders is evidence of the work that still needs to be done in explaining how the asset class makes a positive contribution to the development of businesses. "The reason why we are where we are in terms of understanding and knowledge is we spent far too long over the past two decades not explaining the role of private equity more widely, and ultimately we created a void that others chose to fill with some facts and some misinformation," says Yasser El-Ansary, CEO of AIC.

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• Topics
• Australasia
• GPs
• IPO
• Australia
• Openspace Ventures
• Anacacia Capital
• KPMG
• Quadrant Private Equity
• Australian Investment Council (AIC)