Australia’s varied markets

Its size and geography can create distortions, as can an economy like Australia’s which is  heavily weighted towards one sector – in this case, mining and resources. The efficiency and transparency of its financial system, the stability of its banks, its market openness, and its proximity to major, complementary markets are also key determinants.

For better or worse, many Australian companies were forced to re-evaluate their balance sheets decades ago, allowing them to – for the most part – power straight through the last two downturns. Australia often tends to be seen as a country of similarly well-situated opportunities, but a closer look reveals that underneath the attractively-positioned economy, there exists a range of targets with very different fundamentals.

Top performer

As a recent OECD report outlines: “Australia has been one of the best-performing economies in the OECD over the past two decades. From 1992 to 2008, the country enjoyed 17 consecutive years of economic growth. Over the 1990s, improvements in the regulatory environment, coupled with the emergence of information and communications technologies (ICT) led to vigorous growth in productivity.

“In the current decade, strong employment and in particular investment growth, have driven GDP increases despite a lower productivity performance. Incomes have also been boosted over recent years by a sharp rise in the terms-of-trade, which increased by over 65% between 2003 and mid-2008. This increase was primarily driven by the commodities boom associated with the rise of China and India. As the global economy moved toward recession in 2008, Australia’s terms-of-trade fell, offsetting some but by no means all of the previous gains.”

As a result, the impact of the global recession has been less severe than in most other developed countries. The Australian economy has benefitted from a healthy macroeconomic situation coupled with a strong fiscal position. Monetary and fiscal policies shielded businesses and citizens alike from the more damaging aspects of the global recession as the country benefitted from the rapid rebound of some Asian economies, in particular China. And as inflation risks were still present, Australia was the first G20 country to raise interest rates in the second half of 2009, the report observes.

A fantastic place to invest

Andrew Thompson, national head of private equity with KPMG in Australia, echoes the OECD’s view of the country’s economy, citing even more positives. Technically, he notes, Australia is one of only three countries worldwide that didn’t go into recession at all during the crisis.

“Part of that is obviously due to the government’s stimulus effort. But it’s also due to the relative strength of the economy. The banking system is in excellent shape and didn’t have the kinds of structural imbalances seen elsewhere.”

“Also, as a destination for capital, Australia is a fantastic place to invest – allowing for the observation that we’re clearly not one of the world’s biggest markets. Our ability to deploy huge pools of capital is a little constrained. But from a general security of investment point of view, I’d rather be invested here than in many other places.”

Lawyer David Wenger, a partner with leading Australian law firm Allens Arthur Robinson (AAR) agrees, and adds that unemployment, which has been kept below 6% (at a time when projections were pegged at 8%); plus a relatively low level of national debt, even after the stimulus spending, have helped. He further notes that, apart from traditional resource sector strength, even sectors that initially experienced GFC-driven weakness, such as retail and commercial property, are now showing signs of recovery.

Closer range, more contrasts

Anthony Sweetman, head of M&A for UBS, notes that the country has a split personality; the western half of the country, being very mining and resources-focused, and is booming. The east - and particularly New South Wales (inclusive of Sydney) – by contrast, hasn’t seen this price and inflation growth. The east has also been halted from an economic growth point of view.

“If you’re in mining and resourced-focused businesses, with the exception of late 2008 and early 2009, things have been, and are, strong. But if you’re manufacturing-based, especially with an export angle attached, things have been pretty tough,” he says.

Part of the reason is simply due to the Aussie dollar strength which, combined with import pressure from Asia, makes the difficulties in manufacturing industries almost systemic.

Supply-side shrinkage

Gary Stead, managing director and co-founder with Sydney-based Shearwater Capital Group, provided some insight on the credit conditions prevailing in Australia at the moment.

“There’s an imbalance between the supply of, and demand for, credit,” he told AVCJ. “On the supply side, prior to the GFC you had a lot of competition with the regional banks, foreign banks, the major trading banks and non-bank financial intermediaries. That competitive landscape created very aggressive lending structures, high levels of leverage, aggressive terms, weak covenants, long duration debt and more. But that’s all changed now.”

“There’s been a massive contraction on the supply side. The foreign banks have either gone or scaled way back; the regional banks have either scaled way back or been consolidated away; and many other sources have just gone away, permanently,” he observes.
The end result is that suppliers have more or less dwindled to just the four major trading banks. And while these have issues as well: funding issues, Basel II issues, or NPL issues; they have also shown the ability to earn good money engaging in basic business like providing senior debt to their long-term core clients.

“They have no need to pursue business with non-core clients, or fringe investment grade credit, or more complex situations. With the far less competitive supply-side of the credit environment, they don’t need to take on the risk in order to make very good margins.”

Escalating demand

The demand-side picture stands in sharp contrast. Australia has a substantial re-financing pipeline that needs to be addressed over the next two to three years, spanning corporate, real estate, infrastructure and resources sectors, to name a few.

“Last year equity markets were remarkably bullish in Australia, as they were in other places,” Stead says. “Lots of capital was raised through equity, through rights offerings (though often at substantial discounts).

“That helped some companies, but not the unlisted ones such as unlisted REITs or portfolio companies with private equity funds or fringe investment grade credits; in other words, even with the equity raised, any number of entities couldn’t really tap into this rich vein.”

New conditions, new opportunities

With the need to address the re-financing market, and lower levels of investment raised in the public equity markets going forward, one result may be a more active M&A market, as groups sell assets to pay down debt. Likely the unprecedented gap between credit supply and demand will create new opportunities for credit suppliers like mezzanine players, especially when more structured types of financing are required.

There are also opportunities in secondary deals in which, as an example, a bank may be selling a portfolio of loans – another byproduct of an economy which boasts very high levels of consumer leverage.

“In an economy like ours, which is doing well overall but is also one in which credit is very tight, achieving very attractive risk-adjusted returns through providing credit looks most promising,” Stead concludes. “That’s because the driver in this situation is mostly about the suppliers of credit having consolidated, contracted or disappeared. Certainly that’s what we aim to tap into.”

Confidence re-emerging in the ‘new normal’

Yet another take on what this shift in Australian corporate balance sheets may mean was offered by KPMG’s Andrew Thompson. He says that, while corporate Australia went into the global financial crisis overleveraged relative to the ‘new normal’ post-crisis levels, Australia’s suddenly buoyant public equity markets were to a large extent a function of the country’s unusual 9% superannuation guarantees. Oz pension funds, in fact, have very large pools of investible money, more or less irrespective of the state of their actual fund. Much of this went into stocks: much is also available for private equity commitments.

This is having a significant transformational effect on newly re-fuelled corporate investment attitudes, he says. “What we’re noticing is some of those corporates who, last year, were battening down the hatches are now getting more interested in strategic moves,” such as CHAMP’s sale of its United Malt business to Graincorp for $665 million in December 2009.

“That deal underscored that corporates are getting stronger in their belief that the worst is over, and that this could be the time for some strategic initiatives before things get too expensive,” he explains

With respect to private equity IPO exits, Thompson does not see a ‘no go’ environment shaping up. Rather he believes recent events are reflective of a broader equity market pullback and a particular softness in the retail market. Other IPOs in this segment may have been shelved for the moment, but he says there are other IPOs being considered by private equity players in sectors like services – particularly mining services – and general industrials.

AAR lawyer David Wenger shares his optimism: “The IPO market is continuing to recover in Australia and is expected to gain momentum in 2010,” he told AVCJ – but selectively. “Our expectation is that many vendors will continue to examine ‘dual track’ disposal processes which allow them to judge the merits of a trade sale versus the risks and potential upside of an IPO.”

In terms of the ongoing viability of public market IPO exits, Sweetman’s view is that it is case-by-case. But unlike the US, he sees no evidence of a pronounced pullback, not least because the process is different in Australia; it becomes very quickly obvious whether a deal is viable or not. Sweetman also notes that while current market sentiment is a deterrent, it can change quickly. Much bullishness in the latter half of 2009 morphed suddenly into caution when things got choppy in January and early February of this year. He notes that an upturn could occur just as quickly.

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• Topics
• Australasia
• CHAMP Private Equity