Australian M&A: Sweet deals Down Under?

Nevertheless, the pattern in the Lucky Country’s M&A market is consistent year-on-year: a slowish start, more or less doubling in the second half. But the value side is a little different. As per the AVCJ Research figures, a total of almost $123 billion in 2007 has subsided by 1H10 to almost $14.2 billion, with a total of 1066 deals (835 disclosed) for the same year down to 442 (348 disclosed) in 1H10.
And even though this data excludes mega transactions like the merger of the West Australian iron ore assets of BHP Billiton and Rio Tinto, worth an estimated enterprise value of $116 billion, there’s little doubt the M&A pot came off the boil somewhat in the first half of 2010.

Headwinds Down Under

Underlying this are a number of issues with which the market has had to contend. The resources sector (mining, metals and energy) is still firing on all cylinders, thanks to Asian demand which never really fell off. But it risks becoming a victim of its own success, in the form of a proposed super-tax, the political fallout from which included the recent election of a hung parliament. One consequence that has yet to be confirmed is that while new taxes are inevitable, they’re likely to be substantially moderated.

Another factor has been that – economic health and sound banking segment notwithstanding – debt financing has been hard to come by. And the IPO markets have disappointed expectations that they would come back with gusto.

Meredith Paynter, an M&A and private equity partner with Mallesons Stephen Jaques in Sydney, told AVCJ, “We’ve seen a change in our work mix. That’s partly a result of post-GFC economic and market conditions, with the resources sector seemingly having made a come back as a result of China and the greater confidence there. But there’s still uncertainty in the US and Europe. There’s all that ‘double dip’ talk. “Truthfully, our debt market hasn’t been nearly as affected as the US and Europe. But that hasn’t prevented corporates and other borrowers having more trouble accessing debt than prior to the GFC. And those that do borrow are finding it’s much more expensive and restrictive than previously.”

That said, however, she sees a lot of activity underway across the market, mostly in “true” M&A work, and transactions are taking a longer time to execute; examples would include restructurings, sounding out possible de-mergers and the like. As yet, not a lot of it has materialized as done deals.

“There certainly isn’t as much acquisitive behavior as there was,” Paynter adds. “I think that’s a reflection of a lot of companies being inwardly focused, reassessing their strategies and bedding down their operations; basically sticking to their knitting.” Nevertheless, others dismissed the notion of a slowdown.

Deals stoking up

Anthony Sweetman, head of M&A with UBS, a perennial M&A powerhouse Down Under, observes that the Australian market has always been comparatively shallow and heavily weighted towards resources. Consequently, mega-deals in this area can and do skew the overall picture in the data year-on-year. But that acknowledged, he sees “…nothing dramatic” in terms of fundamental changes.

“There’s been something like A$25 billion [$23.4 billion] of announced deals over the past month,” he told AVCJ.

A quick look through the bigger items of the recent past includes Thailand-based coal miner Banpu’s acquisition of a 14.9% stake in Centennial Coal for $1.8 billion – a first from this source, after an earlier $3.7 billion bid by US miner Peabody Energy for Macarthur Coal in the spring. Also, there was the biggest transaction in 1H10, the $3.2 billion acquisition of Arrow Energy, a coal seam gas company, by a 50/50 JV between Shell Energy Holdings and a subsidiary of PetroChina.

But there has been significant activity beyond the resources sector as well, for example Wilmer International’s $1.75 billion cash buyout of Australia-based CSR’s sugar and renewable energy business, Sucrogen. The acquirer, Singapore’s second biggest listed company, beat out Chinese SOE Bright Food, which had been pursuing this particular target for months.

And in a different kind of marquee deal in July, the Canada Pension Plan Investment Board offered roughly $3.5 billion – a 36.3% premium on the target’s last July trading price – for Australian highway operator Intoll Group.

“I’m not exactly sure of the detail in arriving at the A$25 billion figure,” Sweetman adds. “But certainly, we’ve been very busy as far as announced transactions go; probably as busy over the past three weeks as we were any time in 2006-07.”
Inbound, outbound, and domestic

Angus Barker, MD and head of M&A with Deutsche Bank in Melbourne, agrees. He says his team is going flat out. And he adds that there is now sharp competition in many of the deals now in the works.

“We announced this AWB/Graincorp merger [for A$856 million/$808 million] in July, only to suddenly be 25% outbid by a late offer from Canada’s Agrium [for A$1.25 billion/$1.18 billion]. When they made it, the board changed their recommendation,” he says.

However, Deutsche Bank promptly announced a $383 million Xstrata bid for another Aussie miner, Sphere Minerals; so the pace shows no sign of slackening.

“I think there may have been a question around expectations after the enormous equity capital markets year in 2009, and the wave of equity re-capitalization that went on. A lot of people just assumed that M&A would pick up the baton this year,” Barker explains. “That’s probably turned out a little slower than hoped for in the first half. But over the past couple of months, our pipeline has been filling nicely.”

As for the inbound activity, Barker believes, “It’s the continuation of a long-term trend, the flip-side of when you run a current account deficit for years and years, as Australia has. You’ve got to fill the hole either by selling equity or selling off bits of the farm. As a result, inbound M&A is always a mainstay of what happens.”

But that’s not to imply that the domestic and outbound sectors are idle. AVCJ Research’s Top Ten deals list for Australia shows at least half are domestic – depending on where you place the corporate definition yardsticks.

Outbound, all agree, has been generally quiet. But that’s not to say things can’t or won’t happen. The recent BHP mega-bid for Canada’s Potash Corp., covered earlier in AVCJ, while still undecided, nevertheless emphasizes that many Australian corporations of size are very cashed-up, and therefore capable of making major moves.

Looking ahead: likely hot spots

In the immediate future, as UBS’ Sweetman sees it, the red-hot energy sector is likely to stay that way, particularly as regards the coking coal needed for steel production. Furthermore, he doesn’t reckon the Arrow transaction will be the last in its space:
“There are constant rumors in the press about further consolidation in LNG (coal seam gas) projects in Queensland. Whether that occurs at the company or project level is harder to say,” he observes.

Another promising front, though less obvious, is the whole infrastructure sector. It’s currently very active for all that completed deals to date have been rare.

“Infrastructure has been out of favor here, largely because they were highly-geared entities trying to be sold to investors on the basis of yield – which was mostly unsustainable because it was funded by debt. Now the assets are generally trading well below fair value. And pension funds are happy to put money to work for, say, 20+ years, and can recognize that value without having to worry what the share price is.”
Mallesons’ Meredith Paynter adds another area of interest longer term: the agriculture and food sectors.

“If we can successfully address issues such as water security, Australia has excellent potential as a regional player in agricultural development, and especially in providing increased amounts of food for the region,” she conjectures. “But that will require some different policy settings and infrastructure development.”

There has long been contention over the bi-polar nature of the Australian economy, as locals see it: the uber-prosperous resource segment, largely based in sparsely populated Western Australia and Queensland, and the more challenged other components based in the east of the country, where most of the people – and therefore, voters – live. This is at the root of the tax pressures that are still unresolved.

But addressing this imbalance via furthering the agricultural sector is likely to be crucial to rural independent members necessary to sustain the current hung parliament. And that could overcome the inertia to date in resolving the dichotomy.

The private equity component

Within the overall M&A picture, private equity activity has been muted since the GFC, for much the same reasons affecting corporate peers: uncertainty over the tax regime, a moribund IPO market, and difficulties in obtaining debt. But a sudden spate of deals (or at least, very active bids) by financial sponsors suggests this too is changing.

Paynter doesn’t feel that the tax concern in relation to private equity is likely to derail deals where the value proposition otherwise is compelling. And deals like the recent HealthScope buyout in the $2 billion range, which pitted Carlyle and TPG Capital against Kohlberg Kravis & Roberts in an Australian first, plus the recent – and rejected – Cerberus Capital Management bid for Foster’s Group’s wine business (driven by wine market volatility and the sharp rise of the Australian dollar) are only two examples.
The debt access problem, however, key as it is to the private equity leverage model, remains serious. “The multiples are still quite expensive compared to what they were,” Paynter told AVCJ.

Another impediment is the number of private equity houses with stressed portfolios post-GFC. Unsurprisingly, these firms are too pre-occupied managing the birds in their hands to pay much attention to investment opportunities in the bush.

And there’s still the stubbornly stagnant IPO market Down Under to contend with, she says. “Just this week I was talking to somebody at [a prominent Aussie PE fund], who said that with the IPO situation, he’s seeing increased confidence in doing secondary or tertiary buyouts. That said, there’s a certain paranoia around buying something from another private equity firm, because if things don’t go according to plan, it becomes all the more difficult for them, as compared with acquiring an asset through trade sales and the like.”

Anthony Sweetman agrees, saying he too is seeing an uptick in secondary buyouts. As to the IPO issue, he likewise concurs but sees improvement just being a matter of timing. “With global equity markets clearly trending down for the last while, that’s not great for any capital markets issuance, especially IPOs.”

Funding factors?

Ultimately, M&A activity doesn’t happen in a vacuum. Australia has the strong economy required, though with some nervousness about the degree to which that depends on the resources sector. But the broad assumption, based on past and present performance, is that this will remain solid. With private equity once again becoming more active, the funding issue remains the biggest question mark.

“A concern people have is around the interbank or wholesale funding markets offshore, given the reliance of our Big Four banks on those markets for funding,” Sweetman told AVCJ. “If that continues to get tougher, the flow-through impact on the credit environment in Australia may start to have an impact.”

However, looking more closely at the larger deals going on in Australia, and funding is really only an issue for financial investors. “If you have a look at the major resources projects, they’re being funding by very major companies in a global sense,” he says. “They have no issues accessing funding; if demand tails off, they’ll pull back on development. But at this stage there’s no sign of that.” 

Further reading

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• 15 Jul 2010

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• Cerberus Capital Management
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• The Carlyle Group