Australian private equity: Behind the numbers

Through the end of 3Q10, there were 72 deals this year, for an aggregate c. $4.3 billion in value. That’s a far cry from the boom years of 2006-07, when 258 and 244 transactions were chalked up, valued at over $19.7 billion and just over $18 billion respectively. With the impact of the GFC, these numbers slumped to 181 and 108 deals worth slightly over $8.1 billion and $7.4 billion in 2008 and 2009 respectively.

Note however that in 2005, before the feeding frenzy set in, while there were a comparable number of deals (198) completed, their aggregate value was only just over $3.2 billion.

Looking at the present, just one transaction – the Carlyle/TPG Capital buyout of medical business Healthscope Ltd for $2.36 billion – makes up more than half of the total value. It does not suggest vigor and depth at first sight, but in a regional context, that too is misleading.

A unique market position

The private equity market Down Under is unusual in more ways than one. Simon Pillar, founding MD of front-running Pacific Equity Partners (PEP), notes, “The two largest buyout markets (in Asia) are Australia and Japan... Australia is, by a long chalk, the more active and mature LBO market. It’s been more consistent with more deals done at the large, mid-cap and small ends. And that’s an important distinction.”

Australian private equity operates in an exceptional economy, particularly compared to other developed markets. Because of its natural resources wealth, and proximity to the escalating Asian demand for same, to say nothing of its relatively robust domestic banking supervision, Australia has been able to skirt much of the GFC damage and still boast enough buoyancy to make a rise in interest rates likely in the near term, while driving the Aussie dollar to record heights against the greenback.

At the same time, though, with a population of just 21 million, the Australian economy is small compared to the global economy giants, whether east or west, even though its currency is presently the world’s fifth most actively traded. Which means it is more subject to aberrations than most.

One of these is evident in the contrast in public market activity in 2009 and 2010. “In 2009 there was roughly A$90 billion [$88.8 billion] of equity raised through the public equity markets,” notes Gary Stead, Managing Director and Founder of Shearwater Capital Group. “Most of that was used to refinance debt and recapitalize businesses. But the point is, the markets in that year were alive and roaring. This year to date, the biggest IPO has been coal miner Aston Resources, which closed in August valued at A$400 million [$392 million]. So presently, public equity markets are fragile; meaning, IPO exits have not been an option.”

A future deal driver

On the other hand, this same phenomenon may well spur much higher private equity activity levels in future, as PEP’s Pillar explains:

“If you look at the most successful deals, they’ve been the traditional non-core asset divestments of both local corporates and MNCs. The problem over the past 18 months or so about that traditional deal source is that in 2009 a lot of Australian corporates got out of jail via the A$100 billion [$98 billion] or so of discounted rights issues that came into the market. They shored up their balance sheets, and so put off performance challenges that some of the divisions within those businesses face.

“This has created a bit of an earnings-per-share time bomb, unless they can get their EPSs back up. Ultimately, underperforming assets will be found out. The strategy cycle is inevitable. What’s core today will be non-core tomorrow.”

Exits still viable

This doesn’t imply that exits are entirely moribund, however. As Nat Childres, Director at CHAMP Private Equity, which has managed two major exits over the past year – United Malt Holdings and Study Group International – puts it:

“There’s been a lot of discussion about whether the IPO window is going to re-open, but frankly, with the right company put at the right price, I think the IPO market remains open. There’s always the credible prospect of an IPO for well-run, high quality businesses. And that’s a health sign for the private equity community.”

Julian Knights, Managing Partner with Ironbridge Capital, agrees. “The public market is actually quite robust, in that there is no evidence of attractive assets emerging at ‘fire sale’ prices. Very few public-to-private offers from private equity have succeeded, as sentiment toward mid-cap stocks has improved,” he told AVCJ. “There are also signs that the IPO market is improving. Queensland Rail will be a key barometer.”

Knights adds that there is a natural cycle to vintage exits, and for capital raised in 2005-06, this is now at its beginning. “We’ve seen strong inward interest in several portfolio companies, which suggests trade buyer appetites are likewise improving.”

Debt market dilemma

Debt supply and cost remains an issue, though. A year ago, the expectation was that public market strength would translate into a much broader availability of debt. But it hasn’t happened, at least on nothing like the predicted scale. Shearwater Capital’s Gary Stead points out that Australian banks are offering 6%+ on some deposits as a stark indicator.

“They’re doing this because they want to re-engineer their sources of funding. These used to be overly skewed towards the international wholesale markets. But those are now very expensive, very competitive and very choppy. Instead they are saying, ‘let’s forget that and find other sources of capital.’ That’s what’s behind the increased term deposit rates.

The other gorilla in the room is the refinancing pipeline to work through over the next two years. “There’s a lot of paper that needs to get financed, a lot of debt. And a significant percentage of that is private equity portfolio debt which was put on the books based on valuation multiples, leverage multiples, that nobody would do today… I think that access is going to be limited and constrained. It might be better than it was. But it’s not going be anything like it was before the crash.”

PEP’s Simon Pillar takes a more sanguine view. “We’re cautiously optimistic. Debt markets have recovered. They’re not back to where they were, but the Healthscope deal has been very helpful,” he told AVCJ. “It was around 4.7x and some of the equity is going to be swapped out for a note that is going into the market; so probably around 5x leverage.”

Perhaps even more importantly, a lot of banks were engaged, he notes.

“We’re starting to get the same issue as we had pre-Crisis in terms of the overall cost of debt. We’ve got 4.5% base rates, with swap rates in the 500-basis-points range, and spreads on top of that of about 350-400 basis points. So your all-in cash cost of senior acquisition debt is up around 9%, which is not dissimilar to where it was pre-Crisis.”

That’s the nub of the constraining factor, the total cost of carrying the debt. So, while providers may be more selective than they were back then, Pillar sees the debt markets as now essentially open – though at a price – and deals at least potentially back on track. 

Further reading

Australian M&A: Sweet deals Down Under?

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• 21 Sep 2010

CHAMP seeks sale exit for Healthcare Australia

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• 04 Oct 2010

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Australia's Crescent Capital plans National Hearing healthcare IPO

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• 15 Sep 2010

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• Topics
• Australasia
• Performance
• Funds
• Buyout
• CHAMP Private Equity
• Simon Pillar
• Pacific Equity Partners
• Julian Knights
• Ironbridge Capital
• Nathaniel Childres