Going walkabout: Australian outbound investment

When CHAMP Private Equity set up its office in Singapore in 2008, the goal was to expand an Asian strategy that had been established around two decades earlier.

Datacraft was one of the first investments completed by Australian Mezzanine Investments, the venture capital operation founded by Bill Ferris and Joe Skrynski in 1987, more than 10 years before the tie-up with Castle Harlan created what is now known as CHAMP. Having begun life as a relatively modest enterprise in Melbourne, Datacraft grew into a regional technology leader. It listed on the Singapore Exchange in 1997, becoming the first-ever Australian-backed IPO in Asia.

This early success story was the seed for CHAMP's later expansion into the region, notes Nat Childres, a managing director at the private equity firm. "Our proposal around the Singapore office sat very firmly with our broader approach to Asian integration that CHAMP has now pursued for nearly 25 years," he says. "The idea being that an Asian strategy was so important; it should be a dedicated capability of our fund, not an afterthought."

In recent months this strategy has begun to bear fruit, as the firm closing it first deals outside Australia. CHAMP started with a joint $1.05 billion investment with Castle Harlan and Lime Rock Partners in Dubai-based shallow water drilling services company Shelf Drilling in September 2012. A couple of weeks later it acquired a 33.2% stake in Singapore-headquartered shipping services provider Miclyn Express Offshore (MEO) from Macquarie Capital Group for around A$199 million ($206 million).

Both companies are using the capital to expand operations in Asia. CHAMP remains the only Australian GP with an office overseas that acts as staging post for investments and supporting domestic portfolio companies as they expand into Asia. There is no question that the region is increasingly relevant to Australia but it is unclear whether other domestic private equity firms have the will or the resources to play a direct role in this integration.

Commodities plus

To date, the Asia-Australia relationship has been characterized by commodities, as countries like China and India tap into the Australia's mineral wealth to feed their rapidly growing economies. This is reflected to a certain extent in CHAMP's investments in Miclyn and Shelf Drilling. But what are the prospects for companies in other sectors?

"Large populations and high organic growth rates on Australia's doorstep are a compelling opportunity for growth that Australian companies, big or small, cannot really afford to ignore," Childres insists.

There is already an appetite for outbound M&A among Australian companies. Deal flow actually fell dramatically in 2012 to $7.2 billion from more than $32 billion the previous year, which represented a post-global financial crisis high point, according to Thomson Reuters. However, the role played by Australia's own commodities giants, notably Rio Tinto and BHP Billiton, shouldn't be underestimated.

Strip out everything apart from the transactions involving financial backers such as private equity funds and the pattern is more consistent. Net deal value reached $727 million in 2012 and $667 million in 2011 across 32 deals, levels unseen in the previous few years.

There is no shortage of government encouragement. "More than ever corporations are being encouraged by the Australian government to participate in Asia because that is the logical replacement for the eventual slowdown of the mining boom, it is the next leg of growth," says Craig Boyce, managing director with Bain Capital in Hong Kong, adding that his firm has long been interested in local buyout opportunities where there is potential for regional expansion.

While taking an Australian company into Asia is an obvious play for the likes of Bain, which has the resource and network to facilitate entry into new markets, it can also be a strategy for GPs investing in mid-market firms. The country boasts well-run companies and strong brands, but with a population of just 22 million there is only so far a mid-size business can go. Asia as a destination also offers low costs that can translate into profit improvement through outsourcing.

"This is a key opportunity given Australia's relatively high cost structure, particularly at current exchange rates," says Childres. "If you look at the difficulties with the lack of scale and the difficult cost environment and how you can address those two limitations, Asian integration is a solution to both in different ways."

Asian integration is a driver for about one third of CHAMP's existing portfolio. Mid-market multinationals tend to be the ones that executed this strategy most effectively in the last 10 years. The private equity firm created Accolade Wines in early 2011, after paying A$290 million for Constellation Brands' UK and Australian interests, including its South African brands, wineries and vineyards. The company's path into Asia came through the acquisition of Shanghai CWC Wine Trading. 

Distribution is the foundation stone of any effort to expand Australian consumer brands into Asia. Market penetration typically comes through joint ventures or bolt-on acquisitions - with Accolade it was the latter as the purchase of CWC opened up distribution channels in the fast-growing China market.

However, there is a perception among Australian GPs that these deals are the exception rather than the rule. Asia, which comprises 19 different economies, each with different regulations, currencies, business structures and legal systems, remains an incredibly difficult place to do business without the people on the ground.

"We are only really experts in this market," says Tim Sims, co-founder and managing director at Pacific Equity Partners (PEP). "If there is an option value in tying in with Asia then that option value is best provided by someone who is Asian and fully established in Asia. You need someone who has much deeper roots than a guy just riding into town and wanting to set up."

He adds that industries such as wine and films have recognized this idea and there are agents capable of acting as broad-based distributors, but other industries aren't so accommodating.

Market participants note that a prospective foreign market entrant may own an innovative product, but the power lies with the distributors it approaches as partners, particularly if they are few in number. As gatekeepers to the industry, these players decide whether or not to roll-out the product and take a large portion of the economic interest.
Size and opportunity

While finding suitable partners can be tricky, some domestic GPs have still been able to leverage their networks to capitalize on the Asian growth story. The scale of the business and the industry in which it operates are key factors.

Like CHAMP, one third of Advent Private Capital's businesses have significant offshore operations, including in Asia. The private equity firm acquired Locker Group, a manufacturer of metal products used in industrial flooring and handrails by the industrial and mining sectors, in 2006 through leveraged deal that valued the business at A$109 million. Advent wanted to outsource certain operations to Asia and internal connections came to the fore in India.

"It was joint venture but we provided the technical skill," says Rupert Harrington, managing director at Advent. "We had someone in the company who was married to an Indian, spoke the language, and spent time over there working on the venture." The private equity firm exited the business to a US trade buyer earlier this year, generating a 2.5x money multiple.

Once a company reaches the size and scale where it of interest to mid-market investors such as CHAMP and PEP, management teams are well established and there might already be a degree of exposure to markets beyond Australian borders. In those situations, the onus is on the company rather than the GP to further these interests.

"It's more the role of the CEOs, rather than us," agrees Peter Wiggs, managing partner at Archer Capital, another mid-market player.
He cites Emeco, and earth-moving equipment manufacturer bought by Archer and PEP for A$450 million in 2004 and exited via a A$1.1 billion IPO two years later. Overseas expansion was a key element of the deal, but the PE owners supported the company in pursuing this strategy rather than driving it themselves.

"The most important thing is putting guys into the management team who know what they are doing and giving them the money to do it," Wiggs explains. "That's where we focus our attention."

Another potential source of strategic backing for Australian private equity firms as they take portfolio companies overseas might turn out to be their LPs. Foreign investors are becoming more prominent in domestic funds and the Asia contingent is expected to expand over time. Andrew Thompson, head of Australian private equity at KPMG, suggests that these LPs could leverage their own networks.

"Asian LPs are able to offer some assistance by way of facilitation and introductions to GPs as they seek to grow portfolio companies offshore," says Thompson. "You might be trying to expand into China, you have a Chinese LP in your fund, and they can get you the high-level introductions you need."

This trend could gather pace as LPs seek more communication and involvement with GPs - in some cases as a precursor to co-investment opportunities - but it is very much one for the future. Asia's institutional investor base remains rather thin and there are no guarantees that funds will be able to call on the right GP at the right time.

As it stands, the investors best positioned to take Australian portfolio companies into new markets are pan-regional funds.

Affinity Equity Partners has completed two acquisitions of food assets in Australia and New Zealand in the last two years, buying poultry producer Tegel Foods from PEP for around $480 million and deli meats specialist Primo Smallgoods out of family ownership for $758 million. There is a clear angle selling fresh produce into Asia's emerging markets and sources close to the company say that Sydney-based partner Brett Sutton is spending a lot of time on the road helping arrange distribution deals.

Financials and strategics

Bain's Boyce admits to keeping track of Australian GPs' portfolios in order to identify secondary buyout opportunities. Several potential targets are currently under consideration, each a relatively large-scale company that would require a A$200 million equity commitment.

The private equity firm completed one such transaction in 2011, buying accounting software provider MYOB from Archer Capital, HarbourVest Partners and Squadron Capital for A$1.2 billion. The original investors more than doubled their money on a deal worth a reported A$450 million only three years previously, thanks in no small part to intense competition for the asset. KKR also submitted a bid while a higher offer from UK software firm Sage fell through at the last minute for internal reasons.

The strategic investors that feature most prominently on private equity firms' radar hail from Asia, typically corporates looking to diversify their business through Australasian exposure or acquire new products, technologies and industrial expertise. Both CHAMP and PEP have benefited from these situations. The former exited Manassen Foods to China's Bright Food Group in 2011, not long after PEP and Unitas Capital sold New Zealand beverage firm Independent Liquor to Asahi.

"I am sure we will not be the only player participating in this space," says Bain's Boyce. "We are particularly well placed to participate in this trend of Australia-Asia engagement because we have the relationships and we participate in both directions: supporting Asian companies going into Australia and supporting Australian companies expanding into Asia."

However, there is no clear consensus among domestic private equity firms as to how Australian GPs will participate in this process, whether they will continue to be primarily local, exiting companies when a more evolved Asia strategy is required, or become more active players beyond their own borders.

KPMG's Thompson argues that regional integration impact is obvious and inevitable. Part of the private equity pitch is that they can generate alpha for investors by helping companies grow faster. As Australia becomes more aligned with Asia on a macro level, the potential for value creation through regional expansion will rise

"It is not going away," agrees CHAMP's Childres. "It is a challenge for all companies that have historically been focused on the domestic market. They need to mindful of regional integration, whether they view it as an opportunity or a threat."

 

SIDEBAR: Planning ahead - Australia in the "Asian century"

Australia's interactions with its Asian neighbors already account for a significant amount of economic activity, and this interedependence is expected to strengthen in coming years. 

Out of the A$1.2 trillion Australia had invested abroad in 2011, $150 billion was destined for Asia. Three of the country's top 10 investment destinations are in Asia - Japan, Singapore and Hong Kong - with investments in those territories amounting to around $76 billion. On the flipside, total foreign investment entering Australia was around $2 trillion in 2011. While the US and the UK still account for half of this capital, total Asian investment in Australia totaled $300 billion. Japan, Singapore and Hong Kong ranked among the top three.

The extent of this Asian integration and what it means for Australia was captured in a government white paper called "Australia in the Asian Century." Published in October last year, the 300-page document is broad in its scope, covering everything from the education to science innovation and the economy, and details how the country can take advantage of Asia's rise to prominence.

The report describes this rise as "staggering," noting that by 2025 the region as a whole will account for almost half of global output and become the world's largest producer and consumer of goods and services. Two of Asia's largest economies, China and India, have seen their share of global economy almost triple in the last 20 years while their their absolute economic size has increased nearly six-fold.

The report explains that despite uneven economic conditions across its sectors, Australia itself has as positive outlook for the Asian Century.

The country's per capita GDP will enter the global top 10 by 2025, up from 13th place in 2011. In addition, average income per person is set to increase from $652,000 in 2012 to $73,000 in 2025. Unemployment is low, inflation is contained and while commodity prices appear to have passed their record peak, considerable minerals and energy investment is still to come. This will see more large-scale production come online and boost exports.

The key growth industries for Australia in the Asia Century include mining, tourism, agriculture, manufacturing and infrastructure development.

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• Topics
• Australasia
• Investments
• Buyouts
• Buyout
• Australia
• New Zealand
• CHAMP Private Equity
• Pacific Equity Partners
• Archer Capital
• Advent Private Capital
• Bain Capital Asia
• KPMG
• Commodities