Australasia bounces back for buyouts

Indeed, 2009, elsewhere a nadir for buyouts worldwide, began and ended with two huge direct investments: Canada Pension Plan Investment Board’s $5.7 billion acquisition of Macquarie Communications Infrastructure Group in 1Q09, and the joint CPP IB/Ontario Teachers' Pension Plan c.$11.4 billion bid for major toll road operator Transurban Group in 4Q09. Yet an attractively Western-style market like Australia can seem all too seductively familiar to major pan-regional funds, and the Australasian landscape is populated by outcomes that show things can go just as wrong here as in the less sophisticated markets of Asia.

Australasia’s unique position

Australasia does seem to have come out of the global downturn remarkably well for a developed economy, rather in the same manner as fellow former colonial dominion Canada – through a combination of sound banking regulation, competent economic management, and exposure to mining and resources sectors fueled by Asian demand. In Australia’s case, of course, the latter factor is even more pronounced.

“At present Australia/New Zealand is properly recognized as one of the highest-potential investment environments around the world,” affirms Paul Shaw, Director at Pacific Equity Partners, bracketing the region in the class of ‘advanced New World economies’ that share first-world market development and rule of law with “above average growth prospects.”

Joseph Skrzynski, Founding Partner at CHAMP Private Equity, confirms that “the major settings for private equity are better in Australia than in comparable developed markets in the West. The overall economy has been more resilient, one of only a couple to avoid recession and to resume near-trend growth as the outlook for 2010-11.  The banking system is in much better shape than in Europe or the US.”

“Over the last 24 months despite unusually negative circumstances good deals have been available and possible to execute,” Shaw continues, citing his firm’s own deal flow. “It is particularly pleasing to see these deals are coming from the whole range of different environments: larger private, domestic subsidiary, subsidiary of an international, and even a local public company.”

This rosy picture does not mean that the economy is free from distress or shortfalls, however. But private equity players can find the problems fruitful as well.

“Australia was not immune to the capital constraints experienced by the rest of the developed world,” notes Chester Moynihan, Managing Director at Allegro Private Equity. “The result of this is a multitude of companies in the mid-market sector that are fundamentally sound businesses, but are struggling to raise capital to refinance debt, and are having to put off growth plans and vital capital expenditure in order to survive.”

Strategies and approaches

Once the usual, albeit well-earned, plaudits for Australasia’s macro situation are out of the way, then comes the question of how seriously to make money out of this market. Private equity investors who see its flaws as attractive points of entry also need to be aware that the Lucky Country’s advantages can actually work against them. In particular, post the crisis, Australia’s robust and relatively well-capitalized banks appear all too eager to stay that way – by giving away smaller tranches of leverage, on tougher terms.

“Private equity cannot rely on financial engineering as a value creation strategy in today’s market,” says Moynihan. “A challenge for private equity managers is now how they can compete with trade buyers as private equity firms are unable to use leverage as a means to compete on price.”

Skrzynski does feel that, “as the economy picks up, credit availability improves, and private equity is available, we expect deal flow to pick up.” However, for portfolio investments in the meantime, he emphasizes, “the motto ‘never waste a good crisis’ should be employed. This is the time to take the lid off issues that may have traditionally been in the ‘too hard basket,’ and take the hard decisions for major structural reform, repositioning of products and services, and/or diversification.”

“The economic environment over the past 18 months has resulted in a shift in the focus of GPs away from new deals and towards the active portfolio management of their investee companies,” adds Moynihan. “Private equity managers have had to apply their skills and capital in a variety of unprecedented ways to help their investee companies not only survive but ensure that they are well placed to deliver the required results as the economy recovers.”

Firms also need to look carefully at how they work alongside their peers – Australia’s much-lauded advantages once again working against, rather than for, the funds’ interests. “In a market where there are few secrets, asset selection and the real ability to nurture and release value, become even more important points of differentiation,” remarks Shaw. Moynihan, meanwhile, feels, “a focus on buy-and-build strategies is warranted in order to overcome the inherent advantages that trade buyers have to leverage their understanding of a sector, management expertise and synergies.”

And however well Australasia has fared through the crisis, there are still many instances of difficulties or damage created by it, however small these may seem when compared to other markets. “The current environment has thrown up many unanticipated challenges along the way,” says Shaw. “In these circumstances the size and experience of the investment team, the scale and market position of the operating companies and the scale and consistency of the fund performance have a profound impact on investment outcomes.”

Taxation and private equity’s broader contribution

Australia has created one unique problem for private equity to deal with that other developed markets have not thrown up post the crisis: a sudden and dramatic confrontation with the local regulator over taxation of private equity returns. This whole question arose, of course, when the Australian Tax Office sought to tap the proceeds raised by TPG Capital in its IPO of department store chain Myer. And, as elsewhere, regulatory challenges are driving the industry to articulate its value case and defend its contribution to Australasia.

“Institutional investors from overseas and from Australia have relied on over a decade of tax predictability when making decisions to invest into Australian private equity funds,” observes Philip Bilden, Managing Director at HarbourVest Partners (Asia). “Overseas GPs have equally been able to evaluate tax structures within an understood framework that allowed foreign capital to finance Australian businesses.”

Unfortunately, he adds, the ATO action with regard to the Myer exit, “has changed all that in a very short time and created considerable uncertainty that has left investors (LPs and GPs) on the sidelines until the Australian authorities provide clarity. This will unquestionably have an adverse impact on capital flows to Australia, and is an unfortunate and unexpected regulatory action in an otherwise transparent and predictable market environment.”

“It surprised a lot of people, and created uncertainty in the market,” confirms Matthew Arkinstall, Investment Director at Greenpark Capital. “And where there’s uncertainty there’s resistance, and where there’s resistance, people won’t invest.”

Lest anyone conclude that this matters more to the investors than the broader Australian economy, the industry is quick to point out the benefits of private equity to the business community as a whole. “Private equity at its best has fundamental advantages over other forms of ownership,” avers Shaw. “Investors begin with thorough diligence, investors can choose to invest at a price or walk away. Management have a simple and clear set of goals to maximize performance, against a plan which often involves further growth and investment. Their incentives are entirely aligned with value creation; board processes are simple and practical. Equity and debt are calibrated and adjusted to maximize performance, interim performance distractions are minimized, and finally, investors choose when to exit and how.”

Arkinstall also emphasizes that, “a healthy private equity industry contributes to healthy industry, and from that point of view, it should be encouraged rather than discouraged.” Alongside the benefits to Australian business, though, are the benefits to Australian pensioners and super investors from the deals themselves, he adds. “Bottom line is that there are a lot of Australian pension and super funds that are invested in private equity. A large proportion of the Australian population is a beneficiary of what private equity is able to achieve, which is basically to buy a company and make it gain strength, and make it stronger and more valuable, and earn a return from doing so.”

“Australia has for the past ten years had an enormous competitive advantage in the Asia Pacific market for predictable tax structures based on precedent of how funds were treated by the tax authorities,” says Bilden. “Unfortunately, the recent ATO action, which is a departure from precedent, makes Australia a riskier market with characteristics more akin to developing Asian economies, where tax policy is fluid, opaque, and a negative risk factor to be weighed before investing. We expect capital flows to suffer, and Australian businesses to have fewer sources of funding for growth.”
 
Words to ponder as Australia continues to work its way out of the lingering residue of the 2008-09 crisis. For, as Shaw warns, “there has been and will continue to be huge turmoil and turbulence in the system. This is both the opportunity and the challenge for investors. The investment skills of the different teams in the market have been tested to the limit, and will continue to be so.”

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• Topics
• Australasia
• Buyouts
• Buyout
• Regulation
• Philip M. Bilden
• Paul Shaw
• Joseph Skrzynski
• CHAMP Private Equity
• HarbourVest Partners
• Pacific Equity Partners