2016 Australian Private Equity Outlook: Cashed Up and Looking for Deals
In reviewing the current state of private equity in Australia, we met with Grant Koch, partner at law firm DLA Piper, to get his outlook on the local market.
23 August 2016
While there’s been a slow start to private equity (PE) deal activity in 2016, there is clearly no shortage of capital. In reviewing the current state of private equity in Australia, we recently had the chance to sit down with Grant Koch, partner at law firm DLA Piper, to get his outlook on the local private equity market. As a corporate advisory and M&A lawyer, Grant has advised on a number of the most successful private equity investment firms investing in Australia, the Asia-Pacific region and the UK. In 2015, he advised on the initial public offering (IPO) of Pacific Equity Partners-owned Link Group, Australia’s largest IPO of the year, and acted for private equity firm KKR in connection with its participation in the consortium that acquired GE's $8.2bn Australian and New Zealand consumer credit business.
I’m sure you’re already asking: So, how does the future of private equity in Australia look? In Grant’s opinion, pretty bright: “There is absolutely no shortage of capital. PE funds are cashed up and there’s a lot of equity to be put to work, so they’re looking to do new deals.” However, he explained the challenge firms are facing is that there has been an overall theme of uncertainty in the market that has been impacting deal flow in the first half of the calendar year.
Australian sponsors are very sophisticated buyers and responsible investors. While a number of the leading private equity funds are cashed up and ready to invest, they are looking for the right deals and acting with caution. Grant believes there are a number of factors contributing to the current market uncertainty, including continuing macroeconomic instability and political uncertainty, with Brexit, the US Presidential elections and Australia Federal elections all playing their part. Further, oil prices, fluctuations in the Australian dollar and concerns around the Chinese economy are also contributing factors for the lack of Australian deal activity, particularly at the larger end of the market.
In addition to market uncertainty, Grant sees the persistent valuation gap as another challenge for dealmaking. There’s a disconnect between what buyers are willing to pay for targets and what vendors think their businesses are worth — causing a lack of targets at the right price points. Grant shared, “The broader uncertainty, and the lack of alternative investment options, provides an additional conundrum for potential sellers. If they do sell their businesses at prices that reflect the current economic environment rather than historical expectations, how are they going to invest the sale proceeds? Cash rates are low and public markets are volatile, posing the question, How do I continue to get a decent return now that I've sold my business?” As a result, many business owners may choose to hold onto their businesses for another 12 months to see if things stabilize and prices come up, improving their returns in the near term.
Competition is also tough as the Australian market is seeing an influx of foreign buyers from China — notwithstanding the Foreign Investment Review Board (FIRB) angle and the potential execution risk that now presents for sellers and buyers alike. Foreign strategic buyers are often focused on securing a particular sector or asset type, whereas private equity buyers tend to be more agnostic. From a diversified portfolio perspective, there is little to be gained from paying over the odds for local assets in an unsettled market. Moreover, for certain assets, there is a reluctance from Australian-based sponsors to chase assets if there is significant Chinese buyer participation, says Grant. “Why run hard at a deal and incur the associated transaction costs if you're up against potential purchasers who are willing to pay extremely high multiples to secure what they see as strategic assets? Sponsors need to find a strategic angle that will enable them to price more aggressively, and if they can’t do so, they will tend to withdraw and focus on pursuing other opportunities."
When asked to comment on the number of deal opportunities, Grant stated: "Given the competitive dynamic surrounding this market and the limited number of larger-sale processes that have come to market in the last 12 months, we are seeing an increased focus on proprietary deals. But, of course, proprietary deals generally have longer germination periods, which is another reason why we've seen less deals this year. However, I think they'll be increasingly common part of the PE landscape over the next 12 months."
In terms of the types of deals where buyers will pay maximum value, Grant says that agriculture, transportable health care and health products are good considerations. In the current market, any asset that presents a significant opportunity for an offshore buyer to come in and export domestic technology and talent is attractive.
“The financial services sector remains active and, in the small to mid-market, scalable financial technology opportunities are generating interest,” says Grant. "There is a degree of investor caution around smaller technology plays, given the fate of several unicorns (tech start-up company valued at over $1 billion) over the last 12 months, but there is still potential for investment growth. Structured investment strategies can often help to mitigate investor risk while providing these businesses with the growth capital they need."
"Deals overall are likely to take longer to close, but activity levels are improving. We have definitely seen an uptick over the last month or so," noted Grant.
Even though the year started off slow in terms of dealmaking, the Australian private equity market is ready and sponsors clearly have the cash to get the deals done. At the same time, as they should, they are taking a very careful approach in terms of investments. According to the Australian Financial Review’s Joyce Moullakis, “Private equity firms are tipped to be busier spending $5.5 billion of capital in 2016, rather than exiting investments.” As we push into the second half of the year, deal activity should pick up — and Australian private equity firms had better be ready.