37%11 deals valued at $1bn+
public M&A deals valued at
Complex taxation requirements
Tax treatment of special dividends
$398m average deal value 57% of transactions achieved a premium above 30%
of transactions are friendly
but hostile bids are on the rise
Low organic growth prospects
Opportunism Low interest rates
ASIC hot buttons Independent Experts
food & agribusiness
Transition period for foreign investment
Activism on the horizon
Full story of M&A market told in two halves
FY16 was another active year for public M&A activity in Australia. Our analysis focuses on public M&A transactions valued at $100m+, of which there were 31 in FY16. Eleven out of the 31 transactions (37%) were valued over $1.0 billion, and the median deal value was $398m.
FY16 was a tale of two contrasting halves, with the majority of deals in our sample size (22 or 70%) announced in the first half of the year to 31 December 2015. The decline in deal flow in the second half of FY16 could be attributed to a range of factors including:
global share market correction
uncertainty in the lead up to the federal election
slowing growth in China
persistent concerns over the health of the financial sector
M&A activity was fairly evenly spread across a diverse range of industry sectors including telecommunications, mining, infrastructure and utilities. Transport was a hotspot this year, largely due to the competitive auction for control of Asciano.
Public M&A activity in FY16 by industry sector (> A$100m)
Chemicals Real Estate Food Beverage & Tobacco Software & Services
Energy Commercial Services & Supplies
Metal & Mining Telecommunication Services
Capital Goods Transportation
Utilities Health Care Equipment & Services
Consumer Services Retailing
1 2 1 1 2 4 2 2 2 4 2 2 3 2
Industry Sector Number of takeovers
Takeover activity is a little less friendly
Consistent with FY15, the majority of takeover bids in FY16 were 'friendly'; i.e. recommended by the target's board (in the absence of a superior proposal). Interestingly, the strength of that majority diminished almost 25% in FY16 from 88% in FY15, to 68% in FY16, with a corresponding increase in hostile bids. This likely reflects an increasing propensity to pursue opportunistic, hostile bids for targets whose share prices have fallen steeply. A lower valuation presents an attractive baseline for bidders to assert that they are offering target shareholders an attractive premium for control.
As we've come to expect in friendly takeovers, schemes of arrangement remain the preferred structure in most cases (67%). This is slightly lower than in FY15 (75%) but the attractive aspects of schemes - certainty of timing and outcome and structuring flexibility - explain its ongoing appeal.
75 67 Takeover
26 16 58
17 17 65
Cash/Scrip Scrip Cash
There was a rise in the number of auctions for control from two in FY15 to four in FY16. This uptick may be a reflection of: fewer bidders submitting compelling, fully priced offers at the outset
57% of transactions (compared to 70% in FY15) delivered a starting premium above 30% competing parties being more willing to engage in an active contest for strategically important targets.
Stub-equity as consideration
Although 'all cash' offers remained the preferred form of consideration for most takeovers, we saw the return of so-called 'stub-equity' in which private equity bidders offer to provide target shareholders with some or all of their consideration as unlisted scrip in the private equity fund that will acquire control of the target. PEP's bid for Patties Foods is an example, with MinterEllison advising Patties Foods.
The 'stub equity' alternative allows target shareholders to retain an ongoing investment in the company and 'go along for the ride' under private equity ownership, recognising that an exit will be made at some stage, which could deliver additional future value to shareholders electing stub equity.
Early disclosure to capture the momentum
Many target companies iSelect, Oil Search, OzForex, ALS and the a2 Milk Company for example elected to disclose the receipt of non-binding indicative proposals from prospective acquirers, even though the ASX listing rules are clear that this is not required. Some listed targets may be more inclined to use voluntary early disclosure to get on the front foot and control the timing and public messaging for a potential change of control transaction, rather than facing the risk of having to respond to market speculation before the proposal is fully developed and announced.
Activism in decline
Compared to previous years, there was noticeably less shareholder activism in large Australian public deals in FY16. However, boards of targets and bidders still need to be prepared for a broad spectrum of shareholder activism when a takeover is announced. It could well be that boards are now more attuned to activist intervention and are taking steps to ensure the terms/structure are likely to be well received by potential activist shareholders at the outset, before deals are publicly announced. See FY17 predictions for more.
PEP recommended cash bid for Patties Foods
PEP's bid incorporated an alternative for Patties shareholders to elect unlisted scrip to retain an ongoing investment exposure to Patties.
Jangho acquisition of VisionEye
Jangho successfully launched a recommended 'all cash' offer for Vision Eye, which Vision Eye's board welcomed and promptly recommended off the back on defending a hostile 'all scrip' offer from Pulse Health
MinterEllison acted for Jangho and Patties Foods
Transitional period for foreign investment
The proportion of takeover offers from foreign bidders fell noticeably in FY16 compared to FY15. In FY16 foreign bidders accounted for 12 out of 31 announced takeovers (39%) and 2 other bids were made by foreign bidder consortia or local bidders associated with foreign companies. Most foreign bidders were concentrated in the US and Canada with Asian, European and African bidders also making an appearance. In FY15 foreign bidders accounted for 63% of takeover offers. Elsewhere, in private M&A and real estate, demand from foreign investors has continued unabated.
In our view the dip in foreign investment activity in public M&A is a short term aberration, possibly attributable in part to the market adjusting to the new FIRB regime, which took effect in December 2015, mid way through the financial year. The new FIRB regime represents wholesale change
(see graphic on key changes) which in turn will affect planning, timing, costs and availability of attractive target assets for foreign bidders, who may be waiting to see how the new regime will impact their acquisition plans in Australia. The sectors that remain highly sensitive from a FIRB perspective are Agribusiness, Health, Transport/ infrastructure and State privatisations.
New conditions regarding compliance with Australian tax laws for foreign investment applications also came into force in February 2016, including requirements for an annual reporting mechanism to FIRB confirming that the conditions have been met. In substance, the conditions mean that the management of tax risk remains a key aspect of planning future investments into Australia and is now considered at an earlier stage by the ATO.
FIRB regime change
application fees of $5,000 to $101,500 now payable
more active regulators
completely new law, with 46 Guidance Notes
criminal and civil penalties, including divestment
sale of S. Kidman and Co blocked
more conditions on health transactions
Asciano / Qube / Brookfield transactions delayed , though ultimately approved
ASIC hot buttons
In public transactions, ASIC has closely scrutinised the appointment of independent experts who do not regularly prepare such reports. ASIC has also scrutinised the independence of experts in friendly transactions who were jointly appointed by bidder and target (e.g. in scrip takeovers where the expert is valuing both parties' scrip). ASIC is particularly interested in situations where a jointly appointed independent expert is later required to assess competing offers for the target from rival bidders.
Shareholder intention statements
Bidders or targets often solicit public statements about the intentions of major shareholders (to accept or reject a takeover offer or to vote in favour of or against a scheme). ASIC considers that procuring so-called shareholder intention statements creates a risk of association and in turn a risk of breaching the 20% rule and the substantial holder notice rules. For example, in the hostile takeover bid by Metro Mining for Gulf Alumina, the target issued a statement disclosing that 15 of its shareholders (holding 70.6% of Gulf's shares) had advised the board that they did not intend to accept the bidder's offer. ASIC made submissions to the Takeovers Panel in proceedings brought by the bidder complaining about this shareholder intention statement, prompting corrective disclosure by the target.
This refers to where target shareholders may elect to receive bidder's scrip which is potentially subject to being scaled-back and substituted with cash consideration if a maximum cap on scrip elections is exceeded. ASIC considers that the potential for scale-back introduces uncertainty for shareholders who may receive consideration that is substantially different to that which they elected. ASIC requires the scheme company (notional target) to set the election date before the scheme meeting and to announce the outcome before the scheme meeting, including whether scrip scale back will apply and to what extent. The Patties scheme included an option to elect to receive unlisted shares in PEP's bid vehicle, but ASIC insisted that scrip elections had to be received 4 business days before the scheme meeting . ASIC further required that PEP release an ASX announcement 3 business days before the scheme meeting, regarding the outcome of scrip elections including whether scale-back applied.
ACCC continues close scrutiny of M&A activity
In FY16, the ACCC undertook public reviews of 29 proposed M&A transactions. Confidential reviews or pre-assessments were undertaken on a significantly greater number of transactions.
Of the publicly reviewed transactions, the ACCC:
opposed just two: Sea Swift's proposed acquisition of Toll's marine freight business in the NT and FNQ and GPC's proposed acquisition of Covs Parts from Automotive Holdings Group Ltd.
cleared 4 transactions subject to s87B undertakings including Iron Mountain/Recall, and Primary Healthcare/ Healthscope. Recently Metcash's proposed acquisition of Home Timber and Hardware was cleared subject to an s87B behavioural undertaking, as was the Qube/Brookfield consortium acquisition of Asciano, after the parties restructured the deal to address vertical integration concerns.
Completed transactions subject to ACCC review
The ACCC's post facto review of Primary Healthcare / Healthscope resulted in Primary divesting the pathology assets it acquired from Healthscope, largely reversing the deal. Not only did this indicate the ACCC's willingness to review completed transactions, it also highlighted the risk to companies of completing contentious acquisitions without securing ACCC clearance beforehand.
Is merger authorisation now commercially viable?
After the ACCC opposed the Sea Swift / Toll marine freight acquisition, authorisation by the Competition Tribunal was sought by the parties and granted in July 2016 making it the first successful authorisation application since AGL / Macquarie Generation in 2014. In the right circumstances, authorisation by the Tribunal may become a more commercially viable option for obtaining clearance for a transaction, either as a form of appeal from an ACCC decision or as a direct avenue.
GPC proposed acquisition of Covs Parts from Automotive Holdings Group
This transaction was subsequently cleared by the ACCC after the parties agreed to carve out certain parts of the deal through the provision of a s87B undertaking.
MinterEllison advised GPC, as well as Iron Mountain and Toll in navigating complex ACCC issues.
23 approved 1 opposed 1 opposed then approved with undertakings 1 subsequently authorised by Tribunal 4 approved with undertakings
Tax themes arising in M&A deals
Taxation of special dividends
The payment of special and ordinary dividends prior to completion was a common theme in many public transactions including the Pacific Brands and Patties Foods takeovers. Despite a long history of use, companies will often seek an ATO class ruling on the tax treatment of special dividends. This delivers additional certainty for shareholders of the target company. In this context a class ruling should generally address whether: any part of the dividend
constitutes capital proceeds from the disposal of shares in the target; franking credits may be accessed by shareholders; franking credit streaming anti-avoidance rules apply to the payment of the dividends; the general anti-avoidance rule relating to schemes which involve obtaining franking credit advantages is applicable.
Australia's thin capitalisation rules operate to deny debt deductions to certain taxpayers to the extent that the group is highly geared. They generally limit debt deductions to a maximum level based on safe harbour debt-toequity levels (equal to 60% of the accounting value of assets) or arms' length debt financing principles. Thin capitalisation rules continue to be a focus for forward investing entities as decisions are made around internal and external financing or between local and foreign financing for public M&A transactions.
Non-resident capital gains withholding tax
Since 1 July 2016 purchasers of direct, and some indirect, interests in Australian land (including leases and mining rights), and grantees of options to acquire those interests, may have to pay to the ATO an amount equal to 10% of the purchaser's cost base in the relevant asset on or before completion of the sale. Broadly, the withholding applies unless either there is sufficient proof of the vendor's Australian tax residency, there is proof that the interest is not an indirect Australian real property interest, or the transaction is otherwise exempt. Vendors and purchasers, whether Australian resident or not, need to consider whether their transactions are affected by the new rules as this can impact on completion timing.
Global factors not an impediment to domestic M&A activity
We may yet see some Brexit-related reduction in M&A activity by companies with a large reliance on UK-based divisions, but otherwise we do not expect any material overall impact on Australian M&A activity levels.
The principal drivers of M&A activity are companies who identify a need to 'buy growth' through acquisitions and/ or companies who identify opportunities to acquire companies trading below their true underlying value. Market volatility
arising from short-term external shocks is unlikely to deter acquirers and in fact may embolden opportunistic bidders to move more quickly if the volatility is causing a material downward correction in the share price of a previously identified target. Locally, many well funded companies with low organic growth prospects will be increasingly prepared to explore M&A opportunities to drive revenue growth, as their share prices tend to respond well to announcements of bolt on acquisitions that are immediately earnings accretive.
FIRB is now a real deal risk
With the Coalition Government being re-elected with only a one-seat majority and the rise of populist and protectionist tendencies on the Senate crossbench, FIRB is emerging as a potential deal execution risk for sensitive transactions, in contrast to its lower risk profile in recent years. Agribusiness deals in particular might be harder to close. This may also extend into infrastructure transactions, especially those involving critical infrastructure such as power, water, transport and telecommunications assets.
FIRB's recent rejection of the Ausgrid transaction is a vivid illustration of this.
Faced with this heightened risk, it is more likely that Australian targets will not simply accept FIRB conditions in transactions in industries considered most problematic without additional comfort from bidders. This may lead to foreign bidders needing to offer targets bespoke forms of comfort, such as reverse break fees, to remain competitive in auction processes. In this respect, Australian corporates will have an advantage in contested M&A.
Healthcare, food & agribusiness and financial services should continue to be active sectors in FY17 and attract attention from foreign bidders.
In the healthcare sector Chinese bidders have been very active including the acquisition by China's Luye Medical Group of Australia's third largest private hospital operator, Healthe Care, the acquisition of Vision Eye by Jangho Group, and the acquisition of a majority stake in GenesisCare by China Resources Group and Macquarie Capital. Chinese players are able to leverage Australian medical know-how to service strong domestic demand in China and we expect these drivers to continue.
In food & agribusiness -- notwithstanding that Dakang Australia's bid for the Kidman properties has been twice blocked -- underlying demand for Australian beef from North Asia is strong as is the continuing strategic rationale for food security. Interest has extended into vitamins and dairy/ milk products, where Australia's 'clean and green' brand has been of particular interest to Chinese buyers. The ability to sell Australian food products directly into the domestic Chinese market makes acquisitions attractive and was the driver for Legend's buy-out of Kailis Bros' seafood processing assets in WA, and Primavera and Shanghai Pharma's proposed acquisition of Vitaco. Looking forward into FY17, water rights will become valuable assets for foreign bidders as will diversification into other protein classes leveraging Australia's 'clean and green' brand.
Financial services has seen strong deal flow over the last 12 months including the sale of GE's Australian commerciallending operation to Sankaty Advisors and the announcement of Nippon Life's $2.4 billion acquisition of 80% of MLC Life from NAB. We think the banks are likely to continue to deleverage and divest non-core assets, including further disposals in the life insurance sector. The fintech start up industry will also continue to evolve and we may even start to see some consolidation in the crowded marketplace lending space.
Impact of low interest rates
Low interest rates have been a feature of the prevailing low growth environment in corporate Australia. In turn this has informed the capital management strategies of large issuers and has seen an uptick in the number of companies undertaking share buy-backs (Qantas, CIMIC and James Hardie). The availability of cheap debt has also seen companies favour bolt-on acquisitions as a means of buying growth in preference to building new plant & equipment. We expect this will continue into FY17.
Low interest rates also tend to increase the pressure on listed companies to deliver solid dividend streams and share price growth, as investors demand a return on their investment that exceeds what is available on debt. We expect this pressure will prompt listed companies to turn to M&A activity to deliver growth in FY17.
Targets boards to be better prepared to defend opportunistic offers
Last year we foreshadowed that target boards and shareholders will become increasingly pragmatic in assessing offers that incorporate a reasonable control premium. This was aptly illustrated in the takeover of Broadspectrum by Ferrovial where Broadspectrum's board ultimately changed their initial and emphatic 'reject' recommendation to 'accept', in the face of uncertainty over the renewal of a key government contract that was material to Broadspectrum's future profitability.
Although target boards should remain pragmatic in evaluating the adequacy of takeover offers, that should not extend to simply 'rolling over' in response to an opportunistic bid that materially undervalues the target. The prospect of more opportunistic bids mean that target boards need to be far more proactive in undertaking valuation work well in advance of any bid so that they have an objectively credible valuation benchmark from
which they can confidently dismiss any nonbinding indicative offer (or indeed any formal takeover) that is materially inadequate.
Take for example ALS's spurning of Bain and Advent. Within 48 hours of the receipt of the non-binding indicative approach, ALS publicly disclosed the approach and its rejection, despite the bid incorporating what was described as a 31% premium. This disappointed Advent and Bain who had anticipated being granted due diligence access to ALS' non-public information on the strength of the premium. ALS described this approach as 'opportunistic'.
Boards must remain cautious in dismissing takeover offers on the basis of a perceived inadequacy of the offer price. On numerous occasions target boards have rejected indicative proposals, only to face deteriorating conditions or other impediments which in turn translate to a share price well below the rejected offer price.
Companies prepared to raise capital to fund acquisitions
Despite the low cost of debt, we will continue to see issuers raise capital to fund strategic acquisitions. In FY16 we saw Vocus Communications raise capital to acquire Nextgen Networks, Mayne Pharma tap the capital markets to acquire a portfolio of U.S. generic products from Teva and Allergan and SmartGroup undertake a capital raising to fund its ongoing M&A strategy. Each of those capital raisings was well received by the market and we expect that this might encourage more listed companies to fund their M&A activities in this manner.
Activism still on the horizon
FY16 may have been relatively quiet on the activist front but there is still potential for M&A transactions in FY17 to be influenced by activist pressure including from:
key shareholders of a target who consider the terms of an announced offer to represent an inadequate control premium or otherwise to not be in their best interests such shareholders are not afraid to privately and publicly agitate for an improved offer to secure their support for the deal.
hedge funds that purchase key parcels of shares in the target on-market following the announcement and then seek to use their stake to extract a higher price to secure their support a high risk strategy because if the hedge funds do not deliver their shares into an offer at the announced price and the offer fails, the hedge funds will incur substantial (paper) losses.
existing key shareholders of the target who apply pressure on an 'obstructive' board to be more facilitative in how they engage with the proponent of a non-binding indicative takeover proposal, so that shareholders have a better opportunity to receive a formal offer.
industry competitors who purchase key parcels of shares in the target on-market following the announcement of an offer, with a view to using their stake to defeat an offer or extract some greenmailing collateral benefit as the price for not impeding the takeover.
Boards need to anticipate all angles of potential challenge to their announced deal structure and terms and be prepared to adapt the structure and/or deal terms in response. Companies that believe they are susceptible to takeover should also maintain regular dialogue with their key shareholders to ensure they understand the strategy that is being pursued to deliver long-term value creation. Regular engagement with key shareholders is important to build credibility and confidence in the board's strategy. The absence of regular engagement and communication with key shareholders may mean that they are more likely to be open to accepting an opportunistically timed bid at a material under-value. Of course, regular engagement and communication with key shareholders must not stray into the illegal territory of selective briefings where they receive access to further or better information than all other shareholders.
We also predict that dedicated activist funds will be a driver of M&A activity. These funds purchase key shareholdings in a listed entity with perceived shortcomings and then seek to engage with the board to re-set their strategic direction. This could include applying private and public pressure on the board to spin off or demerge a division to unlock value (as we saw with Sandon Capital's activist intervention with Tatts), divest non-core businesses, pursue growth by acquisition or initiate a formal process to sell the company's main undertaking or actively solicit takeover bids for the company.