An extract from The Acquisition and Leveraged Finance Review, 8th edition

Overview

Australia has a long history of merger and acquisition activity, and consequently, the debt financing of these acquisitions is a well-trodden path for lenders and borrowers alike. Traditionally, the senior debt financing of acquisitions in Australia has been the domain of the banks, international and domestic, with the local 'Big Four' banks often taking lead roles in relation to the arranging and underwriting of these facilities. However, consistent with the European experience, the market has recently borne witness to the emergence and proliferation of non-bank, institutional lenders.

Traditionally, an Australian acquisition finance package will feature an amortising term loan A, together with a bullet term loan B, to fund the acquisition of the target group. These facilities will generally be accompanied by a pari passu revolving facility that is designed to meet the target's working capital or contingent instrument needs, or both, post-acquisition. Capital expenditure or acquisition facilities are often also included as required (generally on a committed basis). Subordinated debt provided by specialised institutions (usually in the form of mezzanine loans or local capital markets products) also often features where the acquisition is of a sufficient size. Recently, there has been a trend for mezzanine funding to be provided at a level above the bank group, being the holdco level. This enables sponsors and senior lenders to avoid much of the complexity that comes from having this subordinated debt provided at (or just above) the level of the senior debt. As a general rule, loan documentation in the Australian market is relatively standardised, thus enabling loans to be drafted, priced and syndicated to a wide pool of financiers.

Unitranche loans (a hybrid loan that rolls senior and subordinated debt into a single debt instrument) remain popular, particularly on the basis that they are nimble, flexible (from a covenant perspective) and relatively easy to execute.

As with 2021, the predominant influence on the Australian lending market (as with any other market) continues to be the global covid-19 pandemic and the lending market's response to the unprecedented effects of pandemic-related lockdowns and geopolitical responses to the virus. It was believed that 2021 would be a year of heightened M&A activity as financiers and sponsors sought to employ liquidity previously withheld from 2020. In line with expectations, the first part of 2021 was characterised by an increase in deal activity amid a global economic recovery following the widespread distribution of the covid vaccine and achievement of a relatively stable geopolitical context.

The value of Australian syndicated lending decreased by 31 per cent over the first half of 2021 (year on year) relative to the same period in 2020 and deal volume decreased by 24 per cent (US$34.8 billion from 81 deals in the first half of 2021, down from US$50.3 billion from 106 deals in the first half of 2020.2 The decrease in value in the first half is inconsistent with a global rise in syndicated lending by value (a 22 per cent global increase in value year on year with no change in deal volume year on year).3 The decrease in syndicated lending should also be considered from the perspective of the diminished values in 2020 where Australian syndicated lending reached US$77.33 billion and declined 13 per cent in value and 27 per cent in volume compared to 2019.4

As a measure of regulatory relief to the economic outlook, the Reserve Bank of Australia announced a reduction in the cash rate to 0.10 per cent as a policy response to establish and provide liquidity in the market. Consequently, we are now in an environment where people are becoming increasingly concerned about negative interest rates (similar to the experience in Japan in 2016). From a documentation perspective, this has led to a continued focus on interest rate floors in loan documentation, both in the leveraged market and more generally.

Despite the pandemic's dampening effect on M&A-related financing in 2020, private equity dealmakers demonstrated a clear willingness to put capital to work on large-scale M&A financings in 2021. For example, Square Inc's A$39 billion acquisition of Afterpay in 2021 was the largest public M&A transaction in Australia's history and the largest cross-border fintech deal globally. The resurgence of private equity in M&A has been accelerated by structural shifts in the liquidity and appetite of global credit markets that resulted from the lower leveraged loan volumes in 2020. These factors have manifested themselves in enhanced difficulty in valuing potential buy-out targets. M&A-related financing for the Asia Pacific region experienced low volumes in the first half of 2021 (volumes reached US$21.15 billion in the first half of 2021, down by 4.5 per cent from the same period the year prior).5 It is expected that the current low interest rate environment, together with the view that Australia remains a favourable jurisdiction for international dealmakers seeking opportunities in the Asia Pacific given its status as a mature economy with a sound legal system and response to the challenges of the pandemic,6 will continue to draw M&A-related financing activity to the local market led strongly by service-based and technology sectors.

As noted earlier, growth in the Australian unitranche market remains strong. Term loan B (TLB) financing constituted a larger market share for leveraged buyout deals (LBOs) in Australia. Of the total US$6.45 billion loans that funded LBOs completed in 2020, traditional bank loans 55 per cent, TLBs accounted for 32 per cent, and unitranche deals the remaining 13 per cent.7 Early signs for 2021 for TLBs are promising – with Australian TLB volumes in the first half of the calendar year already surpassing the volumes for the entire year of 2020.8

Following a string of substantial government privatisations in past periods (which included the privatisation of a majority stake in the WestConnex freeway project (A$9.26 billion), the New South Wales Land Registry Services (A$2.6 billion) and the Victorian Land Titles and Registry office (A$2.86 billion), 2021 has continued the trend from 2020 and seen a continued deceleration in the number of privatisations and new infrastructure projects with some of the more notable transactions involving the refinancing of existing debt. Despite the slowdown, asset privatisation remains an integral part of broader government strategy because it allows governments to unlock significant capacity to reinvest into new transport and social infrastructure projects, which in turn generates additional deal flow.

Notable projects in 2021 include Multiplex's successful bid for the Western Sydney International Airport (A$5.3 billion), the WestConnex financing (A$4.2 billion), PoWar consortium's acquisition of Tilt Renewables (A$3 billion), ESR Milestone Partnership's (a partnership between ESR and Singapore's sovereign wealth fund GIC) acquisition of the Milestone Logistics Portfolio (A$3.4 billion) and the new Royal Adelaide Hospital Project (A$2.2 billion).

Regulatory and tax matters

i Regulation of foreign investments in Australia

The Australian Foreign Acquisitions and Takeovers Act 1975 (Cth) (FATA) and its associated regulations (administered by the Foreign Investment Review Board (FIRB)) regulate the making of investments by foreign persons in Australian companies and assets (and in some cases offshore companies with the requisite Australian connection).

In general, the legislation regulates four kinds of actions: significant actions, notifiable actions, notifiable national security actions and reviewable national security actions.

Significant or notifiable action

The Treasurer has the power to make orders in relation to significant actions (including blocking them, or ordering divestments) if he or she considers the transaction to be contrary to the national interest. Approval only has to be sought for these if they are also notifiable actions or notifiable national security actions, but obtaining approval cuts off the Treasurer's powers (although he or she can in certain circumstances re-open approvals). Seeking approval is strongly advised. Notifiable actions are a category of transaction that requires approval. Most notifiable actions are also significant actions (meaning the Treasurer has the above powers).

Common significant, or significant and notifiable, actions are:

  1. the acquisition of 20 per cent or more of an Australian entity that is valued above the current monetary thresholds (currently A$281 million, or A$1216 million where a higher treaty threshold can be relied on, and the business is not a sensitive business);
  2. the acquisition by a foreign person that is a foreign government investor of 10 per cent or more (and sometimes less than 10 per cent) of an Australian entity or business (subject to a de minimis exemption, where the acquisition is of an offshore entity with an Australian subsidiary that meets certain tests);
  3. the acquisition of 10 per cent or more (and sometimes less than 10 per cent) of an Australian entity that carries on an agribusiness where the investment is valued above the then current monetary threshold;
  4. the acquisition of an interest in land valued above the then current monetary threshold (which varies depending on the kind of land and who the acquirer is), unless an exception applies; and
  5. the acquisition of 5 per cent or more of an Australian media business.

A foreign government investor (FGI) in general includes a foreign government or agency, sovereign wealth funds, state-owned enterprises, public pension funds, public universities and the like, or corporations, trustees of trusts or general partners of limited partnerships where, in respect of the corporation, trust or limited partnership:

  1. FGIs from one country hold 20 per cent of the interests; or
  2. FGIs from multiple countries hold 40 per cent or more of the interests, subject to an exception for passive investors (which does not apply to the 20 per cent limb).

Many PE funds are FGIs because of the amount of US state pension fund money in them.

Notifiable national security action

The Treasurer has the power to make orders in relation to notifiable national security actions (including blocking them, or ordering divestments) if he or she considers the transaction to be contrary to national security (which is narrower than the national interest test above). These actions require approval. An action is a notifiable national security action if the action is taken, or proposed to be taken, by a foreign person and the action is any of the following:

  1. starting a national security business;
  2. acquiring an interest of 10 per cent or more (and in some cases less than 10 per cent) in a national security business;
  3. acquiring an interest of 10 per cent or more (and in some cases less than 10 per cent) in an entity that carries on a national security business;
  4. acquiring an interest in Australian land that, at the time of acquisition, is national security land; or
  5. acquiring a legal or equitable interest in an exploration tenement in respect of Australian land that, at the time of acquisition, is national security land.

A national security business is one that is carried on wholly or partly in Australia whether or not for profit or gain and is publicly known, or could be known after reasonable enquiry, that the business:

  1. is an owner or operator of critical infrastructure assets as defined in the Security of Critical Infrastructure Act 2018 (SOCI Act) (currently the SOCI Act covers certain ports, water, gas and electricity, but is undergoing consultation and is likely to be significantly expanded at some point this year);
  2. is a carrier or nominated carriage service provider to which the Telecommunications Act 1997 applies;
  3. develops, manufactures or supplies critical goods or critical technology that are for military or intelligence use by Australian or foreign defence or intelligence agencies;
  4. provides critical services to Australian or foreign defence or intelligence agencies;
  5. stores or has access to information that has a security classification;
  6. stores or maintains personal information of Australian defence and intelligence personnel collected by the Australian Defence Force, the Defence Department or an agency in the national intelligence community, which, if accessed, could compromise Australia's national security;
  7. collects, as part of an arrangement with the Australian Defence Force, the Defence Department or an agency in the national intelligence community, personal information on defence and intelligence personnel, which, if disclosed, could compromise Australia's national security; or
  8. stores, maintains or has access to personal information as specified in the above dot point, which, if disclosed, could compromise Australia's national security.

National security land is any of the following that is in Australia, and is owned or occupied by the Commonwealth for use by the Defence Force or the Department of Defence:

  1. an area of land or any other place (whether or not it is enclosed or built on);
  2. a building or other structure;
  3. a prohibited area, within the meaning of the Defence (Special Undertakings) Act 1952;
  4. the Woomera Prohibited Area;
  5. land in which the Commonwealth, as represented by an agency in the national intelligence community, has an interest that:
  6. is publicly known; or
  7. could be known upon the making of reasonable inquiries.
Reviewable national security action

Reviewable national security actions are transactions with an Australian nexus that are not significant actions, notifiable actions or notifiable national security actions. These transactions, together with significant actions for which approval is not sought, are subject to the Treasurer's 'call in' powers for a period of 10 years if he or she considers that the transaction poses a national security concern. Like significant actions, reviewable national security actions do not have to be notified, but obtaining approval cuts off the Treasurer's powers (although he or she can in certain circumstances re-open approvals). The Australian government encourages seeking approval for certain kinds of reviewable national security actions.

While FIRB approval is principally a matter of concern from an M&A perspective (where ownership in the shares or assets are actually being transferred), it is also relevant in a debt finance context given that 'obtaining an interest' also extends to the grant of a security interest over such shares or assets or the enforcement of such security.

In a finance context, there is an exception from this requirement if the interest is either held by way of a security or acquired by way of enforcement of a security, solely for the purpose of a money-lending agreement. This applies to persons whose ordinary business includes the lending of money (which is deliberately broad enough to capture institutions that are not authorised deposit-taking institutions (ADIs) and also captures a subsidiary or holding company of such a lender, a security trustee or agent, and a receiver or receiver and manager of an entity that holds or acquires the interest). This exception also applies to a 'foreign government investor', although in respect of an interest acquired by way of enforcement of a security, a foreign government investor is restricted in the amount of time it can hold an asset (12 months in the case of an ADI and six months in the case of a non-ADI, unless the foreign government investor is making a genuine attempt to sell the assets acquired by way of enforcement). The money-lending exception has more limited application where the security is over residential land, national security land or a national security business.

Where the acquisition is not politically sensitive, these approvals are generally provided as a matter of course, although the need for FIRB approval should be considered where security is being granted over material Australian entities and the imposition of conditions around tax, data handling and the like is becoming routine.

Other government approvals can also be required to take security over certain types of assets (such as mining and resource interests) that are subject to separate regulation.

Note that the above is a summary only. Australia's foreign investment rules are notoriously complex and are affected by non-statutory guidance, and legal advice should always be sought.

ii Interest withholding tax

Interest withholding tax (IWT) of 10 per cent applies on gross payments of interest (or payments in the nature of, or in substitution for, interest) made by Australian borrowers to non-resident lenders (except where the lender is acting through an Australian permanent establishment or where other exceptions apply). IWT is a final tax and can be reduced (including to zero) by domestic exemptions and the operation of Australia's network of double tax agreements (DTAs).

Under DTAs with Finland, France, Germany, Japan, New Zealand, Norway, South Africa, Switzerland, the United Kingdom and the United States, there is no IWT for interest derived by a financial institution unrelated to, and dealing wholly independently with, the borrower (subject to certain exceptions).

Under Australian domestic law, IWT may also be exempt where the debt satisfies the 'public offer' exemption (contained in Section 128F of the Income Tax Assessment Act 1936 (Cth)). Once the debt satisfies the public offer exemption, it is typically more marketable as an incoming lender remains entitled to the benefits of the exemption from IWT (subject to certain criteria being met). Broadly, the public offer exemption applies where an Australian company publicly offers certain debt instruments via one of several prescribed means, including (most commonly):

  1. the debt instrument is offered to at least 10 persons, each of whom is carrying on a business of providing finance, or investing or dealing in securities in the course of operating in financial markets, and are not known or suspected by the borrower to be associates of one another or of the borrower; or
  2. the debt instrument is offered to the public in an electronic form that is used by financial markets for dealing in debentures or debt interests.

Syndicated facility agreements can only satisfy the public offer exemption where the borrower or borrowers will have access to at least A$100 million at the time of the first loan (among other criteria).

An IWT exemption will not apply where the issuer (or arranger acting as agent for the issuer) knew or had reasonable grounds to suspect that the debt instrument will be acquired by an offshore associate of the Australian borrower, unless the associate acquired it in the capacity of a dealer, manager or underwriter in relation to the placement of the debt instrument, or a clearing house, custodian, funds manager or responsible entity of a registered scheme.

IWT relief also applies to certain foreign pension funds and sovereign funds. The IWT exemption will only apply to foreign pension and sovereign funds with (broadly) portfolio-like interests, being interests in an entity that are less than 10 per cent of total ownership interests and do not carry an ability to influence the entity's decision-making. Additionally, the IWT exemption for sovereign funds will only be available for returns on investments in Australian companies and managed investment trusts.

iii Thin capitalisation

Australia has a thin-capitalisation regime that can operate to deny income tax deductions for interest expenditure on overly geared Australian groups that have debt deductions over the de minimis threshold of A$2 million for an income year. There are three methods to calculate the maximum allowable debt of a taxpayer. Most Australian borrowers will rely on the safe harbour, which in broad terms allows for Australian assets to be funded by up to 60 per cent debt. In the context of an acquisition, these provisions allow for the funding of acquired goodwill.

In addition, there is an arm's-length debt test, which broadly allows Australian groups to be debt-funded up to the maximum amount a third-party lender would be willing to lend. This test has not typically been used as it is an annual test and requires an assessment of various quantitative and qualitative factors including the prevailing debt markets and general state of the Australian economy. Another test, the worldwide gearing test, allows an outward investing entity (which is not also an inward investing entity) to gear its Australian operations, in certain circumstances by reference to the gearing level of its worldwide group.