Each year the Corrs M&A team analyses every takeover and scheme of arrangement over $25 million involving an Australian listed target. As we pass the first half of the calendar year, we have checked in on the state of the public M&A market and here are our top ten findings:
1. M&A ON THE UP?
- In terms of public M&A, it doesn’t get much quieter than 2013. Although starting from a very low base, and still not threatening to break any records, 2014 has already delivered much stronger levels of M&A activity.
- Between 1 January and 30 June 2014, there have been 34 deals or indicative proposals announced with a deal value of over $25 million, which equals the total number of deals for the whole of 2013.
- In our M&A Year in Review 2013 we observed that the downturn in M&A in 2013 was largely driven by three key factors: a slowdown in resource sector investment; a drop in inbound foreign investment and significant political uncertainty. 2014 has seen improvement in each of these areas – M&A activity in the resources sector has improved, there has been an increase in foreign investment (particularly inbound Asian M&A activity) and the Australian political landscape is more stable than last year.
- Acquisition demand - which was largely absent during 2013 - appears to be returning and bidders are pursuing bigger M&A opportunities. 2013 was marked by a noticeable absence of “mega” deals (deals over $1 billion), with only 4 for the whole year. The first half of 2014 has seen this increase significantly with 13 mega deals.
2. WHERE IS IT ALL HAPPENING?
- In contrast to the relatively small number of resources deals last year, 2014 has so far been a much stronger year for resources M&A activity, in both metals and mining and oil and gas. So far this year resources deals account for 56% of our deal sample, a big leap from last year’s figure of 35%.
- Gold seems to be back in favour, particularly for foreign acquirers, with targets with gold assets representing 91% of metals and mining deals. Some of the larger deals seen in the sector have been Australian companies with offshore assets.
- Increased activity is expected in the Australian iron ore sector following Baosteel and Aurizon acquiring control of Aquila, which in turn may provide some increased confidence that currently stranded iron-ore assets may be able to be unlocked through the development of new multi-user rail and port infrastructure in the Pilbara region of Western Australia. Junior and mid-tier hopefuls with assets in the region may now become of more interest to potential acquirers
- There has also been increased activity in the oil & gas sector during 2014, with targets in this sector representing 21% of all deals in our sample.
- Despite robust balance sheets and access to relatively cheap funding, resource M&A activity is still mainly at the smaller end of the market. While there have been a few “mega-deals” in the resources sector (the proposals for Aquila Resources Limited and PanAust Limited are both over $1 billion – see our China section below), the vast majority of announced deals in this sector are below $50 million. Continued volatility in commodity prices, together with ongoing wariness about ensuring the success of a deal and managing the risk of any acquisition may see the focus continue on smaller miners which may be struggling in the current environment to raise the required capital to develop their projects.
- Other sectors seeing good deal flow are property (including proposals for Real Estate Corp, Challenger Diversified Property Group and competing bids for Australand Property Group) and utilities and infrastructure (with competing proposals for Envestra by APA Group and CK ENV Investments). Both of these sectors are also seeing increased activity in private M&A driven by listed company vendors with the announcements of the sales process for various business divisions of Leighton Holdings and the sale of UGL’s property services business, DTZ.
- A string of announcements by the Federal and State Governments to privatise various assets is likely to entice a number of investors. The potential for a large number of assets being put on the blocks, may result in investors keeping their powder dry by foregoing, for the time being, potential further investment in public companies in similar sectors.
3. COMPETITION IS FIERCE
- Given the very low deal volume in 2013, there were relatively high levels of competition, with around third of the deal sample involving contested deals. This competition seems set to continue in 2014 with a high proportion of contested deals in our deal sample so far.
- In 2014 rival proposals have emerged for Australand, Ambassador Oil and Gas, Envestra and Aquila Resources. In addition, SAI Global and Roc Oil have both announced that they have received interest from potential competing bidders (at the date of this article the details of potential bidders had not been disclosed).
- In the case of APA Group’s bid for Envestra, Stockland’s proposal for Australand, and Mineral Resources’ proposal for Aquila, we have seen Australian companies’ attempt to consolidate their current market position being frustrated by rival foreign bidders. In each of these cases, the targets have preferred cash bids by foreign bidders over bids involving scrip from domestic bidders.
4. FOREIGN INVESTMENT – IS AUSTRALIA BACK IN BUSINESS?
- 2013 was an anomaly for M&A in many respects – in the decreased levels of foreign investment; the periods of political instability, and the uncertainty surrounding the Treasurer’s rejection of ADM’s bid for GrainCorp.
- Foreign investment has picked up this year and, consistent with patterns for the 5 years before 2013, foreign bidders comprise the majority of acquirers in our deal sample so far in 2014, accounting for 59% of all deals.
- Foreign interest has been predominantly from Asia, with bidders from Hong Kong, PRC and Singapore comprising half of foreign bidders. Interest from North American bidders is also up from last year. Foreign bidders are pursuing bigger deals than domestic players. The average deal value by foreign bidders is 30% higher than proposals by Australian bidders ($775M v $596M) and foreign bidders account for 69% of the mega deals so far this year.
- So far this year, foreign bidders have been most interested in targets in the resources sector (84% of foreign bids in our deal sample). In our M&A Year in Review 2013 we predicted increased activity in the agricultural sector as Chinese and Indian producers seek ways to satisfy growing consumer demand. However, in the aftermath of ADM’s blocked bid for GrainCorp, the agri-business sector appears to remain politically sensitive. This was highlighted in the South Korean Free Trade Agreement where Australia has reserved the right to screen foreign investment proposals of AU$15 million or more in Australian agricultural land and AU$53 million or more in Australian agribusinesses (but otherwise agreeing to a $1billion threshold before investments by South Korean entities will require FIRB approval). Given these low monetary thresholds, it seems agriculture is being treated as a “sensitive” industry where foreign investment will be scrutinised to determine whether it is in the national interest. For further reading see Andrew Percival’s Thinking Piece "The new Korea-Australia free trade agreement is an open door for Korean investors but not in agriculture".
- The first half of 2014 has seen more Chinese bidders in the public M&A market than for all of 2013. While some commentators have attributed this to the relaxation of the NDRC approval process, Chinese bidders may also be taking advantage of an opportunity to average down their cost of acquisition.
- In addition to the formal changes to the NDRC approval process, there seems to be a willingness to relax the “one-bidder policy”. Until the NDRC position on this is clarified, however, there continues to be considerable importance in designing deal protection mechanisms that address this issue.
- Understanding the shifting NDRC approvals process is vital for Australian companies wishing to realise the opportunities offered by Chinese investment. For PRC bidders, ensuring that a target understands the status of confirmation letters and “pre-clearance” will remain important. Target boards will continue to rely on these to assess the certainty of a PRC bid until there is further clarity on this issue.
- For a further update on China see Andrew Lumsden and Lizzie Knight’s Thinking Piece “Boost in Chinese buyers is good news for Australian companies but understanding the drivers for this is key".
6. BIDDERS BEING OUTED OFTEN AND EARLY
- In December 2013, AWE announced that it had received and dismissed a merger approach from Senex Energy – a response which was publicly criticised by Senex at the time. Since then there have been a number of preliminary approaches by potential bidders announced by target companies, despite the proposal by the bidder being “incomplete and non-binding”.
- Other notable examples include Australand’s disclosure of the approach by Stockland, Goodman Fielder’s announcement of the proposal by Wilmar and First Pacific, SAI Global’s disclosure of a formal sales process in light of the proposal received by PEP and PanAust’s statement that it had received a proposal from Guangdong Rising Assets Management
- In some of these cases, the disclosures may be tactical rather than strictly required by the target company’s continuous disclosure obligations. ASX’s guidance (as revised just last year) on this is relatively clear: in the absence of a leak which leads to a loss of confidentiality, incomplete proposals and negotiations do not require immediate market disclosure.
- What, then, accounts for early disclosure? Target boards may be sensitive to the potential reputational damage that could result from failing to disclose a takeover or merger proposal that is later revealed – a concern that is likely to have been heightened after the criticism of David Jones following the revelation in January this year that it had rejected an approach by Myer in August 2013.
- Despite helpful clarifications from ASX in its updated guidance, there may continue to be increased attention given to continuous disclosure generally in the aftermath of Newcrest’s record $1.2 million fine this June – with target boards perhaps taking the approach of “when in doubt disclose”.
- Targets may also be using the disclosure of a ‘confidential’ approach to obtain a tactical advantage. Early disclosure of an approach may be used by a target to flush out rival bidders and create an auction. A target board that wishes to fend off an unwanted suitor may seek to expose a would-be bidder’s plans to public scrutiny before they can be fully formed and ensure the approach is less likely to progress or succeed.
7. BEST AND FINAL FROM THE OUTSET
- There has been a notable increase in the use of “best and final” statements in takeovers and schemes. About half of all deals in our deal sample have involved either a “no increase” or “no extension” statement, or both. This is a significant increase from previous years.
- One of the consequences of the Australian regulatory regime is that there is no statutory timetable by which a bidder has to finish its offer, put in its best price or finalise its terms (other than the 12 month rule that applies to takeovers). This flexibility means that shareholders have little incentive to accept early. Indeed, there is often an advantage to waiting: to see if another bidder emerges; to see if other shareholders will hold out or the market rises and the bidder increases its price. As a result, many “best and final” statements arise from a calculated strategy to close off the auction and build momentum in acceptances.
- In 2014, however, there have been some notable examples of truth in takeover statements being used from the outset, rather than as an end game strategy. Bidders for Goodman Fielder, Australand and Aquila Resources have each made “no increase” statements in the context of indicative non-binding proposals and before getting substantive engagement with the target. Such statements, which are generally only qualified by the emergence of a superior proposal, limit the target’s ability to then negotiate on price.
8. SHAREHOLDER ACTIVISM – A NEW BATTLE FRONT
- In previous years, we have seen examples of “bear hug” proposals, used by bidders to motivate shareholders to put pressure on a target board. When a target is in play, its share register often changes significantly in a short period of time, as event-driven hedge funds buy target shares. A board may have a view on fundamental value - however this view on value may then be tempered by the short term investment horizons of hedge funds. This dilemma can be to a prospective bidder’s advantage – as a legal matter, although a board cannot favour the interests of one group of shareholders over others, as a practical matter, the “squeaky wheels” may apply significant pressure on a board to facilitate an exit opportunity, even at less than the long term fundamental value. Spotless’ takeover by PEP in 2012 was a stand out example of shareholders applying pressure on a target board to capitulate, with the Spotless board noting feedback from majority shareholders as the reason for ultimately recommending the scheme.
- Recently with emergence and higher profile of “activist shareholders”, the attention given to shareholders in an M&A context has changed from enlisting major shareholders to assist the bidder in putting pressure on the target, to dealing with the shareholder’s own agenda. “Activist” shareholders may have their own agenda which does not necessarily align with either the bidder’s or target’s objectives.
- So far this year we have seen Nexus Energy’s proposed takeover by Seven Group Holding voted down by dissident investors, institutional shareholders of Roc Oil objecting to the merger with Horizon Oil, and most sensationally, Mr Solomon Lew’s acquisition of a stake in David Jones, which prompted the scheme meeting to be postponed, and a takeover bid for Country Road to be announced conditional on the success of the David Jones scheme.
- As significant shareholders become independent agents pursuing their own strategies for creating and realising value, bidders and targets may need to tailor transaction strategies and agreements to reflect this. Parties may need to prepare for, and include provisions in implementation agreements to deal with, not only the possibility of a rival bidder emerging, but for the prospect of the transaction being disrupted by significant shareholders.
9. INCREASED JUDICIAL SCRUTINY OF SCHEMES
- M&A practitioners have been carefully reviewing scheme judgements of late, as courts are increasing their scrutiny of certain aspects of the scheme process.
- Our 2013 M&A review looked at the focus on deal protection provisions in several judgements by Justice Farrell (former president of the Takeovers Panel). Judicial observations and developments since then include:
- whether an independent valuation is required to assess any “collateral benefits” in connection with a scheme
- querying whether it is appropriate for holders of partly-paid shares to be excluded from voting
- a preference for including a summary rather than a full version of implementation agreements in explanatory statements, as part of growing commentary about the desire to decrease the length of scheme booklets
- updates on the process for supplementary disclosure and criticism of amendments made to draft explanatory approvals after court approval.
- We suggest that scheme proponents should be prepared for an increased focus and questioning during court hearings; on deal protection, disclosure, class and process issues.
10. DEAL STRUCTURES AND CONSIDERATION
- As in 2013, takeovers continue to be the preferred deal structure for public M&A, representing 60% of deals in our sample in 2014. This preference is seen at both ends of the deal spectrum with 55% of the $1billion+ deals, and 65% of deals between $25 and $100 million proceeding by way of takeover bid.
- On the process side, the shift towards using implementation agreements in recommended takeover bids has continued with the majority of recommended takeovers involving some form of implementation, or process agreement. Although the Corporations Act sets out a clear process and timelines for bidders and targets in a takeover bid, an implementation agreement often gives a target more control over the process than they would otherwise have and offers bidders an opportunity for deal protection in a takeover bid.
- At the end of 2013 we predicted the re-emergence of scrip consideration as global equity markets recovered and bidder balance sheets improved. While cash continues to be the consideration of choice (used in 63% of the deals sampled), interestingly, there has been an increase in the use of foreign scrip with a third of foreign bidders offering shares listed on foreign exchanges (TSX, NYSE, LSE and SGX) as consideration.