Having reached the halfway point for 2011 it is an opportune time to reflect on the year to date and crystal ball gaze into the rest of the year.
We have a 2 speed economy, a carbon tax coming our way, a business sector bemused by a minority government and their policies, a record A$ and a foreign debt time bomb offshore that appears to be now impacting the US where default is threatened. It seems we are living in uncertain times.
Where then is Australian M&A at right now and where are we going? Can we expect any changes between now and Christmas?
Here is our report card with our top 10 observations for 2011 to date:
1. Resources transactions continue to carry the market
Following on from 2010, little has changed for the Australian M&A scene when it comes to the resources sector. Transactions in this sector are still dominating the M&A landscape, accounting for about half of all listed company transactions worth over $100m announced to date in 2011. We see no sign of this changing in the second half of this year.
To date we have seen takeovers of coal, iron ore, gold, copper, coal seam gas and conventional gas companies. With the high profile bids for Macarthur Coal, Sundance Resources and Eastern Star Gas being announced in the last 2 weeks the trend shows no sign of letting up. Interestingly we have seen a real drop off of Chinese based SOE's interest in the sector and M&A generally - is Beijing still nervous about our Government's foreign investment policy?
Interestingly the demand for resources M&A remains notwithstanding a mining tax, a carbon tax, natural disasters and a mixed bag of economic news.
2. Deals are harder and take longer but quality deals can still get done
There is no doubt that deals are harder to do in current times.
Company boards generally remain cautious through a combination of macroeconomic factors and a question as to whether valuations have bottomed. This caution has meant that many proposed deals have not seen the light of day.
Bidders are not inclined to do deals without access to due diligence. Boards remain reluctant to be persuaded about the bear hug. However, they need to be careful showing bidders the door given the potential consequences for a targets share price: see KKR's bid for Perpetual which was rejected late last year and now Perpetual is trading at almost 40% below the bid price.
Other bidders have held back due to concerns about how the market (and their shareholders) may react to bids that seem expensive. Many sale processes and transactions have not achieved a positive outcome because of a mismatch of bidder and target expectations. The risk of a higher rival bid (such as when Barrick trumped China Minmetals bid for Equinox) always remain.
Despite a promising start in the first quarter of 2011, private equity, a key part of Australian M&A activity, remains subdued. Many PE firms are sitting on assets waiting for the IPO market to open or looking at whether they can sell the asset to another PE house or refinance. That being said we are expecting greater private equity activity in the next 6 months.
Given many potential deals do not get announced it is impossible to quantify how many proposed deals have not occurred. However, what is interesting of the listed company transactions over $100m announced this year, almost two-thirds have completed. This augers well for incomplete deals currently in the market.
The conclusion here is that deals with solid fundamentals are getting done but uncertainty remains. Opportunities exist but it seems, at least for the moment, only for the brave.
3. The year of the joint bid
Joint bids are increasingly popular this year. Recent high profile examples of joint takeover bids (all of which are proposed) include:
- Peabody Energy Corporation and Macarthur's largest shareholder, ArcelorMittal S.A, joining together for a proposed bid for Macarthur Coal;
- Santos and TRUenergy coming together to bid for Eastern Star Gas;
- FOXTEL's (being a partnership comprising Telstra, News and Consolidated Media) bid for AUSTAR; and
- CP2 and friends bidding for ConnectEast.
Joint bids come in different shapes and sizes eg the establishment of a bidco to make a bid or an on-sale of some assets on completion of a bid. However, whatever the form, these structures have the advantage of lowering cost, spreading the risk and can also mean there is one less competing bidder to worry about. The Macarthur Coal example in particular is interesting as the joint bid technique is being used to help unlock a complicated share register which stifled 3 separate bids for Macarthur in 2010.
If the current market conditions for M&A continue we expect to see more joint bids as a means of getting otherwise difficult deals done.
4. The Takesovers Panel keeps busy (but perhaps may soon become known as the Associations Panel)
In 2010 the Takeovers Panel released 15 decisions. To 30 June 2011 it had released 11 decisions with a further 2 in July so far.
So does this mean an increase in M&A activity requiring more takeover disputes to be resolved? Well maybe not. Approximately 75% of all cases before the Takeovers Panel this year have concerned associations and illegal aggregations of control.
The Takeovers Panel continues to do an excellent job and indeed, in association cases, the Panel has shown itself as willing to investigate difficult matters considering, at times, voluminous material to be in a position draw inferences of association where it can. However, one wonders, given the Panel's limited resources and investigatory powers, whether this is the best use of its limited resources. The Panel was primarily set up to find speedy commercial outcomes for M&A participants in relation to disputes regarding live takeovers rather than to engage in detailed reviews of association matters. It may not be an issue right now given the Panel's current workload but once M&A activity returns to higher levels with more takeover disputes coming to the Panel, the Panel's resources may be tested.
5. The return of the takeover bid. Back with its 50% minimum acceptance condition
Takeover bids are making a comeback.
Over the last few years, there has been an increasing trend for public company control transactions to be effected by scheme of arrangement rather than takeover bid.
However, in 2011 to date, the majority of successful listed company deals over $100m were done by takeover bid. For deals over $50m undertaken by takeover, there is an almost 70% success rate.
It seems that the prospect of a successful deal is being improved by the flexibility of a lower acceptance threshold. For example, Rio Tinto was successful in acquiring 100% of Riversdale Mining by making a bid that was conditional only on 50.1% acceptances. The recently announced proposal from Peabody Energy and ArcelorMittal for Macarthur Coal has followed a similar model. The 50.1% minimum acceptance condition has been particularly successful for unlocking share registers with a number of large holders.
6. Change of the regulatory guards
In the first 6 months of 2011 we have seen Greg Medcraft take over from Tony D'Aloiso as ASIC chairman and the announcement that Rod Sims will replace Graeme Samuel as head of the ACCC. These changes coming shortly after Kathleen Farrell took over as President of the Takeovers Panel in the second half of 2010.
Will the new regulatory heads bring any radical changes to their new roles? While this remains to be seen, we are nevertheless sure that each of the regulatory bodies will be re-energised by the changes.
ASIC does seem to be talking about a renewed focus in certain areas eg financial reports, remuneration disclosure and insider trading investigations. It has also announced a wide-ranging review to update its regulatory guides relating to takeovers, starting with RG74: acquisitions approved by shareholders, and RG71: downstream acquisitions. However, it remains to be seen whether ASIC will actively re-engage in takeover matters or leave the regulation of takeover bids largely to the Takeovers Panel.
The ACCC continues to cast a keen eye over proposed deals. In recent times it seems its reviews are, on average, a bit longer. To date in 2011, the average time taken for the ACCC to review a transaction is over 50 days, up from 34 days in 2009 and the first half of 2010. The ACCC also continues to take a hands on approach, rejecting Asahi's proposed acquisition of P&N Beverages and obtaining divestment undertakings in other matters.
7. Foreign bidders with cash remain at the forefront
A high $A deterring foreign bidders? Doesn't seem so.
We see foreigners continuing to be interested in quality Australian companies. To date in 2011 approximately 70% of announced listed company deals over $100m have involved foreign bidders.
Foreigners making bids in Australia include all the usual suspects: US, UK, Canada and China. With the Asian demand for resources and agribusiness companies, we expect bids by Chinese, Indian and other companies to increase.
The large number of foreign bidders has also seen the prevalence of cash being used as the dominant form of consideration. In uncertain times cash is always to be preferred, and in the case of foreign bidders, Australian based investors are less likely to see foreign scrip as being attractive.
We expect the preference for cash deals (from both local and foreign bidders) to continue in the second half of 2011. This is especially the case now that debt markets are open for business. Indeed the availability of relatively cheap long term debt in foreign markets is higher than it has been for a long time.
8. Increased disclosure taming the bear hug?
In a developing trend which regulators will welcome we have seen target companies increasingly prepared to disclose 'confidential' and incomplete approaches by potential bidders eg Spotless/Blackstone and Sundance/Hanlong. The proposed bid for Fosters by SABMiller plc is another example of early disclosure.
Often these approaches are, strictly speaking, not required to be disclosed assuming they are confidential and incomplete. Historically, companies have been reluctant to disclose these confidential approaches, perhaps in fear of increased scrutiny by the markets and hedge funds with the added pressure of needing to do something to justify an earlier rejection of a proposed bid. However, now it seems that potential targets prefer to disclose early to avoid later criticism and regulatory scrutiny (and perhaps claims by class action lawyers for disclosure breaches) if a leak makes a proposed bid public at a later stage.
A possible side effect of the quicker disclosure may be to neutralise or reduce the threats of 'bear hug' approaches. The market now seems more used to announcements of incomplete and highly conditional approaches which are rejected. Before, commentators were quick to criticise target boards for not engaging. Now there seems to be a greater understanding and acceptance of targets who refuse to engage because the price is too low. Although, as mentioned above, targets need to be careful in doing this given the potential adverse effect on share price in the medium term.
9. Equity capital markets looking for a kick start
Australian capital markets have been very tough for new equity raisings. Many proposed IPOs have been deferred with vendors being dissatisfied with the price they would receive if they were to proceed. The IPO market is at its patchiest we have ever seen in this market at any time in the last 10 years.
In some respects this trend is surprising. It is at odds with the strength of IPOs in foreign markets eg Hong Kong/China and high profile IPOs like Glencore and Linkedin. Also this is in the context that the last large Australian IPO at the end of 2010, QR National, proved to be very successful for investors in the IPO, up almost 40% in a little over 6 months.
Some positive signs in the Australian IPO market are starting to emerge with Pacific Equity Partners in the process of getting away its Collins Food float. Incredibly, at $200m it is the largest IPO in the Australian market this year. While it helps, it is unlikely to be the catalyst for an IPO explosion. Nevertheless, a few more like this may give the market some momentum in the next half.
Given current market sentiments and the 2 speed economy, making it tough for any non-resources stocks, we expect the difficult equity markets to continue for the rest of 2011 before returning to better times in 2012.
10. Opportunities are out there - is the time now!?!?
For the astute and opportunistic bidder, good deals can be done, and done at an excellent price. The general Australian market is trading at historically low PE multiples.
Some private equity bidders have undertaken significant acquisitions, for example Blackstone's acquisitions of Valad and of key US based assets of Centro Properties Group. Time may also come to show that various resources deals being done are at a relatively cheap price.
Bargains may be being missed while the prevailing underlying philosophy seems to be "wait and see".
Indeed and while not in all cases, a lack of competitors for targets has meant that bidders have been prepared to wait to see if the global uncertainty improves and valuations have bottomed. With foreign financial conditions arguably starting to improve the time to move may be now.
While we forecast an increase in M&A activity over the next 12 months, this shift may not occur until the start of 2012. The catalyst, in our view, to greater M&A and capital markets activity is financial and political stability which will breed confidence in the business and consumer sector and global markets generally. Less radical and uncertain policy from our government and a sustained period of calm offshore and resolution of the foreign debt issues is required. The reality is this may take some time.
It is notable that, to date, more Australian companies have not taken advantage of the high A$ and weak European and US economic conditions to make strategic overseas acquisitions. The medium term sustainability of the current A$ highs against the US$ has to be uncertain. Therefore, we expect to see more foreign acquisitions by Australian companies in the second half of 2011, such companies taking advantage of what may prove to be a unique opportunity.