Hot sectors in FY16
Health & allied services
Education & child care
Private equity exits FY16
average time held
46 68No. of exits
$393 average deal value million
Factors that shaped PE in FY16
Lower Australian dollar and low interest rates
Return of the scheme
Advantages of the
PRIVATEDIRECTIONS IN EQUITY
Hot sectors for FY17
Health & allied services
Education & child care
(Leisure & Tourism)
Turnaround & transformation
Buy & build
Mezzanine HoldCo Loans Term Loans B
Private Equity activity is on the rise and FY17 is looking promising.
PE was very active in exits in this sector to Chinese buyers, including:
In FY16, we saw the PE contribution to M&A activity by value in Australia jump from 4% in FY15 to 20% in FY16.
FY15 4% FY16
the exit by KKR from GenesisCare by way of trade sale to Macquarie/China Resources for $1.7 billion, and
While the last quarter of FY16 saw PE deal activity fall o (factors included macroeconomic instability and political uncertainty leading into the federal election), in FY17 we're seeing numbers start to climb again.
In the past year, a number of PE funds successfully raised money, which will lead to increased competition for quality assets.
Some sectors stood out. For example, as anticipated in FY15, activity in the health care sector increased substantially. More broadly, the volume of M&A deals increased by 18% and deal value increased by 8%.
the exit by Archer Capital from Healthe Care (Australia's third largest private hospital operator) by way of a trade sale to the China-based Luye Medical Group for $938 million.
Similarly, technology deals in the healthcare sector became increasingly attractive to PE.
Hot sectors for FY17
Health and aged care: Home care is a hot trend with government policy favouring consumer directed care. This in turn has led to increased interest by PE in allied health services, in both the aged care and disability sectors (with the National Disability Insurance Scheme generating interest and opportunities for PE).
Education and childcare: While vocational training has been impacted by regulatory changes, early education remained a hot sector in FY16 with the take-private of ASX listed A nity Education by Anchorage Capital Partners and the acquisition of Guardian Early Learning by Partners Group. This trend has continued in FY17 with the acquisition of Only About Children by Bain Capital. Currently favourable government policy with non-means tested child care rebates and bene ts and a fragmented industry will continue to drive consolidation.
Technology: PE interest in software providers and technology-based businesses has increased, as demonstrated by A nity Equity Partners' investment in MedicalDirector and CHAMP Equity's investment in Containerchain.
`Buy and build' to generate value
PE funds are being increasingly creative and using `buy and build' strategies to generate value, with a trend of `rolling-up' related smaller businesses in fragmented markets to create businesses of su cient scale that are more likely to be exited at some point via a trade sale or an IPO. For example, we saw Quadrant Private Equity's acquisition of Great Southern Rail from transformation capital specialist, Allegro Funds, as the cornerstone of an 'experiential tourism' play, and Quadrant Private Equity's acquisition of Fitness First, Goodlife and Jetts to create Australia's largest gym/ tness group.
Opportunities abounded from 'unloved business orphans'
PE funds took advantage of the 'leaner and meaner' approach by larger companies of divesting ancillary non-core operations to focus on core assets. These 'unloved business orphans' are attractive to PE funds who can provide the necessary resources and capital investment required for them to ourish. Examples include Primary Health Care's sale of Medical Director, Woolworths' sale of Masters and Home Timber and Hardware.
Trend towards investment partnership models
Co-investment deals gained momentum in the market as superannuation funds actively sought to directly access privately owned businesses with growth potential, in an e ort to reduce management fees.
Lower A$ and a low interest rate environment fostered strong competition for assets
The Australian dollar remained relatively low in FY16 compared to many other major currencies, making Australian assets cheap for foreign acquirers. The in ux in foreign buyers led to increased competition, which in turn led to bidding up asset prices for domestic purchasers. This forced the typically sector agnostic private equity investor to either pay higher multiples in hot sectors or strategically consider more creative opportunities in alternative sectors.
Return of the scheme in public to privates
In recent years, PE in Australia has not chased many public to private deals. PE is now seeing value on the listed market, and in FY16, turned its attention to undervalued ASX companies and proposed take private deals for them. To provide security over the target's assets, where the bidder must own 100% of the target, PE funds got on board with schemes of arrangement.
Examples of recent PE schemes we've acted on include:
Anchorage Capital Partners $258 million acquisition of A nity Education
Baring Private Equity Asia's recently announced $1.24 billion acquisition of SAI Global
PEP's $230 million acquisition of Patties Foods
Shanghai Pharma/Primavera Capital's $314m acquisition of Vitaco
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Recent and complex changes to the Australian foreign investment regulatory framework has resulted in an increased interaction between FIRB, the ACCC and the ATO. PE funds on both the buy and sell side must consider execution risk and adopt appropriate strategies to proactively engage with and respond to various regulators during the sale process.
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Institutional and retail investors are increasingly expecting PE funds to demonstrate their con dence in the upside potential of an investment post-IPO by retaining stakes in the range of 20% to 40%.
Higher levels of VC investment and foreign interest in the Australian market resulted in a period of positive increased activity in the venture capital industry and, as a result, we expect that the Australian private equity industry is likely to bene t in the long-term. Sectors traditionally attractive to venture capital, such as life sciences and information and communication technology, will continue to grow due to increased capital availability and support courtesy of the Australian Government's innovation agenda, o ering PE funds a strong pipeline of potential investments in years to come.
New entrants into the Australian warranty and indemnity insurance market are helping to keep policy premiums and coverage competitive. Insurers are looking most closely at coverage of accounts and tax warranties, which continue to give rise to most claims.
Trends to watch in PE fundraising in FY17
Divergence from cash to kind an increase of in-kind payments for capital contributions through services or goods. Upturn in pre-IPO funds funds tailored to guide the investee from VC to IPO, including hybrid funds maintaining both listed and unlisted assets. Continued preference for co-investment structures to deal with fee pressures. Arrival of foreign managers they are becoming increasingly interested in setting up their own operations in Australia,
and this will drive further competition for local investors and deals.
Driven by an appetite for discrete and bespoke investment structures, superannuation funds and large institutional investors have been favouring single investment trust mandates with certain types of PE managers (as opposed to contractual IMAs). This structure is not appropriate for certain types of PE and VC strategies, but has been working well for longer term and evergreen investment strategies.
There has been a proliferation of deal-by-deal managers in the PE space. Whilst this structure was previously the choice for High Net Worths and club deals, we have now seen its preference with institutional investors. With a number of General Partners spinning out of larger GPs, this deal-by-deal approach has been a good way to get the new business o the ground and give investors exposure to quality deals.
We saw a signi cant increase in VC funds being raised in FY16, with a considerable number of new VC funds launched, particularly with Early Stage Venture Capital Limited Partnerships, and superannuation funds providing large allocations to VC investments. Buoyed by tax incentives that grant ESVCLP investors a 10% tax concession and a 20% concession to angel investors, the VC model is alive and well. Some have raised concerns of a VC bubble. However, our experience is that GPs are being discerning regarding deal quality and there have been a number of recent deals indicating strong returns, including Canva, Airtasker and Hipages.
It was anticipated that the new Signi cant Investor Visa regime would contribute an uptick of $350 million this year to VC in ow. However, in reality, SIV holders have responded in a bearish manner. The number of primary SIVs granted in FY15/16 declined 40% year-on-year, with only 24 of those granted being subject to the 1 July 2015 changes. These mandate a $500,000 investment in Australian VC, therefore contributing only an additional $12 million to the industry. Potential applicants have shied away from the new mandatory asset class requirements (VC and emerging companies) with the downturn in the Chinese economy a contributory factor (Chinese applicants accounted for 90% of all SIV applicants in FY15/16). There were too many SIV funds chasing too little money. It is expected that availability of funds will pick up in the coming 18 months, however.
With regulators placing more onerous fee disclosure requirements on superannuation funds, the PE industry is reconsidering how performance fees are to be derived and disclosed to investors. For managers, an increase in disclosure obligations on the superannuation funds brings an increase in administrative burdens whilst investors concurrently seek like-for-like performance fee models. It remains to be seen, once a new industry standard of disclosure emerges, what feedback the regulators will provide post-implementation.
There is rising demand for high quality managers in response to a number of new entrant managers in the PE space. Quality, active managers have seen initial funds being oversubscribed, successor funds occurring earlier than expected and a prevalence of strong exits. Quadrant Private Equity (MinterEllison advised Quadrant) is a great example of a quality manager who has outperformed in its fundraising initiatives this year raising its most recent fund in under 2 months. We have also assisted other leading Australian PE funds such as Allegro Funds, Next Capital and CHAMP Equity on their recent successful fundraisings.
The rise of the Mezzanine Holdco Loan
The market for mezz loans is only expected to go one way, and that is up, with increasing demand from growing funds looking for solid returns. Aiding and abetting this expansion will be PE demand for higher leverage mezz lenders can provide an extra turn at least. The scene may be set for a proliferation of mezz loans, the development of a secondary market and continued innovation.
Are Term Loans B here to stay?
With the nancial crisis hopefully fading in memory (if not reality), a question arises as to whether TLBs were just a blip responding to the times or are here to stay. After many years of sourcing funds in the US TLB market, it seems as though Australian borrowers may now have access to equivalent terms in an emerging Australian TLB market. If this continues, the Australian TLB market should become an attractive option for Australian borrowers and PE seeking the bene ts of TLBs without needing to leave home or to incur the costs of AUD/USD cross-currency swaps.
Vendor nance a handy backstop if the lenders run out of leverage
It seems to be a feature of this low interest rate environment, where there is ample liquidity up to a point, that PE deals are increasingly structured with a component of vendor nance. For example, when Ardent Leisure recently opted to dispose of its Goodlife gymnasium chain (acquired by Quadrant Private Equity), it went as far as detailing the terms of its proposed vendor nance in its public announcement: $30m, 24 months, no interest and subordinated to bank debt.
Ability to meet vendor headline price expectations when third party lenders have otherwise been tapped out.
`Intercreditor' issues unless the vendor agrees to be unsecured and deeply subordinated.
More debt less equity, enhances IRR on a successful exit (the converse is also true).
Vendors will generally accept their debt being subordinated to senior and mezzanine debt so it will be invisible as far as bank covenants are concerned. This also gives rise to an optical presentation of a more lowly leveraged deal which will be attractive in some market quarters.
Vendors may come to the party and accept long dated maturities with little or no interest, pushing down the overall cost of the deal.
If a vendor will not accept a deeply subordinated unsecured position then the buyer will embark on a slippery slope of complexity, all of which may still be worth it if the numbers stack up. These complexities may include:
If the vendor loan entails current periodic payments including cash pay interest, the senior and mezzanine lenders will likely impose conditions in their loan agreements restricting when such payments may be made.
If the vendor wants security in support then it will just be extra documentation provided the vendor is happy to take its security above where the senior and mezzanine lenders are secured. But if not, there will need to be documented subordination and priority arrangements.
There are several advantages to vendor nance but these can sometimes be outweighed by disadvantages, depending on the structure of the transaction. Deals invariably have twists and turns so it will just be a matter of factoring any complications into the overall deal and going in with open eyes.
Where there are subordination and priority arrangements, issues to be resolved will include whether the senior and mezzanine lenders are happy to give the vendor any enforcement triggers, which might include the ability to trigger enforcement if, say, the senior and mezzanine lenders have not been repaid 6 months after their maturity and have not enforced.
A well advised vendor may also require some protection around the conduct of any senior or mezzanine enforcement, including that any duty under law to the company to obtain the best price on enforcement is contractually extended to the vendor.