Buyers are becoming more discerning
There are a bunch of decent sized deals in the pipeline but they are taking a long time to come to market, writes
Despite the strength of corporate balance sheets and the amount of cash washing around, the deal flow so far this year has been slow. To give you some flavour, 2015 saw a huge number of assets moved, with key deals including Aspire2, Manuka Health, ACG Education, NZ Pharmaceuticals, Macpac, Yealands and Vector’s gas transmission asset sale. Interestingly, many of these involved Australian private equity firms.
Last year saw lower deal volumes and transactions reflecting more strategic (as opposed to financial) drivers. Key deals included Solid Energy’s asset sales, Nuplex, the proposed Sky/Vodafone and Fairfax NZ/NZME mergers, the sale of UDC and Sistema, and ACC and NZ Super’s investment in Kiwibank. Private equity led acquisitions were limited with the most obvious being CHAMP’s acquisition of Strait Shipping. There were three IPOs — Tegel, NZ King Salmon and Investore.
And yet, contrary to expectations, 2017 has been slow. The Tower takeover is in-play and reflects another opportunity for the Commerce Commission to flex its muscle. Other key deals have been Todd’s sale of Nova Energy, the Oceania IPO, and the proposed sale of Mainland Poultry.
There are a bunch of other decent sized deals in the pipeline but these are taking a long time to come to market.
Market conditions certainly remain conducive for deal activity — we have strong GDP, low interest rates, high employment, and immigration, leaving our companies with strong balance sheets and well poised to make acquisitions.
Additionally, there is a lot of equity capital available — with many of the Australian and New Zealand private equity funds having capital raised in recent years ( New Zealand funds alone raised over $800m in 2016), and quasi-governmental investors (such as ACC and NZ Super) are pursuing opportunities.
In contrast, debt capital is harder to find. The banks are being more selective with their lending. They now have greater capital adequacy pressure as Basel III has pushed them toward long term retail deposits rather than shorter term wholesale funding.
Arguably this year’s deal shortfall suggests that the fundamentals and sensitivities underpinning 2016 deal flow will apply again in 2017. They key sensitivity is not to over-pay.
Price inflation seen in the public and private capital markets over recent years has starkly increased this risk. In the last five years, the NZX50 has doubled with private deal values following suit. Low interest rates have kept the weighted average cost of capital down and pushed valuations up. These values are also propped up by demand driven from available capital.
Given these factors, asset quality has become critical with buyers becoming increasingly sensitive to protecting returns and looking for growth.
Also underpinning this sensitivity is a concern that New Zealand economic growth has been partly fuelled by unsustainable migration numbers and the slowing Christchurch rebuild.
Fortunately, international political uncertainties seem to have abated to an extent since Brexit and Trump have bedded-in and the French election has left Europe-watchers with greater predictability.
The concern not to over-pay has resulted in a more discerning lens being applied by buyers and institutional investors in both the private and public capital markets.
A high percentage of recent deal volume seems to therefore reflect strategic imperatives and is supported by the synergies that naturally flow to trade buyers.
In the public capital markets, this sensitivity seems to be reflected in the limited number of initial public Global economic events — potential volatility: 2017 promises turbulent times for the world’s economies. This should support NZ’s reputation as a safe haven
Private Equity — ready to shop: Private Equity continues to be seen as a safe pair of hands in troubled times
A rebalancing of public assets: Expect a growing willingness on the part of local authorities to dispose of non-core infrastructure assets
Initial Public Offerings flat: We expect to see very few companies come to market this year
Continued innovation in capital raising: For those companies already listed, we expect greater flexibility in the options available to raise money
Regulatory development: In its prolonged investigations of the Z/Chevron, Sky/Vodafone and NZME/Fairfax tie-ups, we have seen the Commerce Commission display renewed zeal. offerings. We have seen only one IPO this year — Oceania, another aged care asset.
The presence of so many aged care businesses, property companies, electricity companies and utilities reinforces the view that our market is largely defensive and yield focused.
It hasn’t helped investor confidence that six of the eight technology stocks listed since 2013 are trading below their listing price. Only Vista and Gentrack have delivered.
We now seem to be in a world where three to four IPOs annually is the norm. The years 2013 and 2014 were anomalies with seven and 12 IPOs respectively, and the Crown deserves credit for kickstarting the capital markets with the Mixed Ownership Model process.
We should be concerned, however, with these numbers, given at least nine listed companies have been the subject of takeovers since the beginning of 2016 — most were successful.
On the subject of takeovers, the most interesting development has been the re-emergence of courtapproved schemes of arrangement as an alternative to the classic takeover. Schemes were used in the case of both Nuplex and Tower.
Schemes have been out of favour for years (branded a “sneaky loophole” for takeovers). A new regime with Takeovers Panel support is likely to see them become the preferred structure for public mergers and acquisitions.
On the secondary front, 2017 has seen only one material capital raise, which was Heartland’s $20 million share purchase plan. NPT proposed a large capital raise to part finance its deal with Kiwi Property but this was blocked by Augusta and Salt. It will be worthwhile watching NPT given Augusta’s actions and previous bids for NPT.
An interesting trend in the last couple of years has been the adoption of the accelerated rights entitlement offer (AREO) structure from Australia (used by Sky City, Synlait and Restaurant Brands). Rather than a standard rights issue — which sees all investors having an extended offer period where they consider whether to take up or trade their rights — the AREO requires institutional investors to invest up front, but allows retail investors the normal consideration period.
AREO typically reduces underwriting exposure and therefore costs, reduces the price discount compared with traditional rights issues (given reduced risk for institutional investors), and accelerates receipt of the offer proceeds for the issuer.
Trend predictions are always difficult. Appropriately priced quality assets will get sold given the fundamentals. Since the markets are looking for growth and the digital disruption phenomena, tech deals will undoubtedly still contribute to future deal flow despite the failures of recent years. Tech is obviously an international commodity.
Equally, we are expecting to see further recycling of public assets. The Mixed Ownership Model was the catalyst to deeper equity capital markets only a few years ago.
Substantial public assets still remain in the hands of central and local governments without adequate public policy and commercial justification. Whether these assets find a home on the NZX remains unknown.
Michael Pollard is head of the corporate and commercial department at Simpson Grierson