AUSTRALIAN UPDATE – Australian Regulatory Response to Chinese Investment Opportunities and Challenges
Highlights:
- Chinese state owned enterprise investment into Australia’s resources sector is helping create unprecedented high-levels of M&A activity.
- In recent years, Australia’s Foreign Investment Review Board has taken steps to balance the benefits and risks created by this influx by successive revisions or elaborations of the foreign investment policy, amendments to the regulatory framework and the attachment of conditions to particular investment approvals.
- Feedback from some Chinese SOEs suggest that they view these policy changes and the foreign investment review process as confusing and discriminatory.
- The record, however, suggests that China’s SOEs have adapted to the foreign investment process and policy by changing their approach to investment and being prepared to engage with the Government earlier in the investment process.
- China is likely to continue to be a significant source of investment in Australian energy and resources, and increasingly in other areas, especially agriculture and food.
Article
In the past decade Australia has enjoyed unprecedented high rates of foreign investment. This has been driven by a once-in-a-generation boom in investment in the country’s resources sector. In large part, this boom has been due to the activities of China and Chinese state owned enterprises (SOEs) eager to secure reliable sources of iron ore, coal and other commodities.
This trend has presented both opportunities and challenges for Australia. The influx of foreign capital confers obvious economic benefits. However, for Australia’s Foreign Investment Review Board, the challenge is to balance these obvious benefits against national interest considerations.
Over the last three years, Australia’s foreign investment policy has evolved in response to this trend. This evolution has not been smooth. At times Chinese SOEs have referred to Australian investment policy as discriminatory, citing highly publicised rejections of deals and confusing policy and process. Over the last twelve months, FIRB has made steps to make the process more transparent and Chinese SOEs have changed the way they look to invest to avoid some of the issues.
This dialogue may be about to begin again. Recent media quote the Australian Government Treasurer Wayne Swan on his plans to impose a two-stage foreign approval process for investment in resource exploration and mining.[1] This would require foreign-government-related entity investors to obtain approval from FIRB to acquire an exploration business and, if a viable discovery is made, to re-apply for permission to develop the resource. If introduced, this would create greater uncertainty for SOE investment in new projects to add to the claims that the Australian investment regime already makes things difficult.
At this point, it is important to look back at the history of the recent evolution of Australia’s foreign investment policy to:
- provide an overview of the regime and how it applies to Chinese and other SOEs;
- examine the perception and reality behind the Government’s track record in relation to Chinese investment proposals; and
- outline the strategies that Chinese SOEs have employed to maximise their chances of obtaining foreign investment approval./li>
A closer look provides hope that while the debate rages, there are signs that the dialogue involved in the Australian foreign investment regime policy and process is shaping the structure of investment to serve the demands of investors and regulators.
Overview of Australia’s foreign investment regime
Foreign investment in Australia is regulated by a combination of legislation (the Foreign Acquisitions and Takeovers Act 1975 (Cth) (FATA)) and published government policy (the Policy).
In general terms, the FATA obliges foreign persons to notify the Australian government and obtain prior approval for the following types of proposals:
- any proposal whereby a foreign person will acquire an interest of 15% or more in an Australian business or company that is valued, or has gross assets, above A$231 million[2]; and
- any proposal whereby a foreign person will acquire an interest in certain types of Australian real estate.
In addition to the FATA, the Policy requires foreign governments and their related entities[3] to notify the Australian Government and obtain prior approval for any proposal whereby the foreign government or related entity will acquire:
- an interest of 10% or more in an Australian business or company irrespective of the value or gross assets of that business or company; or
- an interest of less than 10% in an Australian business or company irrespective of the value or gross assets of that business or company, where the foreign government or related entity will obtain special voting rights, the ability to appoint directors or contractual rights.
The aspect of the Policy regarding foreign government investment was first introduced in February 2008.
All proposals must be notified to the Foreign Investment Review Board (FIRB), which is an advisory body that examines proposed foreign investments and makes recommendations to the Australian Treasurer on whether to prohibit or approve proposals. The Australian Treasurer is empowered to prohibit a proposed investment if it is “contrary to the national interest”.
The ‘national interest’ test
The Act does not define the concept of “national interest” nor provide any guidelines on how it is to be assessed. However, the Policy states that FIRB reviews foreign investment proposals on a case-by-case basis with national interest considerations given to a broad range of factors. These considerations include:
- national security – the extent to which foreign investments affect Australia’s ability to protect its strategic and security interests;
- competition – the effect that foreign investment will have on the diversity of ownership within Australian industries and sectors to promote healthy competition;
- other Australian Government policies – including the impact on Australian tax revenues and environmental objectives;
- impact on the economy and the community – including the impact on: plans to restructure the target entity, the nature of investment funding arrangements, the level of Australian participation in the target entity following the transaction and obtaining a fair return for the Australian people; and
- character of the foreign investor – the extent to which the foreign investor operates on a transparent commercial basis and is subject to adequate and transparent regulation and supervision.
The ‘national interest’ test is broadly similar to Canada’s ‘net benefit’ criteria, and both are broader than the US’ focus on security considerations.[4]
Considerations specific to SOEs
In addition to the above, the Policy contains the following considerations for SOEs:
- whether the nature of the investment is commercial and at arm’s length;
- the extent of actual or potential foreign government control, including through lending arrangements embedded in the source of the investor’s funding;
- the nature of any part-privatisation; and
- mitigating factors which may assist the Government in determining that the investment proposal is “not contrary to the national interest”, including:
- existence of external/private partners or shareholders in the investment;
- level of non-associated ownership interests;[5]
- governance arrangements;[6]
- ongoing arrangements to protect Australian interests from non-commercial dealings;[7] and
- whether the target will be listed on the Australian Securities Exchange (ASX).[8]
Observations regarding the Policy
On first read, the Policy appears to make the approval process more onerous for SOEs than for other investors. It imposes more stringent approval thresholds (ie. approval is required irrespective of the size of the target company or business), it expands FIRB’s review power beyond that under the FATA, and applications for approval made solely under the Policy need not be dealt within in a particular time frame (whereas applications under the FATA need to be assessed by the Government within 30 days, unless extended by FIRB by an additional 90 days).
The current Policy (in place since June 2010) does represent, however, a significant improvement for SOEs compared to the previous policy. Under the previous policy, all investments by SOEs were be subject to FIRB review, even if the proposed acquisition amounted to less than 10% of interest in an Australian company. The current policy exempts acquisitions of less than 10% unless the SOE acquirer obtains special voting or other rights.
In addition, it needs to be recognised that most of the ‘additional’ requirements and national interest considerations are not ‘new’ in the sense that they were not previously applied to SOE investors. The national interest considerations which FIRB may take into account are not exhaustive and were never limited to those in the previous Policy. This was again made clear by the Australian Treasurer’s recent decision in rejecting the proposed merger between the ASX and Singapore Exchange (May 2011).
Arguably, the current Policy merely codifies some of the considerations that had already been applied to SOEs, and provides a degree of additional guidance to foreign investors.
Sentiment towards investments from China: perception vs reality
The Australian Government has consistently stated, both in its Policy and on many occasions, that it welcomes foreign investment. This enthusiasm has been reciprocated by Chinese investors: as of July 2011, China has invested a total of A$39 billion in Australia, making it the largest national target of Chinese outbound investment ahead of the US and Brazil.[9] While large SOEs continue to dominate China’s outward investment by volume, the SOE share has dropped from 94% in 2010 to 89% in the first half of 2011.[10]
Given these impressive investment statistics, it can be surprising to learn that some Chinese investors (mostly SOEs) view Australia’s foreign investment approval process and its administration by FIRB to be a major hurdle to the success of their investment.[11] The following points have been raised as ‘evidence’ supporting the perceived discrimination.
- Sensitive cases of Chinese investment – These include the widely publicised collapse of the A$24 billion Chinalco / Rio Tinto deal (2008), China Minmetals’ reduced bid for Oz Minerals (2009) and the withdrawal of China Nonferrous Metal’s offer for Lynas (2009).
- Informal FIRB position – In 2009, a FIRB representative made unofficial comments about FIRB ‘guidelines’ restricting foreign SOEs to minority equity ownership in Australian companies.[12] The context suggested that the statement was directed at Chinese SOEs.
- Change in FIRB Policy – Whilst the current Policy applies equally to all SOE’s, it has been viewed as targeting China rather than state-backed foreign direct investments in general.
- Negative press – Chinese investors and officials have viewed the Australian media as playing a negative role in influencing popular opinion and FIRB decision-making regarding Chinese investment. For instance, recent media attention on China’s food security concerns and its growing investment in Australia’s food and agribusiness sectors preceded the current Senate inquiries into FIRB’s handling of foreign interest in agricultural industries and rural land.
- Delays in approvals – According to policy the review process typically takes a 40 day initial review period, but it is common practice for FIRB, if their review is not completed within that time, to ask Chinese applicants to withdraw and re-submit their proposal. Anecdotally, it is not unusual for FIRB applications for Chinese investment to take longer than the usual 30 day statutory period. FIRB either extends the period of review for an additional 90 days as it is empowered to under FATA or requests that applicants withdraw and resubmit their applications so as to restart the statutory timeframe.
However, such ‘evidence’ of discrimination does not – to put it candidly – stack up against the evidence. What the evidence in fact reveals is that the Australian Government has, for the most part, approved Chinese investment proposals. In 2009-10, 1,766 approvals were granted to Chinese proposals, consistent with the 1,761 approvals in 2007-08 prior to the global financial crisis. Where approvals were granted, FIRB has on occasions imposed conditions to ensure that the investment would comply with the ‘national interest’ test – though it is true that certain FIRB conditions (e.g. ownership caps) have had the effect of altering or blocking the proposed acquisition.[13] The table in the Schedule outlines the FIRB review outcome for major Chinese investment proposals in the last three years.
The evidence also reveals that there has been no noticeable slowdown in Chinese investments proposals since the Policy was first amended in February 2008 to refer specifically to investments from SOEs.
In many instances, the withdrawal or non-approval of Chinese SOE investment proposals have related to commercial reasons (eg. concerns about overpaying, or potentially overpaying, for a target company[14]) or reasons that are not specific to the nature of the investor (eg. two major proposals which did not receive FIRB approval in 2009 sought to acquire assets located in the Woomera Prohibited Area which is reserved for national defence purposes[15]).
Finally, it would be misguided to believe that the Australian Government is more likely to approve, or to approve on an unconditional basis, investment proposals from private enterprise than SOEs. The Government has recently given unconditional approval to COFCO in its 100% acquisition of Tully Sugar (May 2011), and reportedly also to Bright Food’s proposed acquisition of a 75% stake in Manassen foods (August 2011).[16] It may represent the beginning of a trend as Chinese SOEs and other investors increasingly expand their targets beyond the resources sector.
A few strategies for dealing with Australia’s foreign investment regime
FIRB decisions and experience have provided some clues as to how Chinese investors, SOEs in particular, can (if commercially feasible) structure their investment strategically important or potentially sensitive projects to maximise the chances of receiving FIRB approval. These strategies include:
- seek minority rather than controlling interests – aim for smaller, non-controlling stakes (eg. various share placements in ASX-listed companies of less than 20%);
- partner up with a non-Chinese investor – seek JV arrangements between Chinese and non-Australian companies to invest in Australia (eg. the acquisition of Arrow by the PetroChina/Shell JV);
- selling to the public/listing – as in Yanzhou Coal’s undertaking to sell down to 70% by 2012 and list the operating company on the ASX; and
- appropriate governance arrangements to ensure transactions are conducted on arms’ length / commercial terms.
In a recent example, two of China’s largest State-owned renewable energy businesses, China Datang Renewable Power Co and Baoding Tianwei Baobian Electric Co formed a renewable energy joint venture, called AusChina Energy Group, with Australian listed company CBD Energy Limited. Datang Renewable is a major wind farm developer and operator. Baoding Tianwei Baobian is the main operating company of the Baoding Tianwei Group, the largest electrical supplier in China and a producer of wind turbines and other alternative energy technology.
The new AusChina Energy Group is an important opportunity that will enable both Chinese SOEs and their Australian joint-venture counterpart to work towards a development target of approximately $6 billion worth of renewable energy projects over eight years, which would represent one third of Australia’s wind energy market. Obviously, there are a number of commercial reasons for the joint-venture, but it highlights a successful path towards foreign investment for Chinese SOEs.
As well as an opportunity to maximise the chances of FIRB approval, this strategy could have commercial advantage for SOE investment. With the price of acquiring Australian resources businesses at an all-time high, it is likely, going forward, that SOEs will look beyond the acquisition of operating Australian miners towards investment in exploration and development. Joint-venture arrangements often have commercial advantages for exploration companies looking for capital and investors looking to take a more speculative investment. It remains to be seen how the Treasurer’s recent statements about potential FIRB policy changes will impact on this investment strategy in the future.
Schedule – Regulatory Outcome of Chinese Investment Proposals
| Date |
Acquirer |
Target |
Commodity |
Value |
Approval |
Conditions / Reasons for refusal |
| May 2011 |
COFCO (SOE) |
Tully Sugar |
Sugar |
0.136 |
Yes |
Unconditional. |
| Apr 2010 |
PetroChina / Shell (JV) |
Arrow Energy |
Coal seam gas |
3.5 |
Yes |
Unconditional. |
| Nov 2009 |
Hanlong Mining (private) |
Moly Mines |
Molybdenum, Iron ore |
0.2 |
Yes |
Unconditional. |
| Oct 2009 |
China Baosteel (SOE) |
Aquila Resources |
Coal, Iron ore, Manganese |
0.286 |
Yes |
Limited to 19.99% holding. |
| Oct 2009 |
Yanzhou Coal (SOE) |
Felix Resources |
Coal |
3.5 |
Yes |
Sell down to <70% by 2012; operate using an Australian incorporated, headquartered and managed company; list operating company on ASX by 2013; off take arrangements on arms’ length basis. |
| Sept 2009 |
Wuhan Iron & Steel (SOE) |
Western Plains Resources |
Iron ore |
0.45 |
No (Dept of Defence) |
National security concerns associated with the Hawk Nest magnetite site located within the Woomera Prohibited Area. |
| Sept 2009 |
China Nonferrous |
Lynas |
Rare earths |
0.5 |
Yes |
Limited to 49.9% holding. |
| May 2009 |
Ansteel (SOE) |
Gindalbie Metals |
Iron ore |
0.162 |
Yes |
Limited to 36.28% holding; support the development of Oakajee Port and Rail Project; not alter the 50/50 ownership of pellet plant without Government approval. |
| Apr 2009 |
China Minmetals (SOE) |
Oz Minerals |
Copper |
1.2 |
Yes (2nd proposal) |
Sensitive assets excluded; arms’ length off take pricing; operations headquartered and managed in Australia; compliance with Australian industrial relations laws. |
| Mar 2009 |
Hunan Valin Steel (SOE) |
Fortescue |
Iron ore |
0.636 |
Yes |
Compliance with Fortescue Directors’ Code of Conduct and the information segregation arrangements agreed between Fortescue and Hunan Valin. |
| Feb 2009 |
China Minmetals (SOE) |
Oz Minerals |
Copper |
2.6 |
No (1st proposal) |
National security concerns associated with Prominent Hill, which is located within the Woomera Prohibited Area. |
| Sept 2008 |
Sinosteel (SOE) |
Murchison Metals |
Iron ore |
N/a |
Yes |
Limited to 49.9% ownership to maintain diversity of ownership in the Mid-West region. |
| Aug 2008 |
Chinalco (SOE) |
Rio Tinto |
Iron ore |
24 |
Yes |
Limited to 14.99% ownership and not to seek to appoint a director to Rio Tinto without fresh approval. |
| Jan 2008 |
Sinosteel (SOE) |
Midwest Corp |
Iron ore |
1.48 |
Yes |
Unconditional. |
[2] This threshold is subject to indexation each year. A threshold of A$1,005 million applies in respect of US investors, except in certain industries (including media, telecommunications, transport, military and uranium) where the standard A$231 million threshold applies.
[3] Entities in which foreign governments have control or have more than 15% interest are considered to be “related” to the foreign government.
[4] See The Foreign Direct Investment Process in Canada and Other Countries, Parliament of Canada, 19 September 2007.
[5] For example, the approval of the Shell/PetroChina bid for Arrow Energy (April 2010) without conditions.
[6] For example, the approval of Yanzhou Coal’s investment in Felix Resources (October 2009) on conditions that: 1) Yanzhou operate its Australian mines through an Australian company, headquartered and managed in Australia, with its CEO and CFO principally residing in Australia; and 2) the Australian operating company have at least two directors principally residing in Australia, one of whom must be independent.
[7] For example, the approval of Hunan Valin’s investment in Fortescue Metals subject to Hunan Valin undertaking that its nominee directors will comply with: 1) Fortescue’s Directors’ Code of Conduct, and 2) the information segregation arrangements agreed between Fortescue and Hunan Valin.
[8] For example, the approval of Yanzhou Coal’s investment in Felix Resources (October 2009) on conditions that 1) the Australian operating company list on the ASX by the end of 2012, and 2) by that time Yanzhou will have reduced its ownership level to 70%.
[11] See John Larum, ‘Chinese Perspectives on Investing in Australia’, Lowy Institute for International Policy, June 2011.
[12] Speech delivered by then-FIRB director Patrick Colmer to an Australia-China investment forum on 24 September 2009.
[13] FIRB’s cap on majority holdings caused Chinese acquirers to terminate their takeover proposals – China Nonferrous Metal’s plans for Lynas (2009) and Sinosteel’s initial proposal for Murchison (2008).
[14] Minmetals’ bid for Equinox Minerals (April 2011) and Yanzhou Coal’s bid for Whitehaven Coal (May 2011).
[15] Wuhan Iron & Steel’s bid for Western Plains Resources (2009) and China Minmetal’s first proposal for Oz Minerals (2009). Woomera Prohibited Area is the weapons testing range operated by the Royal Australian Air Force.
[16] Reported by China Daily on 29 August 2011.
AUSTRALIAN UPDATE – Deal Landscape, Deal Structures and Origin of Bidders in Australian Public M&A in 2011
Highlights:
- The market for Australian public mergers & acquisitions (M&A) has seen a strong resurgence in the two financial years since the GFC, both in terms of the number of deals being done but also in terms of their value.
- Success rates are also on the increase, with 70% of announced deals ultimately resulting a successful outcome.
- Deal protection is currently under intense scrutiny, with the UK Takeovers Panel taking a strict line and prohibiting deal protection mechanisms such as “no-shop / no-talk”, matching rights and break fees. It remains to be seen whether the Australian Panel has a similar view on the anti-competitive nature of many deal protection arrangements.
- Deals are still highly conditional – approximately 90% of transactions in FY2011 had conditions attached to them.
- There has been an increase in foreign M&A activity with 51% foreign bidders in FY2011, compared to 42% foreign bidders in FY2010. In particular, FY2011 saw strong activity from North American bidders.
DEAL LANDSCAPE
The market for Australian public mergers & acquisitions (M&A) has seen a strong resurgence in the two financial years since the GFC, both in terms of the number of deals being done but also in terms of their value. The total consideration publicly committed to by bidders in FY2011 was $79m, up from $19m in FY2009 – additionally the number of deals with a market value over $500 million is on the increase. It remains to be seen whether this resurgence will continue in the face of current global economic uncertainty around. The early M&A figures for FY2012 do not look too alarming, but it may be too early for the effects to impact Australian public M&A, given most deals are often planned many months in advance.
Success rates are also on the increase, with 70% of announced deals ultimately resulting a successful outcome. This seems to be due to a number of factors, including an improved degree of success amongst hostile deals, an increase in the number of friendly deals and also a continued use of deal protection mechanisms, which have a strong correlation with success. Success rates have also been impacted by noticeably more bids originating from China and India being successfully completed.
DEAL STRUCTURE
Deal protection is currently under intense scrutiny, with the UK Takeovers Panel taking a strict line and prohibiting deal protection mechanisms such as “no-shop / no-talk”, matching rights and break fees. It remains to be seen whether the Australian Panel has a similar view on the anti-competitive nature of many deal protection arrangements, however they feature prominently in friendly deals in Australia and yet do not appear to have a negative effect on competition in M&A – both 2010 and 2011 saw a healthy number of competitive auction scenarios in public M&A.
Deals are still highly conditional – approximately 90% of transactions in FY2011 had conditions attached to them. Overall, the trend in takeovers seems to be towards having more conditions, which goes against the trend of last year. An indication that, despite the increased activity, bidders seem to be more cautious. In contrast, FY2011 also saw the continuation in the trend of more unconditional on-market bids.
Bidder caution continued in relation to the minimum acceptance thresholds, with an increase in 90% minimum acceptance thresholds and a decrease in 50% minimum acceptance thresholds in FY2011. In only three of the deals with 90% minimum acceptance thresholds was the condition waived or varied. Overall, only 11% of bidders waived their minimum acceptance condition.
42% of transactions had lock-up arrangements in FY2011. This is significantly higher than in both FY2009 and FY2010, when only around a quarter of deals had some form of lock-up. There is also a clear movement towards implementing a range of lock-ups. Directors stating that they will accept the offer in the absence of a superior offer still remains the most common lock-up, however we are seeing more pre-bid acceptances, option agreements and even voting agreements, all of which appear to be helping success rates.
ORIGIN OF BIDDERS
There has been an increase in foreign M&A activity with 51% foreign bidders in FY2011, compared to 42% foreign bidders in FY2010. In particular, FY2011 saw strong activity from North American bidders. Given the relative strength of the Australian dollar against theUSand Canadian dollars over the past year, it is perhaps surprising that of the 21 deals involving North American bidders, cash was the form of consideration in 13 of those deals.
Bidders in the deals with values over $1 billion were again predominantly offshore, spread across North America, Asia andEurope. Involvement by domestic bidders in ‘mega deals’ appears to have slowed after a resurgence in FY2010.
AUSTRALIAN UPDATE – Trends and Developments in Australian Cross-Border M&A
Executive Summary:
- So far this year, about 70% of Australian announced listed company deals over $100m have involved foreign bidders. Foreigners making bids in Australia include principally acquirors from the US, UK, Canada and China.
- With the Asian demand for resources and agribusiness companies, Chinese and Indian bids are expected to increase.
- The large number of foreign bidders has also seen the prevalence of cash being used as the dominant form of consideration. In uncertain times cash is always to be preferred, and in the case of foreign bidders, Australian based investors are less likely to see foreign scrip as being attractive.
MAIN ARTICLE
Australia has a 2 speed economy, a carbon tax coming our way, a business sector bemused by a minority government and their policies, a record A$ 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 TAKEOVERS 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 under taken 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. CHANGING 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, star ting 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 under takings 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 star ting to emerge with Pacific Equity Partners in the process of getting away its Collins Food float. Incredibly, at $200m it is the largest IPO in the Australian market this year. While it helps, it is unlikely to be the catalyst for an IPO explosion. Nevertheless, a few more like this may give the market some momentum in the next half.
Given current market sentiments and the 2 speed economy, making it tough for any non-resources stocks, we expect the difficult equity markets to continue for the rest of 2011 before returning to better times in 2012.
10. OPPORTUNITIES ARE OUT THERE – IS THE TIME NOW?
For the astute and opportunistic bidder, good deals can be done, and done at an excellent price. The general Australian market is trading at historically low PE multiples.
Some private equity bidders have under taken significant acquisitions, for example Blackstone’s acquisitions of Valad and of key US based assets of Centro Properties Group. Time may also come to show that various resources deals being done are at a relatively cheap price.
Bargains may be being missed while the prevailing underlying philosophy seems to be “wait and see”.
Indeed and while not in all cases, a lack of competitors for targets has meant that bidders have been prepared to wait to see if the global uncertainty improves and valuations have bottomed. With foreign financial conditions arguably star ting to improve the time to move may be now.
While we forecast an increase in M&A activity over the next 12 months, this shift may not occur until the start of 2012. The catalyst, in our view, to greater M&A and capital markets activity is financial and political stability which will breed confidence in the business and consumer sector and global markets generally. Less radical and uncertain policy from our government and a sustained period of calm offshore and resolution of the foreign debt issues is required. The reality is this may take some time.
It is notable that, to date, more Australian companies have not taken advantage of the high A$ 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.
AUSTRALIAN UPDATE – Regulatory Developments, Private Equity Trends and Deal Terms in Australian M&A
Editors’ Note: Ewen Crouch is Chairman of Allens Arthur Robinson and a member of XBMA’s Legal Roundtable. Mr. Crouch brings a rich perspective to this paper, as one of Australia’s leading M&A lawyers with expertise acting in some of Australia’s most significant transactions, including representation of Foster’s Group in the recent SABMiller transaction.
Executive Summary:
- Public M&A activity in Australia has been patchy during 2011. Notably, the mining sector was more subdued than anticipated, with companies deploying stockpiled cash into growth projects, dividends or share buy-backs.
- Upon the recommendation of the Foreign Investment Review Board (FIRB), the Federal Treasurer rejected the proposed merger of ASX with Singapore Exchange Limited (SGX). The ASX/SGX merger was rejected as contrary to Australia’s national interest (because of the loss of sovereignty over ASX clearing systems), indicating that in addition to foreign state-owned acquirer and national security considerations, FIRB will likely heavily scrutinise foreign persons’ acquisitions of businesses that, in the Government’s view, provide or perform some function that is critical to the Australian economy.
- Sponsor to sponsor private equity deals have dominated the private M&A landscape in the first half of this year.
MAIN ARTICLE
1. Overview
This paper will briefly report on the current Australian M&A environment covering:
(a) government regulators;
(b) deal trends and terms; and
(c) private equity activity and news.
2. Regulatory snapshot
2.1 ASIC
The new Australian Securities and Investment Commission (ASIC) chairman Greg Medcraft, a former investment banker appointed in May this year, has signalled that the corporate regulator will have a greater focus on surveillance, industry engagement and self regulation. In particular, ASIC has been driving the theme of clear, concise and effective disclosure. This drive reflects ASIC’s ongoing concern that investors disengage from the information needed to make sound financial decisions when that information is unclear, inaccessible or needlessly detailed. Of note, recent consultation papers from ASIC raise the possibility of restrictions on paid celebrity endorsements and the use of photos and images in disclosure documentation to ensure that consumers are not distracted from key messages and warnings. ASIC has also set a date of 30 June 2012 for Australia’s funds management industry (the fourth largest in the world) to come up with voluntary best practice standards for portfolio disclosure.
2.2 ACCC
In recent years the Australian Competition and Consumer Commission (ACCC) has been more interventionist. Two trends over the past year include increased examination of alternative bidders in counterfactual analysis and increased requirements for pre-merger divestiture.
2.3 FIRB
Upon the recommendation of the Foreign Investment Review Board (FIRB) the Federal Treasurer rejected the proposed merger of ASX with Singapore Exchange Limited (SGX). The ASX/SGX merger was rejected as contrary to Australia’s national interest (because of the loss of sovereignty over ASX clearing systems). Supervisory issues impacting on effective regulation were also cited as a reason for rejection. This decision indicates that in addition to foreign state-owned acquirer and national security considerations, it is expected that FIRB will heavily scrutinise foreign persons’ acquisitions of businesses that, in the Government’s view, provide or perform some function that is critical to the Australian economy.
2.4 ASX
The Australian Securities Commission (ASX) has indicated that it is on the lookout for pre-downgrade volume spikes which are indicative of insider trading and/or a breach of continuous disclosure obligations. Also, the ASX has proposed to list derivative products in response to volatility concerns. The trend towards higher standards of continuous disclosure that emerged during the Global Financial Crisis has continued, whereby an entity must immediately disclose to the ASX any information that it is aware of concerning itself that a reasonable person would expect to have a material effect on the price or value of its securities. This was most recently born out in the Fortescue case, where a listed company was held to be in breach of its continuous disclosure obligations when it failed to immediately correct misleading information disclosed to the ASX.
3. Market trends in M&A transactions
3.1 Public M&A transactions
Public M&A activity has been patchy during the first half of 2011. Notably, the mining sector was more subdued than anticipated, with companies deploying stockpiled cash into growth projects, dividends or share buy-backs. The uncertainty caused by rising operational cost pressures together with the rising Australian dollar and volatile equity markets has put a dampener on M&A activity in the resources sector, although there has been some action such as the $A4.9 billion takeover bid for McArthur Coal by Peabody Energy and Arcelor Mittal. More generally, there was an uptick in activity around the mid-year point with the announcement of SABMiller’s $A9.5 billion takeover attempt of Foster’s (subsequently accepted with an increased offer price, valuing Foster’s at $12.3 billion), and FOXTEL’s $2.5 billion bid for Austar, although the uptick was followed by month-on-month deal values decreasing in both July and August. In the latter half of the year it is expected that public M&A will become more opportunistic and erratic, although the possibility remains that one or two major deals could catalyse a flurry of year-end activity similar to what we saw in 2010.
3.2 Private M&A transactions
Sponsor to sponsor private equity (PE) deals have dominated the private M&A landscape in the first half of this year, including the sale of the Healthecare Group by Champ to Archer Capital, and the sale of ATF from Quadrant to Champ. PE funds remain under pressure to spend funds raised pre-GFC and also sell assets held through the GFC, so the trend of secondary sales looks set to continue.
We have seen the following deal trends in private mergers and acquisitions transactions terms sheets over the past 36 months.
In respect of purchase price mechanisms, so-called “Locked Box” transactions are growing in popularity. Under this mechanism, the purchase price for the target company is based on an historical balance sheet settled between the parties as at an agreed date in advance of signing. The “box” is then “locked” by the vendor, who in turn gives indemnities and undertakings not to extract value from the target or incur additional indebtedness prior to completion. The value of the target is in this way determined prior to the sale, which allows vendors to avoid the uncertainties which completion accounts create. These transactions often allow for adjustments made for working capital expenditure in the lead up to completion.
In respect of warranties, it has become typical for vendors to cap their liability at 100% of the purchase price, although we have seen a handful of deals where purchasers have secured uncapped warranties and, at the other end of the spectrum, warranties capped to as low as 2.5% of the purchase price. The time limits within which purchasers must notify vendors of a breach of warranty are typically set at around 18 months from completion for all warranty claims except tax, and 6 years for tax claims (mirroring the Australian Taxation Office’s 6 year time limit for making retrospective claims). In respect of indemnities, it is very common to see vendors fully indemnify purchasers for all tax liabilities arising pre-completion.
4. Private Equity roundup
4.1 Australia roundup Q1 2011
- Deal value US$10.1 billion down 75.5% from Q4 2010.
- Deal count of 84 – ten more that Q1 2010, but 32 less that Q4 2010.
4.2 ‘My Super’ reforms
In recognition of the high proportion of passive super investors, it is anticipated that the government will promulgate new policy to protect consumers, although the proposed changes (known as the “My Super” reforms) are still in the consultation phase. It is likely that “My Super” products will become the government default, and that there may be a statutory obligation to consider fees paid in relation to both super funds and their investments in connection with these products.
While there is some concern in relation to fees associated with PE investments, as compared to other investments, the leader of the government’s consultation process has recently publicly recognised that fees must be considered in light of the net returns of a given type of investment.
4.3 Legal trends in respect of fees
Investors generally are more savvy to the terms on which they invest with PE. With the market slanted towards investors, we have particularly seen more robust clawback terms in respect of PE performance fees. These provisions are operating along two dimensions. First, defining what fees can be clawed back, and under what circumstances, and second, the mechanics to ensure funds will be available if clawback provisions are triggered. In respect of the latter, safeguards have included funds held in escrow and also third party guarantees, typically from the parent company of the PE fund.
4.4 Sectors
In the first quarter of 2011, the two largest PE investments by deal sector were in respect of Consumer Goods and Retail (32% of all deals) and Energy and Environment (25% of all deals).
4.5 Secondary market likely to continue as primary exit route
There have been a number of recent significant secondary deals including the sale of ATF from Quadrant to Champ, Ausfuel from Champ Venture to Archer and the HealtheCare group from Champ to Archer. More secondary deals are likely as internationally sponsors are now actively looking at certain assets help by domestic sponsors, combined with pressure to spend funds raised pre GFC and a continued challenging IPO market.
XBMA – Quarterly Review for Q1 2011
The attached slides summarize trends in cross-border M&A and strategic investment activity throughout the first quarter of 2011.
Highlights:
- Global M&A volume for Q1 2011 was US$671.8 billion, up 29.5% as compared to Q1 2010.
- Cross-border transactions have rebounded substantially from 2009: 38% of Q1 2011 global M&A was cross-border — up slightly from 37% in 2010 and up significantly from the low of 26.8% in 2009.
- Canada and Australia’s shares of global M&A each more than double their respective shares of world GDP, perhaps reflecting the large number of deals involving natural resources.
- Distressed deals have exceeded US$75 billion per annum since 2009.
- Energy M&A remains the most active among cross-border transactions – reflecting the ongoing pressure to acquire natural resources to fuel emerging economies and the churn created by political instability in the Middle East and by the widespread adoption of technological improvements in the natural gas industry – with Materials and Financials cross-border M&A in the second tier.
XBMA Quarterly Review for Q1 2011