AUSTRALIAN UPDATE – Regulatory Developments, Private Equity Trends and Deal Terms in Australian M&A
- 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.
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
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.
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.
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.
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.
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.