2020 was an understandably quiet year for mergers and acquisitions activity in Australia with the full magnitude and duration of Covid-19’s severe impact on the country’s economy unclear, causing investors and company boards alike to remain cautious in the deployment of their capital. However, past the midway point of 2021 it is apparent that the M&A high tide has well and truly arrived despite Australia’s major cities still being affected by lockdowns, welcoming $AUD110.8 billion of deals completed thus far according to a new report from Pitcher Partners and Mergermarket – for comparison, the 6 months up to June 30 2019 saw just $30 billion. This article will highlight some of the major M&A trends and deals of the year thus far as well as explore reasons for this dramatic increase in investment activity.
So what is M&A, exactly?
Mergers, acquisitions or takeovers all essentially refer to the process of a company acquiring (purchasing) another company and its assets – there are differences between the terms but the post-deal result is similar resulting in a consolidated company that contains the assets of both companies involved and the target firm’s shareholders giving up ownership of that company. For the purposes of this article we will be using these terms interchangeably.
In Australia the two most common methods of undertaking a takeover are a scheme of arrangement and an off-market takeover bid. Broadly speaking, a scheme involves target shareholders and the Court to approve the transfer of all target shares to a bidder company in exchange for consideration paid by the bidder to the target shareholders. An off-market takeover involves the bidder making a direct offer to all target shareholders to acquire their shares at a predetermined price.
Takeover bids are financed via cash, scrip (newly issued shares of the bidding company) or commonly a mix of both. Careful deliberation is given in regards to the financing decision of the bidder as taking on more debt increases the company’s risk of bankruptcy and may affect their credit rating whereas issuing more shares dilutes existing ownership and may be received unfavourably by shareholders, amongst many other factors.
Companies may be interested in undertaking M&A transactions for many reasons, including to expand their customer base, expand their product offering, or simply to take advantage of a good opportunity in an undervalued company. Common rationale involves companies realising economic “synergies” in the form of cost savings or more dubiously revenue synergies to justify the premium paid to take a controlling stake in a target company.
What has happened so far in 2021?
According to the previously mentioned report from Pitcher Partners and Mergermarkets, deal volumes were down 19% in 1H21 (447 deals) from 1H19 (551) despite the 271% higher total deal value of $110.8bn. This is due to larger overall deal sizes seen thus far. On the whole, this total has already surpassed the total value of deals reported in Covid-affected 2020 which saw $94.3bn worth over 963 deals completed.
In the technology, media and telecommunications (TMT) space, Melbourne-based online training startup A Cloud Guru sold for $2bn while fellow Australia tech company MessageMedia was acquired for $1.7bn, both to overseas companies. Foreign dealmakers took part in 29% of deals in 1H21 despite Australia’s border closures. Telstra sold half of their mobile phone tower network for $2.8bn in June while Optus parent company Singtel is running an auction process for a majority stake in their towers expected to be worth between $1.5bn and $2bn.
Infrastructure has been a particular area of interest for funds; logistics company Qube sold $1.67 billion of property assets while a stake in NSW toll roads company WestConnex is expected to sell for $10bn shortly. Some other notable deals include the $9bn sale of Coca-Cola Amatil to Coke Europe, the $10.8bn merger of investment companies Washington H. Soul Pattinson and Milton Corporation and Seven Group’s unconventional $8.8bn takeover bid for a majority stake in Australian construction materials company Boral.
These deals mentioned comprise a very small number of deals completed, with many small-cap and mid-market deals closed in the first half of the year. However, what has not been mentioned are various deals that failed to be completed. Notably, a $22bn bid for Sydney Airport was rejected in what would have been the largest takeover in Australian history. Additionally, waste company Cleanaway’s plan to acquire Suez Australia for $2.5bn fell through. Lastly, in light of the ongoing Crown scandal a $12bn merger bid by casino rival The Star was recently abandoned.
What factors have contributed towards the increase in M&A activity?
Record low interest rates resulting in extremely cheap capital
Since the onset of COVID, the Reserve Bank of Australia has undertaken numerous policy actions to support the Australian economy. The RBA set the cash rate at a record low of 0.1 per cent in November 2020 and began a $100bn quantitative easing (bond-buying) program. This has led to companies having access to historically cheap debt financing to fund acquisitions at negligible interest rates, contributing towards the boom in M&A activity. With conservative capital spending in the previous year, many corporate investors found themselves with healthy balance sheets and the choice of how to best spend their dry powder.
Examples of external debt financing sources are Unitranche-debt and Mezzanine-loan financing. Interest rates and the maturity of the financing plays an important role in a company’s cash flow and hence the investment decision. Management buyouts and leveraged buyouts are dependent on the ability of a company to obtain a loan at an ideal interest rate. Given that the cost of a loan has a significant impact on sales and determines the overall return that investors will receive, high interest rates result in lower overall returns for investors meaning low interest rates result in investors generating greater returns. Lower interest rates also suggest lower hurdle rates for board approval, especially for superannuation funds and big institutional investors, and many target boards were more willing to sell now that valuations have recovered to above pre-COVID-19 levels in equity markets.
The discounted cash flow of a company’s future earnings are of greater value with lower interest rates, resulting in a rise in valuation multiples. According to MST Marquee’s Hasan Tevfik, when cost of debt of 2 per cent or less and the average free cash flow yield for the equity market is 5.5 per cent, heavily leveraged buyers are incentivised to acquire companies with steady cash flows and long duration infrastructure-style assets.
Government Stimulus
In an attempt to boost the economy following the escalation of confirmed COVID-19 cases, the federal government invested in substantial stimulus packages targeted towards job maintenance and industry survival. According to the Australian Financial Review, government debt servicing costs are a fraction of what they used to be. Low costs of debt and government stimulus packages provided businesses with the opportunity to flexibly change existing models and operations in response to global changes. These stimulus packages reflected the RBA’s intentions to support economic activity in Australia and helped underpin low costs of financing, contributing to the increase in M&A activity.
Optimism about business recovery
High business and consumer confidence is a catalyst for M&A activity. Vaccine roll outs, low cost financing and significant private capital dry powder has sparked immense optimism in 2021 regarding economic prospects especially for companies that performed well through COVID. Economies were forecasted to be faced with a stable government, improved COVID circumstances, additional government aid and continuing low interest rates in 2021, making dealmakers remain bullish. For example the medical devices sector registered the greatest growth in deal value in Q1 2021 when compared to Q1 2020, followed by healthcare recording a growth of 608%. Pharma recorded the greatest increase in the number of M&A deals in Q1 2021 followed by the medical devices sector. In an attempt to manage the longer-term COVID-19 impacts, companies in the medical, healthcare and pharma sectors have been investing in digitalisation or divestments.
ESG pressures
Given that environmental, social and governance (ESG) considerations and metrics have become a growing focus for companies, their shareholders and stakeholders, ESG factors have become increasingly important to the success of M&A transactions. Goals to achieve net zero emissions by 2050 will drive an array of asset portfolio changes, resulting in quick pick-ups in M&A activity within the resources sector. As CEOs look to use transactions to achieve ambitious environmental targets, M&A into the renewables sector has almost tripled in H1 2021 as compared to H1 2020. Consequently, the value of these ESG related transactions has jumped from US$35.7bn in H1 2020 to US$96.5bn in H1 2021. Notable examples include AGL’s demerger of its power generation business and Woolworth’s demerger of its hotels and retail drinks division.
What’s next?
As of July, the RBA has maintained that there is no intention to raise interest rates until actual inflation is within a target range of 2-3%, with modelling suggesting this condition will not be met before 2024. With interest rates set to remain steadily low, prevailing market conditions seem to indicate there is no reason for companies to slow down M&A activity anytime soon. Deloitte’s annual survey of Australian corporate heads from July backs up this statement, with 95% of respondents expecting the number of deals they pursued to increase or remain stable in 2021 and 58% expecting to pursue more deals in the next 12 months than the previous year.
In upcoming deal news, Australian energy company Santos is seeking to merge with rival Oil Search in a mammoth $23bn deal. However, Spark Infrastructure has rejected a $5.2bn bid while Australian Pharmaceutical Industries has knocked back a $687m bid, suggesting that while buyer interest is well and alive, it means naught if company boards are reluctant to sell.
Despite temporary setbacks with Covid-19 lingering in the country, it is clear the prevailing sentiment within the M&A space is one of confidence as we head into the second half of 2021.
References:
Boyd, T. (2021). RBA’s low rates will boost M&A. Australian Financial Review. https://www.afr.com/chanticleer/rba-s-low-rates-will-boost-m-and-a-20210204-p56zm4
Friedlander, D., Bruce, E. & Hunt, N. (2021). The seventh great M&A wave is here. Australian Financial Review. https://www.afr.com/companies/financial-services/the-seventh-great-m-and-a-wave-is-here-20210620-p582ll
Irving, J. & Turner, I. (2021). The Deal in Focus 2021. Deloitte Australia. https://www2.deloitte.com/au/en/pages/media-releases/articles/deal-in-focus-m-a-today-a-post-covid-bounce-070821.html
Macdonald, A., Redrup, Y. (2021). Dealmakers blow away the COVID webs as M&A values soar. Australian Financial Review. https://www.afr.com/street-talk/dealmakers-blow-away-the-covid-webs-as-m-and-a-values-soar-20210727-p58ddn
Makrygiannis, K. (2021). Global M&A hits highest value on record as post-pandemic market starts to take shape. EY. https://www.ey.com/en_gl/news/2021/07/global-m-a-hits-highest-value-on-record-as-post-pandemic-market-starts-to-take-shape
Sonego, M. (2021) Dealmakers: Mid-market M&A in Australia 1H21 market update. Pitcher Partners. https://www.pitcher.com.au/wp-content/uploads/2021/07/210726-Pitcher_Partners_DealMakers1H21_Final.pdf
Thomson, J. (2021). Our biggest M&A boom: $83b and counting. Australian Financial Review. https://www.afr.com/chanticleer/our-biggest-m-and-a-boom-83b-and-counting-20210608-p57z3j
The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.
