What a difference a year can make in the Australian M&A market. Twelve months ago sellers held the upper hand, conducting competitive auctions for assets that were frequently sold for handsome multiples. The winners, in a lot of cases, were those who could outbid their rivals by using cheap leverage to ratchet up the price -- a strategy frequently employed by private equity firms. Then the financial crisis hit and the flow of cheap finance was cut off, causing the highly leveraged bids to vanish. Vendors have been forced to re-evaluate their selling price, but they haven't done so readily.
"At the beginning of last year, buyers were sitting around waiting for sellers to drop their prices," says Andrew Clarke, head of M&A at Citi in Sydney. The sellers resisted and took many months to come around. When they finally capitulated, "to their surprise, the buyers weren't there anymore - they had left the room", he says.
Paradoxically, Australian M&A activity in the first quarter of 2009 looks relatively robust with $20 billion worth of deals logged by Dealogic versus $19 billion for the same period in 2008. However, most of this is M&A inflow -- involving a foreign acquirer purchasing an Australian asset -- which now accounts for 90% of all transactions. M&A outflow, meanwhile, has come to a virtual standstill, down 81% quarter-on-quarter to just $718 million.
The inflow activity has a distinctly new feel, with Chinese acquirers accounting for four out of the top 10 Australia-M&A targeted deals in the latest quarter. The biggest of these is Chinalco's $19.5 billion bid for a stake in miner Rio Tinto. That deal, which is awaiting regulatory approval, typifies two key trends in the M&A market. First, it is a result of Rio's need to cut its debt burden and convince editors that it can ride out a prolonged economic slump. Second, it has involved the seller rethinking its expectations on price. Rio had originally been courted by BHP Billiton but had rejected all offers on the basis that they undervalued the company. While the regulators debated that merger last year, the market fell away, giving BHP the chance to back out. The new offer from Chinalco is significantly lower than the original BHP deal.
The fall from grace for many of Australia's mining companies has been spectacular. The high commodity prices that fuelled their expansion for most of this decade have plunged, leaving them debt laden and reaching out for help. Much of this assistance is coming from China where
"the ability to secure resources is always going to be a strong point of interest for buyers", says Andrew Low, head of Asia for Macquarie Capital.
While China's interest in Australian mining companies isn't new - there have been several strategic coal and iron ore purchases in recent years -- the latest deals are driven by the sellers' need to buttress their balance sheets. Oz Minerals is getting a $1.7 billion rescue from Minmetals (the deal was revised and approved after the government rejected the initial proposal in late March), and Fortescue received a $450 million injection from Hunan Valin Iron and Steel Group.
Another sector ruing its passion for excessive borrowing is commercial property. Listed real estate trusts have been abandoned by stockmarket investors, with most trusts now trading below their net asset value. To prevent a wholesale revaluation of property assets, creditors have been working hard to prop up companies like Centro Properties and GPT by extending loan maturities and negotiating debt-to-equity swaps. But the consensus is that these workouts aren't fixing the problem.
"This sector will be driven by the need for liquidity," says Clarke at Citi. "The assets will need to be moved along in order to release capital and pay down debt."
Just how the commercial property assets will be moved along is a topic attracting a lot of conjecture. "These companies are trading at such low valuations that the equity clearly isn't worth much; this means buyers will be very focused on transaction structures and the debt component," says John Hanson, head of M&A at Merrill Lynch. "The catalyst for M&A activity in this sector will come when historical complex structures are simplified and appropriate arrangements are made with financiers."
At this stage, it's hard to envisage who the buyers might be. Pension funds have been the traditional acquirers of long-term property assets, but it seems they are waiting for prices to come down. Low at Macquarie says he expects some interest in this sector to come from Asia. "There are a number of buyers in Asia that are taking a closer look at commercial real estate in Australia. They aren't listed funds; they are corporate buyers and unlisted funds."
In general, acquisition activity looks like it will be driven by the buy-side for the rest of the year, and possibly beyond. Ron Malek, joint CEO at advisory firm Caliburn Partnership, expects buyers to be more selective. "There is certainly a lot more caution in the air, but you have to remember that, for many corporates, a strategic asset may only come along once in a decade, and that opportunity might just arise for many companies in the next year or two." Two such opportunistic deals were done in the financial sector towards the end of last year -- the A$16 billion ($12.3 billion) merger between Westpac and St George, and CBA's A$2.1 billion acquisition of Bank West. In both cases, the buyers had been eyeing the targets for some time, and took advantage of a drop in price-to-earnings differentials to seal the deals. CBA's purchase was also done at bargain basement prices -- it paid just 0.8 times book value and 11.2 times profit (based on 2007 figures) for Bank West.
Contrary to what people might think, though, not all deals are being done at severely reduced prices. A recent string of acquisitions by Japanese buyers, for example, were completed at standard multiples. These included: the October 2008 purchase of Frucor by Suntory for $762 million; Asahi's $780 million bid for Cadbury Schweppes in December; and Nippon Paper's $460 million offer for PaperlinX's Australian paper unit in February.
M&A bankers say strategic deals like these aren't necessarily driven by the economic downturn and strategic buyers don't always wait for a market to bottom out before making a move on an asset. Still, buyers are a lot more risk averse than they were 12 months ago, and won't be lured into highly competitive auctions. "Sellers that have run traditional auctions in recent months have generally had limited success," says Anthony Sweetman, head of M&A at UBS. "There often aren't enough willing buyers with the financial capacity to create competitive tension." Buyers are also taking their time to fully assess a business before making an offer. "Unlike the days when private equity firms were driving the terms, there is much less focus on capital structure and market valuation and much more focus on asset valuation and the medium- to long-term prospects of the operating business," says Low at Macquarie.
Jamie Garis, a partner at Caliburn Partnership, says buyers want a quicker payback on purchases. "Shareholders aren't going to be happy with a deal that has a three-year period until accretion. They are looking for benefits to be evident in the short term," he says. "They also want to make sure that the balance sheet is strong and that the company is not left exposed or weakened after an acquisition. All these things mean finer pricing."
Another upshot of the current economic environment is the involvement of banks in the negotiation process. "Creditor banks are doing their own due diligence on deals these days," says Meredith Paynter, a partner at law firm Mallesons Stephen Jaques in Sydney. "There was a time when banks were told what the terms were and they weren't in a position to drive a transaction. Now they want to be very clear about such things as conditions precedent, material adverse changes and the triggers for a right to withdraw." She says while banks don't necessarily make or break a deal, their level of engagement has been heightened.
In many ways, company executives will be navigating unchartered waters as they pursue or rebuff acquisitions in the next 12 months. The depth of the financial crisis means that many of the old conventions have been jettisoned, and a new rule book is being written. While the risk of after-shocks prevails, buyers will remain wary. "For every good story you hear about a company picking up a solid asset at a bargain price, there are 10 more stories about deals that blow up in the acquirer's face," says one M&A banker, referring to transactions such as Bank of America's purchase of Merrill Lynch and Lloyds' acquisition of HBOS. "Until these horror stories die down, a lot of buyers will be
tempted to sit on their hands."
This article was initially published in the April issue of FinanceAsia magazine.