Buying back the farm

Co-heads of M&A at Salomon Smith Barney in Sydney, Paul Binsted and Brian Wilson, talk acquisitions in Australia.

Last year was a mega-year for M&A transactions but this year there has been a drop in volumes, why?

Paul Binsted: Volumes globally are off by about 30% to 40% depending on which market you look at. Australia is doing okay though and this market has survived without too much negative impact mostly because local companies as a whole have strong balance sheets and because there's A$20 billion per year flowing into superannuation funds that provides the industry with ample equity. The recent IAG acquisition of CGU for A$1.8 billion demonstrates the level of support for big transactions.

So have the Australian markets witnessed a drop at all?

Brian Wilson: You can't compare Australia to the rest of the world and come up with a simple statistical calculation. Because we represent only 1.5% of global GDP and global stock market capitalization our markets are very lumpy. For example, if you take out the Singtel/Optus transaction from last year, then dollar values for this year aren't down at all. A couple of big deals can make a big difference between a booming year and a lagging year.

Binsted: I think it is fair to say that 2002 has been a run of the mill year with reasonable levels of activity and a good mix of transactions.

What themes have we seen this year that will carry into next?

Binsted: There is going to be an increase in the number of Australia companies buying assets from foreigners, either Australian assets that are currently owned by foreigners, or overseas assets. There is a lot of activity on this front in infrastructure and utilities. American utility companies in particular are leaving the country and selling off their electricity generating assets.

Are these purchases being financed predominantly by equity?

Wilson: The advent of the superannuation guarantee levy has had a huge impact on Australian domestic investment capacity. There is annual growth of about A$50 billion in super funds when you take into consideration non-compulsory contributions and re-investment of earnings. About 40% to 50% of this, or between A$20 billion and A$25 billion, is earmarked for equity and this equity has to find a home somewhere. The situation is helped further by the dividend franking regime which has lowered the cost of equity for issuers and reduced their reliance on the debt markets.

So the debt markets are now of little significance in M&A transactions?

Wilson: No, they are important but bonds, loans and hybrids are being used not because they are the only source of funding but because they can optimize the capital structure of a deal and maximise the return to shareholders.

Is Westpac's purchase of Principal a classic example of an Australian company buying back the farm?

Wilson: Yes, very much. The Principal funds management business used to be owned by BT before Deutsche Bank bought BT globally in the late 1990s and then decided to sell the Australian division. The buyer at that time was a US company, Principal. Westpac has now bought it back for A$900 million.

Was this a bargain for Westpac?

Wilson: I think it will prove to be so. At the time Deutsche Bank was selling BT back in 1999 Westpac was a front runner to buy the business, but they decided to pull out in part because it was determined that the cultural fit wasn't right. Then Principal moved forward with a deal and paid A$2.1 billion for the business. Three years later they are selling it to Westpac for A$900 million.

So the cultural misfit has been resolved?

Wilson: Yes, during the time that Principal owned the business there was a huge transition of management and at the same time the firm began focusing more on distribution and less on product manufacture. There has also been a change in the local banking industry in Australia with almost all of the big local banks buying into funds management. Investors are now comfortable with the idea of banks owning funds businesses.

What other deals are you proud of?

Binsted: We are particularly proud of the sale of Sydney Airport on which we acted as adviser to the Commonwealth Government. The asset sold for A$5.6 billion which was a stunning outcome. We had been through some tough moments with the transaction because it was first planned to be completed in the fourth quarter of 2001 and final bids were due just about the time of the September 11 terrorist attacks and the collapse of Ansett. We had to advise the government to put the sale on hold. Our mandate could have been revoked but the government rewarded us for giving them the right advice and we retained the mandate to complete the sale on June 30 this year.

Is the tender process the best way to sell big assets like an airport?

Wilson: Absolutely. While it has transpired that the winning bid might have paid a premium price for the asset, it was a good outcome for the government. There are a lot of sensitivities surrounding the sale of such a strategic asset. The Australian government needed to be sure that the airport that acts as the gateway to 60% of the country's air traffic was going to be soundly financed and that the new owners would be mindful of issues such as aircraft noise. So this is certainly a case where the tender process is the right approach. This sort of result would not have been achieved from a purely negotiated transaction.

The foreign investment review board (FIRB) recently intervened in the Shell/Woodside acquisition and stopped Shell from investing in Woodside's gas fields. Do you see the government cracking down on inward investment into Australia?

Binsted: No this was a very special case and an exception to the rule. Back in the 1980s it was difficult to get approval for foreign investment but normally now we take it that approval will be given. I think the reason the Board stepped in with Shell was because of the national significance of the Northwest shelf project. The government was concerned that a foreign investor in these gas fields would have a conflict of interest if they also owned assets in competing gas fields around the world. There was a concern that the foreign party might market and sell their foreign gas over the Australian product. This sort of situation doesn't exist for any other of the Australia resources, all of which have a dominant position in the global markets.

Is the stockmarket reacting differently to the news of mergers and acquisitions these days?

Wilson: It definitely is. A couple of years ago almost every acquisition was lauded by the market. They were seen as strategic even if they weren't and they were seen as offering growth even if there was little to be enjoyed. Now the market is much more selective about what it rewards. In particular it is looking for deals that are properly priced. If there is a hint that a company has overpaid for an asset or that they are expecting to benefit from synergies too quickly then the market is punishing them hard. The market doesn't like empire builders anymore.

What's in your deal pipeline?

We have one announced transaction in the gaming industry but otherwise there is nothing public that we can talk about. The pipeline is strong but it's all under wraps at present.

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