Hitting the right notes

The tag of “Lucky Country” has clung to Australia since the 1964 publication of a book by the same name by social critic Donald Horne. In the wake of the Global Financial Crisis – widely referred to by Australians simply as “GFC” – the description has a whole new application. “We really didn't see blood on the streets – it truly is a lucky country,” reflects Martin Scott, joint head of the Sydney office at Swiss alternative assets manager Partners Group. “Through a mix of good luck and financial management, Australia missed the worst of the crisis. No banks collapsed, we missed a recession and, while we did not avoid the crisis completely, we did come out fairly strong.”

There are many reasons cited for Australia's resilience. Not the least of these was that the country had enjoyed a long period of strong economic growth, and hence was in a better shape than many other economies going into the crisis. Other factors included: a continuing high level of demand from China for the country's natural resources; interest rates of 7.25 percent that gave plenty of room for manoeuvre (they were swiftly dropped to 3 percent, before recently being pushed back up to 3.5 percent); flexible labour laws that allowed employers to reduce working hours rather than headcounts; and a big and bold stimulus package, which included a A$900 (€557; $828) government handout to all taxpayers earning less than A$100,000 per year.

The upshot of these successful measures has been a level of confidence in prospects that can seem alien to visitors. Says one London-based private equity professional who spends a lot of time in Australia: “It's bizarre. Everyone there seems to have taken a happy pill. They're puzzled as to why everyone else is so gloomy.”

But has the private equity market in Australia also come out lucky? In some ways, that seems an accurate assessment of the evidence. For example, during the boom, certain Australian GPs arguably bought into prevailing mega-fund hype – and yet still saw events unfold in their favour. Explains one observer: “Each time the latest big fund was raised, a play was made of being the largest in the country. But as soon as this wave of money was raised by domestic GPs, foreign capital flooded in, treated Australia as a rummage sale and started doing these big take-privates. Australian GPs will tell you that they managed to avoid the worst deals. The truth is, they bid for these assets but ended up as underbidders.”

Unfortunately, since the listing, Myer has tracked down and this outcome has dampened confidence

Martin Scott

Among the high-profile boomera deals to have since caused ripples was media company PBL, which was acquired by CVC Asia Pacific in a A$5.5 billion transaction in 2006. CVC injected A$335 million in equity into PBL towards the end of last year as part of a recapitalisation package designed to keep the company afloat. Another deal frequently cited is Seven Media, the television network in which Kohlberg Kravis Roberts acquired a 50 percent stake in 2006 through a joint venture with Seven Group. In February 2009, Seven Group wrote down the value of its 47 percent interest to zero.

As these LBO-related worries surfaced, the cautious approach of many domestic Australian banks led to claims that they had enjoyed a “good crisis” – and it would almost certainly be harsh to attribute this to luck rather than judgement. Many were reluctant to help leverage deals up to the hilt, partly as a result of which they are now able to boast impressive ratings and healthy balance sheets. In the early months of this year, allegations were cast that the domestic banks were not supporting new deals.

“By March 2009, people were shrugging their shoulders and saying ‘we want to do deals but the banks won't let us’,” says Jon Freeman, a partner at Londonbased secondaries firm Coller Capital and a specialist in the Australian market. However, local GP groups typically hold the view that this was a short-lived phenomenon and say that the banks are now prepared to lend as much as A$400 million in senior debt at multiples of around 3.5 to 4 times EBITDA.

FAVOURABLE DYNAMICS
On the new deal front, things are looking fortuitous from a GP perspective, with some favourable dynamics developing. Tim Sims, managing director of Sydney-based private equity firm Pacific Equity Partners, says: “Vendors normally become active either when it's a sensible time to sell from a pricing point of view or when there is pressure to complete disposals in order to free up resources. At the moment, we're in a unique situation where both conditions may pertain at the same time. There is strong pressure on boards to consider asset sales to increase liquidity, while the recent stock market rally and uncertain outlook has persuaded people that it's not an unhealthy time for a sale.”

Sims proceeds to describe the pressures on corporates to consider strategic options. He relates how shareholders are reacting to disappointing performance and an uncertain outlook with increased pressure on management. This has led to increased management change and this in turn allows new management to take a fresh look at the current spread of assets and consider acquisitions and disposals. He points to “a powerful cocktail of factors creating more of a willingness to buy and sell.”

David Jones, managing director at Sydney-based private equity firm CHAMP Private Equity, is confident in new deal prospects: “The deal flow has markedly picked up since June,” he says. “We believe this is because pricing has reverted to more ‘normal’ levels and some risk appetite is back. As such, it is a reasonable time to consider buying or selling assets at present. This is in stark contrast to the 12 months prior to June, when virtually all ‘normal’ transactions were put on hold.”

If this hints at increasing options for GPs in future, one exit route already appears to have opened up for retail companies in particular. At the end of October, TPG-backed department store chain Myer raised almost A$2 billion from a listing on the Australian Securities Exchange. A couple of weeks later, Kathmandu, an outdoor equipment and clothing retailer backed by Goldman Sachs JB Were and Quadrant Private Equity, raised A$340 million from its IPO. The latest private equity portfolio company set to follow suit is Ascendia, an Archer Capital-owned sports goods retailer, which is targeting an IPO predicted to value the firm at between A$800 million and A$1 billion by the end of the year.

So is the opening of the IPO window also a sign of the gods smiling on the Australian market? David Jones thinks so: “No doubt the recent IPOs have been a confidence boost. Risk appetite is returning which is a positive. Naturally each IPO will be considered carefully on its merits. I would suggest the IPO market is open, but only for strong assets.”

SCEPTICISM
It's notable, however, that scepticism is creeping in – perhaps the effects of the happy pills are wearing off. Says Scott: “Unfortunately, since the listing, Myer has tracked down and this outcome has dampened confidence. It will be interesting to see whether the pending listings in the pipeline over the next six months are delayed a little and whether consumer confidence suffers at all or stalls due to the Reserve moving so quickly on interest rates.”

It's bizarre. Everyone there seems to have taken a happy pill. They're puzzled as to why everyone else is so gloomy

Adds Mark Delaney, chief investment officer at AustralianSuper, a superannuation fund: “The IPO window is still vulnerable to closing as quickly as it opened. The outlook will be clearer after Christmas. If the Christmas period is strong, Myer and Kathmandu share prices will hold up and a fresh wave of retail floats will appear in the first half. The other issue is that the strong Australian dollar is providing a tailwind for retail companies. If it drops significantly, it will impact the outlook for the sector.”

Perhaps the biggest blow to private equity firms' IPO aspirations has come from the unlikely source of the Australian Tax Office (ATO). The ATO claims that TPG owes A$452 million in unpaid taxes stemming from the use of a Cayman Islands structure for the Myer deal. Jon Freeman predicts that the outcome “will be messy and will dampen foreign private equity IPOs”.

Tim Sims says that some funds will be handicapped by the uncertainty created by the current debate as to the proper treatment of investment profits in the hands of overseas investors. The issue will be particularly sensitive for funds seeking to recruit new offshore investors into these type of structures.

Nor is this the only negative factor weighing heavily on the fundraising market. Because of the strength of the Australian dollar, many international investors are now overweight in Australian funds and are therefore likely to stay out of the market for the foreseeable future. Meanwhile, the double whammy of the denominator effect and currency volatility combined to produce a cautious attitude to new commitments on the part of the domestic superannuation funds.

While Australia bathes in the glow of an enhanced economic reputation and private equity players in the country find themselves with fewer problems than counterparts elsewhere, it would be wrong to conclude with the Aussie expression “no worries”. For those on the fundraising trail, there are reasons to be anxious.