The Australian economy has had a remarkable run without a recession for more than 25 years. It has achieved real gross domestic product (GDP) growth of 3.1 percent per annum. Its central bank, the Reserve Bank of Australia, forecasts this growth to continue at approximately 3 percent over the mid-term.
Some key drivers that underpin its resilience to global economic fragilities include population growth from both immigration and domestic births, a stable and conservative banking system, and domestic consumption that accounts for about 80 percent of GDP. The fundamental ingredients are theoretically in place for investors looking at Australia and yet headlines portray it as an economy roiled by the end of a long resources boom and falling Chinese demand.
Cameron Blanks, managing director of Pacific Equity Partners (PEP), says the impact of the Chinese ride and the commodities boom is much more muted than media would have us believe. “The China discussion is overstated on almost every count. China consumes only a modest portion of Australian output today, accounting for just 6 percent of GDP. This is largely low-cost iron ore and coal, with China still behind both Japan and Korea with respect to steel consumption per capita. That same story that Australia is vulnerable to China's growth isn't reflected in reality: niche sectors of the economy such as new mining construction may slow, but the broader domestic economy continues to grow strongly. We're seeing that reflected in the growth rates being achieved across our own portfolio.”
PEP has operated in the local market since 1998, successfully selecting buyout opportunities in the mid-cap space. The firm is the largest and most active domestic player in Australia, with almost A$4 billion ($3 billion; €2.6 billion) in assets under management. Significant recent exit activity has seen the firm return A$6.4 billion over the last three years, ensuring that each of its four funds are top quartile performers relative to Cambridge benchmarks.
The firm is currently investing from its fifth flagship fund PEP V, which closed in September 2015 at its hard-cap of A$2.1 billion plus substantial co-investment relationships. Among Fund V's investments are Kiwi wellness company Manuka Health, food manufacturing business Pinnacle Foods, as well as Auckland-based private education company Academic Colleges Group, with a number of other deals in the pipeline.
PEP credits its success to the operational strength of a team of about 25 investment professionals, backed up by 10 managing directors. Blanks says to excel in this market, firms must be well networked in the local environment and have a trusted brand in the business community.
“People keep telling us that Australia is under pressure because of the China issue,” Blanks adds. “That rumour's been circulating very strongly for eight years and yet we've continued to make record-breaking consistent growth.”
Globally, Australia remains the second most favoured country for Chinese investment, with almost $78.7 billion in accumulated volume from 2005-15, according to KPMG's latest Chinese Investment in Australia Report.
While commentators worry that a slowdown in China and steep falls in commodity prices would dent the economy and even threaten its 25 years of unbroken growth, PEP says it is actually seeing encouraging opportunities for Australia's non-resource sectors.
“An interesting trend is the impact of China's growing middle class. Several key sectors are emerging as material contributors to the economy. Travel is one example; inbound tourism from China has trebled in the last six years. Education is another sector, where currently the number of international students studying in Australia is more than the UK and Canada. The food and wine sector is growing, too. The increase in Chinese consumer spending has meant that China is now amongst the top three export markets for Australian wine,” Blanks points out.
Supportive and buoyant market
Australian private equity has gone through a period of consistently open financing markets and a listed market that's been supportive of exit activity for high quality companies, says Tony Duthie, managing director at PEP.
“We've seen quality dealflow over time as a result of a strong macroeconomic backdrop, and a corporate environment that's supportive of getting acquisitions done,” says Duthie. “That's amid a market where competition for assets is more limited than elsewhere in the world.”
Of the private equity space in Australia, deals are done on average at 8x EBITDA – that compared with, for instance, the US mid-market where average EBITDA purchase multiples are well into the double digits. Duthie also notes that private equity penetration in Australia is below international benchmarks. While Australia is the sixth largest mergers & acquisitions (M&A) market in the world, private equity accounts for only 16 percent of total M&A activity. That's about half of penetration levels in the US and UK.
With regard to deal sourcing, Duthie says that while the breadth of new deal opportunities is as strong as ever, it has seen a change in the style of deals that have been available in the market.
“Ten years ago most large-scale businesses would sell by appointing an investment bank, sending out information to a broad universe of buyers on an undiscriminating basis, and then running a very formal and regimented auction process. More recently, those formal auction processes have disappeared. A large, experienced and well connected team is therefore critical to success in that environment.”
PE-backed and successful
Duthie also points to the success of many private equity backed initial public offerings (IPOs) in Australia.
In a report from the Australian Private Equity & Venture Capital Association and Rothschild Australia, an analysis of 67 IPOs with an offer size of at least A$100 million showed that PE-backed IPOs from 2013 to 2015 have outperformed non-PE-backed IPOs, achieving a weighted average return of 26.4 percent, compared with just 8 percent from non-PE backed floats.
Private equity firms have brought some sizeable companies to market in 2015. The year's largest listings include PEP-backed share registry and pension services provider Link Group and Bain Capital's cloud computing software vendor MYOB. Domestic private equity houses including Next Capital, Ironbridge and Anacacia were responsible for most of the IPO exits in Australia last year, representing almost half of total listings by market capitalisation.
Amid increased scrutiny over private equity divestments, PEP says the track record of PE-backed IPOs speaks for itself. “The notion that PE firms would deliberately overprice IPOs would be an ill-conceived business idea for PE firms; we are repeat players in the IPO market and so protecting our reputation long term is key. There are many checks and balances in an IPO process, more checks and balances, in fact, that I'm aware of are applied to people who jump out of airplanes. And yet from time to time those parachutes disappoint and when they do, because of the nature of PE, there's a lot of criticism. The reality is the track record of PE-backed IPOs is superior to non-PE backed IPOs,” says Sims.
Shannon Wolfers, a director at PEP, adds: “We have a more discriminating market now where there's good institutional IPO demand for high quality assets. PE firms are aligned to the success of their IPOs by keeping a substantial stake post listing.”
Wolfers reiterates that Australia is a 'lucky' country. Its economy is reactive to global financial events, well diversified with high value-added activities and a new emphasis on innovation, all providing long-term optimism in the business community.
What's also exciting for the firm is the Australian government's commitment to boost innovation in the next four years through a $1 billion initiative. The programme includes promoting business-based research and development, tax breaks for investors and start-ups, and a $200 million innovation fund to co-invest in businesses.
“As you move forward a generation, what this agenda is effectively doing is seeding the potential buyout candidates of the future,” Wolfers says.
Share of Australian GDP that goes to China
Accumulated Chinese investment in Australia from 2005-15, according to KPMG
Weighted average return of PE-backed IPOs over A$100m from 2013-15…
Weighted average return of non-PE-backed IPOs over the same period, according to the Australian Private Equity & Venture Capital Association and Rothschild Australia
Pacific Equity Partners' assets under management
Exit returns to investors from PEP over the last three years
This article was sponsored by Pacific Equity Partners. It appeared in PEI's Australia supplement published in June 2016.