Australia: Staying the course

This year the Australian economy is poised to nab the record from the Netherlands for the longest unbroken stretch of economic growth, which currently stands at 26 years. It is testament to the market’s resilience.

The Australian economy, and the private equity managers investing in it, had the good fortune to avoid many of the shocks of the 2009 global financial crisis. Despite more recent worries about the impact of reduced demand from China for Australia’s resources and fluctuating commodity prices, Australian GDP grew 2.4 percent in 2016.

Even recent political upsets – Australia has had four prime ministers in seven years – appear to have had little impact. The government led by Prime Minister Malcolm Turnbull, who took office in September 2015, is widely viewed as a benign influence on business.

But managers have not fully escaped the current mood of uncertainty sweeping through global markets prompted by recent geopolitical upsets – the election of Donald Trump as US president, and the UK’s decision to leave the European Union among them. 

“We live in a globalised marketplace and uncertainty is the new norm,” says Yasser El-Ansary, chief executive at the Australian Private Equity and Venture Capital Association. Macroeconomic conditions “are challenging for business in every sector and that is impacting private equity investment discussions”.

Managers are also keeping a keen eye on proposed regulations governing domestic superannuation fund disclosure that have implications for local GPs, as well as possible reform of new foreign investment rules that have impeded domestic acquisitions.

Despite the global uncertainty, domestic fundraising remained steady in 2016 at A$3.2 billion ($2.4 billion; €2.1 billion) collected by five private equity funds, compared with A$3.7 billion in 2015, according to PEI data. One notable feature of the recent fundraising landscape is the number of experienced industry names raising capital at newly established firms. “It’s a natural evolution of the industry,” says Ken Licence, managing director of Sydney-based placement agent Principle Advisory Services.

Among new managers, Melbourne-based former TPG Capital co-head of Asia Ben Gray and former TPG partner Simon Harle are reportedly fundraising to invest in Australia and New Zealand.

Sydney-based Adamantem Capital, established by former Pacific Equity Partners managing directors Anthony Kerwick and Rob Koczkar, reached first close on its debut vehicle in December. The new fund is reportedly targeting A$600 million to invest in mid-market expansion and buyout opportunities in Australia and New Zealand.

Newly established Odyssey Private Equity reached final close for its debut fund on A$275 million in February after targeting A$200 million to invest in mid-sized growth opportunities. Odyssey was launched by industry veteran George Penklis, who left Quadrant Private Equity in 2014 – the firm he co-founded – and Gareth Banks, Jonathan Kelly and Paul Readdy, all formerly of CHAMP Ventures. The three left the growth investor last year when it decided not to raise another fund.

Funds targeted at growth and expansion deals are rising. In 2016, three vehicles raised A$628 million compared with two that raised A$157 million in 2015, up from A$58 million the year before, according to AVCAL. Almost half of the 60 investments made by local GPs in 2016 were in expansion/growth opportunities.

Activity at this end of the market has been “buoyant” and is less competitive than in same space in the US and Europe, says Melborne-based Steven Lipchin, head of private equity at IFM Investors, which manages A$2 billion of private capital. Its shareholders include 28 Australian superannuation funds.

In addition to established domestic players and new funds, Lipchin notes that global firms – such as Asia’s Affinity Equity Partners that acquired software business Medical Director for A$155 million last year – are lowering their investment thresholds and dipping in to the lower mid-market.

But, despite the arrival of these new mid-market managers, there are still fewer funds investing in the mid-market segment today than there were before the global financial crisis, says Simon Feiglin, The Riverside Company’s Melbourne-based managing partner, who manages its Riverside Asia-Pacific Fund II, a $235 million vehicle that closed in 2014. It is easier in many cases for larger funds to raise capital because local LPs have concentrated their fund relationships and are looking to make larger commitments, he adds.

In an era of abundant capital and low interest rates there is strong competition among all managers for assets. “The competition to put capital to work comes from multiple sources, including from private equity funds, corporates, sovereign wealth funds and pension funds,” says Jamie Palmer, a Sydney-based partner at Allen & Overy.

Despite the upward pressure on valuations “Australian private equity managers have been disciplined and have found ways to execute deals in target sectors,” Palmer adds. “PE managers have shown flexibility, with some firms considering consortium deals or undertaking public-to-privates.”

Local funds stood ready at the end of June 2016 with about A$6 billion of dry powder, with half targeted at buyouts and later stage investments, says AVCAl.

In terms of sectors, managers are active in healthcare, including technology, and old aged and childcare, as well as education, tourism and leisure, including asset operators or ancillary services.

Despite the shadow cast by decelerating Chinese economic growth, Australia’s most significant export partner remains a source of opportunity, not least in terms of exits. At the end of April, TPG completed the sale of Australian power company Alinta Energy to Hong Kong-based Chow Tai Fook Enterprises for A$4.1 billion. That followed the acquisition of KKR’s stake in GenesisCare last year by a partnership of Chinese state-owned company China Resources Group and Macquarie Group for an enterprise value of A$1.7 billion.

Alinta was also prepared for an initial public offering before it was sold to a strategic buyer, mirroring an industry preference in the last 12 months for trade sales. In fiscal year 2016, half of the total exit value of A$2.7 billion was generated by nine trade sales, with only four portfolio companies staging an IPO, according to AVCAL.
The IPOs of Quadrant portfolio company Zip Industries in early May and an upcoming offering from Archer Capital of Quick Service Restaurant Holdings could determine whether the public markets regain their status as a favoured exit route.

AVCAL is busy. The industry group is lobbying for changes to proposed regulations affecting local superfunds, a pillar of the domestic LP base, and foreign investment rules hindering local firms’ ability to acquire Australian assets.

The Australian Securities & Investments Commission’s proposed regulations to enhance superannuation fund fee and cost transparency, known as RG97, are expected to be implemented on 1 October. The impact on interest in the asset class from superfunds, which are already highly sensitive to costs, is a concern for managers.

The regulator is aware that there are “interpretive challenges” that disadvantage private equity, says Yasser El-Ansary of AVCAL. However, ASIC has been willing to engage in further talks, he adds.

At the same time, domestic managers, which draw the majority of their commitments from overseas LPs have been caught by changes to Foreign Investment Review Board procedures.
AVCAL is lobbying for amendments to the rules introduced in 2015 that have broadened the definition of a foreign government investor to include individual funds with commitments from any one foreign country constituting more than 20 percent, or 40 percent in foreign commitments in total, including from sovereign wealth, pension and endowment funds.

AVCAL is lobbying for “more practical” changes, says El-Ansary, including introducing FIRB pre-approval for a programme of private equity investment activity.

The government is currently reviewing responses to a consultation and is expected to make a final decision before the summer.

At a record high of A$2.2 trillion, Australia has one of the largest pool of public pension savings globally and a domestic LP base with huge potential. However, local superannuation fund appetite for the asset class continues to be tempered by nervousness regarding costs and fees.

“Over the years, fees have become a distraction,” says one local GP. “The conversation should focus on manager selection, not the economics of the asset class. If you’re looking for a particular net return then find a manager you feel comfortable will deliver that.”

In April First Super announced the suspension of new private equity allocations following a review of labour practices at underlying companies.

However, Ken Licence of Principle Advisory Services dismisses its significance. The $2.4 billion fund and its A$100 million private equity programme are very small, he notes, and its review was not simply directed at private equity but across its portfolio.

In fact, some funds with stalled private equity programmes are beginning to look at alternatives more broadly, Licence says, including private equity and debt, while others with active programmes have or are restructuring their portfolios.

Among those returning their gaze to the asset class is the New South Wales Treasury Corporation, which is rethinking its approach to private markets having earlier invested in private equity as part of a larger programme, says Licence.

“To the extent funds can achieve a good cost outcome for their members, they are interested in the asset class,” says Steven Lipchin of IFM Investors. “Clearly these funds are very sophisticated and understand net benefit. Private equity will continue to be part of their portfolios as it gives them diversification.”