AVCAL Conference 2018: Perspectives from the annual private equity love-in down under

At the 25th annual conference hosted by the Australian Private Equity and Venture Capital Association Limited ("AVCAL"), the foremost concern of local dealmakers was the competition for quality assets, particularly in the mid-market.

According to commentators at the conference, over the past two decades Australian private equity ("PE") has outpaced the global PE industry. This was well lauded as limited partners ("LPs"), general partners ("GPs"), financiers and advisors reflected on the growth of the industry at AVCAL's silver jubilee, but the foremost message when conference-goers turned to the current state of the market was the increased competition for high quality assets. The stockpile of dry powder around the globe has been well noted, and Australia is no exception, with an estimated AU$8bn at the disposal of local sponsors. Combined with the increased presence and interest of global sponsors in the Australian market, new Australian funds entering the mid-market and increased interest from multinational corporates in Australian assets, GPs are finding it increasingly difficult to secure high growth investments at attractive valuations.

The short-term forecast

Competitive pricing is the clear challenge facing sponsors in Australia, with a market that currently skews in favour of sellers. As a result, prospective buyers are less likely to be given exclusivity in negotiations, and auction sales are tipped to remain prevalent for 'mid cap' (i.e., assets valued between AU$25m and AU$250m) and 'large cap' (i.e., assets valued at over AU$250m) assets.

Despite the competition for assets, Australian buyouts are unlikely to abate any time soon. The opinion of multiple advisors at the conference was that Australian companies are still undervalued in comparison with more developed markets in the U.S. and Europe. As a result, global sponsors have been increasingly active in the Australian market, with Carlyle, Blackstone and Bain Capital all having either acquired or bid on large cap assets in 2018.

Local sponsors will certainly not take a back seat in this market but rather are expected to look beyond the traditional pool of private companies to deploy their capital. A particular area that continues to attract interest from both local and global sponsors is the public markets, which are viewed to have a suite of companies trading at attractive valuations, even considering the premiums usually required for successful takeovers. Already in 2018, a number of major sponsors have pursued public-to-private transactions, such as Billabong's takeover by a company controlled by Oaktree Capital Management and Affinity Equity Partners' recent agreement to acquire Scottish Pacific, which illustrates the perception in the industry that Australian listed companies are more accessible than ever.

Some local firms have also adapted to account for the new market entrants by changing their exit strategies. The increased presence of global sponsors has been one of the factors driving the trend towards secondary buyouts in Australia, as growth investors and mid-market firms have begun partnering with larger (often foreign) private equity firms looking to purchase their portfolio companies that have reached their target enterprise value. The major local or global sponsor will then aim to continue growing the portfolio company, often times by expanding its operations overseas. Given how aggressive global sponsors have been in pursuing assets that come on the market and have a large enough enterprise value, the trend towards secondary buyouts is likely to continue.

Some GPs in the Australian market may also look to alter their mandates to deploy capital. A few at the conference posited that Australian firms may begin to look overseas, particularly in Asia where competition for assets is more favourable than at home, in the U.S. or in Europe.

Additionally, some firms are beginning to consider longer term investments. Notably, KKR and Blackstone have each recently raised 'longer-life' funds which extend beyond the usual 10-year life span employed in the Australian market. Whether local GPs are enticed by this prospect remains to be seen, with some sceptical whether Australia's superannuation industry, which represents a substantial portion of local committed capital, has the appetite for the longer lead time to realising returns.

Finally, the trend towards disintermediation and the prevalence of private capital in the Australian market continues, particularly in the mid-market. Billions of dollars in debt financing will be required to service the dry powder earmarked for leverage deals and sponsors are partnering more and more with debt funds to source that capital. Flexible funding structures that alternative lenders often employ are well liked by dealmakers and are fast becoming commonplace in the Australian market. Unitranche loans, such as that provided by Barings (advised by Hogan Lovells) to The Riverside Company for its acquisition of Energy Exemplar, and Term Loan B facilities have already been utilised on numerous transactions in the past year as debt funds wrest more and more of the market from traditional banks.

Partnering with limited partners through co-investment

From the LP corner, a key message was their appetite for more co-investments. Many LPs in the region have only been able to deploy 10-15% of their portfolios via direct investments or co-investments and increasing that allocation was noted as a focal point. While the primary motivation for LPs is to limit management fees, co-investments also provide LPs with enhanced visibility over their portfolio companies as well as greater discretion on which investments to back. Access to information and the ability to actively manage their portfolios are now instrumental to the success of LPs and co-investments represent an opportunity to address both of these issues.

For GPs, co-investing with LPs is becoming an increasingly popular approach on large cap transactions as an alternative to forming a consortium with other PE investors. For example, earlier this year the newly established PE firm BGH Capital formed a consortium that included AustralianSuper for its AU$6bn takeover proposal for Healthscope, an Australian healthcare provider and hospital owner. With extensive experience operating in the Australian market, LPs note their ability to bring additional value to the investment lifecycle and the opportunity to develop a closer working relationship with the managers as reasons for GPs to consider more co-investments. However, according to Pitcher Partners' report Dealmakers: Mid-market M&A in Australia 2018, there were only 56 companies acquired in 2017 that were valued at over AU$250m, which puts a cap on the number of co-investment opportunities for LPs unless a case can be made for more co-investments in the mid-market.

There are also additional factors which may constrain the growth of co-investments. 'Pure co-investments' (i.e., co-investing with an LP that has not committed capital to the fund) are unlikely to gain any traction as one of the key motivations for GPs to co-invest is the opportunity to showcase their operations and convince the LP to commit additional capital to the cause in future fundraising. Additionally, one advisor at the conference also noted that direct investments and co-investments tend to be highly concentrated in the LP's home market where they have the capacity and investment teams. Australian superannuation funds, which controlled assets totalling AU$2.7tn at the end of June 2018 (according to the Association of Superannuation Funds of Australia) and which allocate substantial capital to GPs both locally and abroad, may therefore be reluctant to co-invest with sponsors they back overseas.

Gazing into the crystal ball

Predictions for the next 25 years of the Australian PE industry were much more varied. The most common threads amongst those gazing into the proverbial crystal ball were the focus on disruptive technologies and the proliferation of venture capital investments in Australia. One prominent member of a leading Australian PE firm speculated that venture capital investments may surpass traditional PE investments in the next 10-15 years and some Australian firms could get ahead of the curve by expanding their venture capabilities.

Whether those predictions materialise or not remains to be seen, though there is undoubtedly excitement around venture capital in Australia with a number of notable early stage investments being exited in recent years, such as Blue Sky Ventures' investment in Pet Circle as well as Brandon Capital Partners' investment in Elastagen (advised by Hogan Lovells).

The one certainty is that there is an abundance of capital available to private equity and venture capital firms in the coming years that can and will be deployed, making the Australian market one to watch in the short and long term.

by Eric Van Winssen

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