i Deal activity
The Australian private equity market saw significant activity in FY2017.
According to figures published by the Australian Private Equity and Venture Capital Association (AVCAL),2 private equity investment grew by 1 per cent in FY2017 to A$3.38 billion. There was a drop in the number of companies invested in from 60 to 39, however this was offset with by average equity investment sizes rising to A$75 million per investment, compared to A$58 million in FY2016. There were six equity investments in excess of $150 million in Australia in FY2017, the same as in FY2016.
Despite an upswing in funding from Australian superannuation funds, there was a decrease in private equity investment overall from domestic funds. International private equity firms compensated for this and continued to make some of the largest deals in FY2017, with investments rising 54 per cent from FY2016. This included the finalisation of Baring Private Equity Asia’s acquisition of SAI Global for A$1.24 billion, which was the largest private equity-backed public-to-private transaction to complete in Australia since 2010. Hony Capital also lifted its stake in Santos Limited to 15.1 per cent.
Private equity has also increased its focus on roll-ups to complement cornerstone acquisitions, which are increasingly attractive as more exclusive sale processes (rather than auction processes) are being conducted in Australia. FY2017 continued to highlight the importance of the ‘expansion/growth’ segment in the Australian private equity landscape. In FY2017, 54 per cent of companies backed by private equity were at the ‘expansion/growth’ capital stage of investment, up from 47 per cent in FY2016. The overall deal value increased 90 per cent from FY2016.
Private equity divestments decreased in FY2017, with IPO exits and divestments through public markets falling for the third consecutive year. According to AVCAL, the total number of companies exited by private equity and venture capital sponsors fell to 37 in FY2017, which was five fewer than in FY2016 and 16 fewer than in FY2015.
In FY2017, private equity exits by way of trade sale accounted for the largest amount divested. This included the sale by Quadrant Private Equity of Canberra Data Centres to Commonwealth Superannuation Corporation and Infratil. Trade sales also accounted for the majority of venture capital exits in FY2017. One of the largest exits of the year was the A$4 billion sale of Alinta by TPG Capital to Hong Kong company Chow Tai Fook.
FY2014 had seen a record number of exits by private equity sponsors via listings, so, although there were fewer IPO exits in FY2015, FY2016 and FY2017, the IPO market still provided private equity funds with opportunities to successfully divest large stakes in investee companies. The end of 2016 also saw the largest private equity backed IPO of the calendar year, Inghams Group Limited, which is discussed below.
In FY2017, the Australian private equity market continued to approach the levels of investment activity seen before the credit crisis. According to AVCAL statistical data recording investments by financial year in Australia, in FY2007, a total of 36 private equity funds invested A$5.84 billion in 106 companies. Comparatively, these figures had dropped in FY2013 to 34 private equity funds investing A$2.7 billion in 67 companies, and again slightly in FY2014 to a total of A$2.1 billion invested by 35 private equity funds in 67 companies. FY2015 saw a significant increase in private equity investment, with a total of 37 private equity funds invested A$3.28 billion in 86 companies. FY2016 saw an increase in total private equity investment of 2 per cent to A$3.33 billion; however, the number of companies in which private equity invested fell to 60, a 30 per cent reduction from FY2015. FY2017 saw a further 35 per cent drop in the number of companies invested in, down to 39. This was accompanied by a drop in the number of private equity funds to 16 from 36 in FY2016. Domestic businesses accounted for 87 per cent of private equity investment by the number of companies and 96 per cent by the investment amount.
Most large foreign private equity firms are present in the Australian market (through their broader presence in Asia Pacific) including KKR, TPG Capital, Bain Capital, Baring Private Equity Asia and the Carlyle Group.
The key sponsors active in the Australian private equity market otherwise remained the traditional players, such as Pacific Equity Partners, Archer Capital, Quadrant Private Equity, CHAMP Private Equity and Crescent Capital Partners.
ii Operation of the market
A share purchase is the most common way of completing an acquisition of a privately owned company or business; however acquisitions are also commonly structured as asset purchases or share subscriptions. If no regulatory approvals (such as those discussed below) are required, a standard asset or share purchase can be negotiated and completed in a matter of weeks.
Structures for publicly listed company acquisitions include takeovers, members’ scheme of arrangements and shareholder-approved subscriptions for shares. Acquisitions of interests in public companies require significantly greater disclosure and are more strictly regulated than acquisitions of privately owned companies and typically take significantly longer to complete.
The length and complexity of a sale process will also depend on whether the sale requires approval from Australian regulatory bodies, such as the approval of the Treasurer under Australian foreign investment laws and Australian Competition and Consumer Commission (ACCC) clearance. Obtaining these approvals can add months to the timeline of a transaction.
Management equity incentive plans are a common means by which a private equity sponsor incentivises the management team of an investee. They commonly take the form of employee share and option plans under which members of management receive ordinary or preference shares (or options over those shares) or a special class of share, and it is common for any shares or options issued to employees to vest at the time of the private equity sponsor’s exit (and not before). Some plans do, however, incorporate time and performance vesting before exit. Taxation considerations for participants will usually dictate the specific structure and class of securities issued under an equity incentive plan.
ii LEGAL FRAMEWORK
i Acquisition of control and minority interests
The Corporations Act 2001 (Cth) (Corporations Act) is the main legislative instrument that governs corporate transactions in respect of privately owned companies. In general, under the Corporations Act, a private equity sponsor will have greater flexibility over its investment structure, the private investee company’s capital structure and significantly less onerous ongoing disclosure requirements.
The Corporations Act and Australian Securities Exchange (ASX) Listing Rules regulate and impose restrictions on corporate transactions involving public companies listed on the ASX.
Where a private equity transaction involves the acquisition of an interest in a public company, and the acquisition of such an interest increases the acquirer’s overall interest in the target company to 20 per cent or more, the transaction can only be conducted through certain transaction structures regulated by the Corporations Act and the ASX Listing Rules. The most common types of regulated transactions are takeovers and members’ schemes of arrangement.
Australian foreign investment laws impose prior approval requirements on certain direct and indirect acquisitions of interests in Australian companies and land by foreign persons over a certain value, and also gives the Australian government the power to compel divestments of interests acquired in Australian companies in certain circumstances.
As a general rule, approval from Australia’s Foreign Investment Review Board (FIRB) is required by foreign persons for acquisitions of 20 per cent or more of an Australian business or company with total assets valued at A$252 million or more, and for certain foreign companies that hold Australian assets valued at A$252 million or more. There is effectively a higher threshold of A$1.094 billion for acquisitions outside sensitive industries by US, NZ, South Korean, Japanese, Chilean and Chinese non-governmental investors. Different thresholds apply for the acquisition of Australian urban, residential and rural land by a foreign person. An entity that is deemed to be a foreign government investor (which could include a private equity fund depending on the nature of the investors in that fund) must notify FIRB before it acquires any direct interest in an Australian entity or business, starts an Australian business, acquires any Australian land or acquires an interest in a mining, production or exploration tenement.
Through FIRB, the Treasurer is empowered to make orders preventing the proposed acquisition by a foreign private equity fund where the proposed acquisition is, in the Treasurer’s view, contrary to Australia’s national interest. In many cases, it is a criminal offence to fail to obtain prior approval for such acquisitions. The Treasurer is also empowered to take certain actions (such as ordering the divestiture of acquired shares or assets) to unwind acquisitions that have been effected without the Treasurer’s approval and where those acquisitions are, in the Treasurer’s view, contrary to Australia’s national interest.
Non-Australian domiciled sponsors will typically structure their fund so as to enable flow-through taxation for investors. This is typically achieved through one of (or a combination of) the following investment vehicles: fixed unit trusts, managed investment trusts (which is a fixed unit trust with widely held ownership and a substantial portion of the investment management activities carried out in Australia and which, depending on the nature of the interests offered, may be required to be registered with the Australian Securities and Investments Commission), venture capital limited partnerships (VCLPs) or early-stage venture capital limited partnerships (ESVCLPs) governed by a limited partnership deed (these funds are typically confined to venture capital and mid-market funds because of the restrictions on the types of investments VCLPs can make). Each investment vehicle has different regulatory obligations (including registration and licensing requirements), tax treatment and may limit the types of investments the fund can make, so selecting the appropriate vehicle for the types of intended investments for the fund is particularly important.
ii Fiduciary duties and liabilities
Under the Corporations Act, shareholders of a company do not owe fiduciary duties to the other shareholders of the company. However, minority shareholders may seek remedies for oppressive conduct by majority shareholders where the majority shareholders use their powers to act in a manner contrary to the interests of members as a whole or their actions are oppressive or unfairly prejudicial to, or unfairly discriminatory against, the minority shareholders. However, such actions are rare.
The key duties that directors of Australian companies owe to the company are:
- to act in good faith in the best interests of the company and for a proper purpose;
- not to improperly use their position to gain an advantage for themselves or cause a detriment to the company;
- to act with care and diligence for the benefit of the company – while there is a defence available where the decision or action is one that satisfies the criteria of being a ‘business judgment’ under the Corporations Act, there are statutory limits on when functions can be delegated and when information or advice from others (including members of the management team) can be relied on; and
- to prevent the company from trading while insolvent.
Under a typical share or business sale agreement, a private equity sponsor selling its interest in an investee company will give warranties in respect of the company or business being sold, which may expose the sponsor to warranty claims by the buyer years after the sale. While it is becoming increasingly common in private transactions for a private equity seller to require the buyer to obtain warranty and indemnity insurance in respect of warranties given by the seller under the sale agreement, under the Competition and Consumer Act 2010 (Cth), a private equity sponsor’s fund may be liable for conduct during the sale process that is misleading and deceptive. This statutory liability cannot typically be contracted out of. A private equity fund may also incur statutory liability for misleading and deceptive statements made in a bidder’s statement or scheme documentation when it is attempting to acquire control of a publicly listed company.
Private equity funds will usually try and obtain a ‘clean exit’ when selling their interests in an investee business in order to facilitate the return of the sale proceeds to investors in the relevant funds rather than after warranty or indemnity claim or escrow periods have ended. In addition, private equity sellers will usually be reluctant to give anything more than limited warranties in respect of the business being sold. Accordingly, it is becoming increasingly common in private transactions for the private equity seller to require the buyer to obtain warranty and indemnity insurance in respect of warranties and indemnities given in relation to the business being sold. The insurance policy allows the buyer to make a warranty claim against the insurer, rather than the private equity fund (which may have distributed all proceeds from the sale and therefore may no longer have any assets to satisfy the claim).
If a private equity sponsor proposes to sell its interests in a publicly listed company, the buyer and the target (being the investee company) will usually enter into a merger or scheme implementation agreement will normally be entered into between the bidder and target that will govern conduct of the buyer’s offer. The target will often provide a ‘break fee’ and give ‘no-shop’ and ‘no-talk’ undertakings under the implementation agreement.
Where a private equity sponsor wishes to realise its investment by way of an IPO of a private company, the Corporations Act and ASX Listing Rules impose strict requirements in respect of the IPO process. The company seeking admission to the ASX will, among other things, need to consider the following issues:
- the level of ownership and control that a sponsor might be required to retain in the listed entity. In certain circumstances, the ASX will restrict or ‘escrow’ shares issued before the IPO so that they cannot be sold for a period of up to two years after listing and, in any case, the underwriters will typically require the sponsors to hold a meaningful stake for the forecast period;
- before a company can be floated on the ASX it must satisfy ASX requirements relating to size or profitability and shareholder spread. It must also ensure that its capital structure and constitution are consistent with the listing rules of the ASX; and
- the Australian taxation consequences of the listing, including consideration of whether the assets of the company or group being listed predominantly relate to interests in Australian land (in which case Australian capital gains tax and stamp duty may be payable by the sponsor on their exit).
iii YEAR IN REVIEW
i Recent deal activity
Private equity investments were spread across a range of sectors in FY2017. According to AVCAL statistics, in FY2017:
- a 51 per cent of private equity investee companies were in the consumer products, services and retail sector, and they accounted for 44 per cent of the total amount invested; and
- b 10 per cent of private equity investee companies were in the business and industrial products and services sector, and they accounted for 39 per cent of the total amount invested.
Combined, these sectors garnered an 83 per cent share of invested dollars. Key private equity investments in the consumer products, services and retail sector included PAG Asia Capital’s acquisition of the Cheescake Shop, Allegro’s acquisition of the master franchisee agreement for Pizza Hut Australia and Pacific Equity Partners A$232 million acquisition of Patties Foods.
FY2017 also saw some noteworthy transactions in the healthcare and life sciences sector. Quadrant’s acquisition of Goodlife Health Clubs, Jetts Australia and Fitness First Australia created a broader Fitness and Lifestyle Group service. Primavera Capital and Shanghai Pharmaceutical Holdings also acquired Vitaco Holdings for A$314 million.
Senior secured debt and mezzanine or subordinated debt are the most common forms of debt funding for private equity acquisitions in Australia. Financing arrangements for private equity acquisitions usually require that the any outstanding liabilities be repaid to the lender on a change of control of the borrowing entity.
The Corporations Act contains financial assistance provisions that restrict a target company from financially assisting someone to acquire its shares (or the shares of its holding company) in the absence of shareholder approval. If the target or its subsidiaries give guarantees or security in favour of a lender who is providing funding to a bidder, this will also fall within the financial assistance regime.
In Australia, the official cash rate has been lowered over the last 18 months. This, together with borrower-friendly conditions in international lending markets, has lowered the cost of acquisition financing for sponsors. Lenders have continued to require sponsors to conduct thorough due diligence on potential acquisitions before agreeing to provide finance, which has lengthened sale processes and has made it harder for private equity funds to make hostile bids for publicly listed companies.
iii Key terms of recent control transactions
In 2016, the largest private equity acquisition in Australia was the acquisition of SAI Global by Baring Private Equity Asia for A$1.24 billion. It was the largest private equity backed public-to-private transaction to complete in Australia since 2010. SAI Global is a leading global provider of risk management products and services, including risk management software, standards, regulatory content, compliance and certification programmes. The transaction was implemented by way of a court-approved members’ scheme of arrangement, and was overwhelmingly supported, with 99.88 per cent of the votes cast by SAI Global shareholders in favour of the transaction.
Exits through trade sales were the most prominent form of divestment in 2017, with a small number of exits through IPOs.
As has been the case in the past few years, market sentiment has required private equity investors to retain shareholdings in the investee company post-listing; however, the terms of escrow now commonly permit sponsors to sell down part of their escrowed shareholding if the share price increases for a period after listing. TPG retained a 47 per cent shareholding in Inghams after listing. The escrow arrangements between TPG and Inghams provided that TPG could sell one-third of its shares before 24 December 2016 and its remaining holding by 1 July 2017. It is often the case that private equity investors will sell their shareholding as they exit escrow.
2017 saw a number of private equity firms exit from investments in companies that listed in 2016 and earlier. Private Equity Partners fully exited Link Group, which underwent an IPO in October 2015, Bain Capital sold down a portion of its stake in MYOB for A$350 million and Advent sold its remaining shares in Integral Diagnostics.
iv REGULATORY DEVELOPMENTS
The Corporations Act is the main legislative instrument that governs the conduct of private equity sponsors and compliance with the Corporations Act is overseen by ASIC.
Generally, an entity carrying on a ‘financial services’ business in Australia must hold an Australian financial services licence (AFSL), unless an exemption applies. Statutory and common-law tests are applied in order to determine whether a financial services business is being carried on in Australia and an entity may be required to hold an AFSL even though it has no physical presence in Australia. AFSLs are issued by ASIC and licence holders are subject to a range of obligations, including in relation to capital adequacy, organisational competence, reporting and holding client assets.
Generally, ‘financial services’ include:
- a provision of financial product advice;
- b dealing in a financial product; and
- c making a market for a financial product.
A ‘financial product’ is broadly defined and includes a facility through which, or through the acquisition of which, a person makes a financial investment, manages financial risk or makes non-cash payments.
There are no specific legal restrictions or conditions imposed on how a private equity firm conducts a sale process for its stake in an investee company, however, as discussed above, depending on the identity of the buyer, the sale may require approval from Australian regulatory bodies, such as the approval of the Treasurer under Australian foreign investment laws or ACCC clearance. Where an IPO is used, there is a high level of disclosure required in order to offer shares in connection with a listing. Misleading or deceptive information in disclosure documents prepared in connection with an IPO attracts significant penalties under the Corporations Act. This statutory liability extends to the individuals and entities involved in the listing or the preparation of the disclosure document (including personal liability for current or proposed directors).
Transaction activity for FY2018 is expected to continue to be strong as a result of an increase in fundraising by Australian private equity funds, as well as interest in Australian assets from overseas private equity firms. Solid Australian business conditions that have arisen as a result of low interest rates and a competitive Australian dollar should also provide support for private equity transaction activity in FY2018. A number of extremely large potential transactions have been mooted by the media, with a collective A$7.69 billion of ‘dry powder’ ready to be deployed by private equity and venture capital funds into promising high-growth businesses.
Private equity transactions within the healthcare and life sciences sector are expected to continue to increase. The acquisition of iNova Pharmaceuticals by Private Equity Partners and the Carlyle Group is indicative of the growth in this area.