Surviving the Bears: Silvana Schenone - Exit strategies for business owners

Silvana Schenone is corporate partner at MinterEllisonRuddWatts. Photo / Supplied

OPINION:

Undoubtedly, the global economy and capital markets around the world have been significantly impacted by the Covid-19 pandemic, the war in Ukraine and a number of other geopolitical events.

It is undeniable that these events have had an enormous effect on all of us. It is probably not worth dwelling on our country's long "world-wide" isolation, but instead to focus on learnings and what we see as the future ahead of us.

There is still activity on the horizon:

• There is cash around to keep the market active;
• Large global investors have settled their eyes in New Zealand as an alternative investment option;
• Private equity and private owners are looking at exit strategies;
• Companies are looking at their shape and size, considering divestments of non-core assets;
• Aggressive bidders are sniffing around for undervalued businesses;
• Listed entities are feeling the pressure from shareholders and regulators;
• But inflation will not be resolved quickly, and the market volatility we are currently experiencing may be here for a prolonged period.

The last 24 months in perspective

In New Zealand, we saw a number of trends developing in 2020/2021 in the mergers and acquisitions (M&A) and capital markets space, and while some of them have normalised by now, it is clear that they have had an enduring impact on our economy and there is a new normal ahead.

Covid and the war for Ukraine not only resulted in inflation and disruptions to global supply chains, but also business and social uncertainty.

Market volatility remains high and we can only expect it will remain at those levels on the basis of macro and geopolitical risks.

The biggest winners at the beginning of the pandemic are no longer the most profitable sectors, and the tables seem to have turned for a number of industries.

Consumer confidence has declined in the last 12 months as signs of negative forward indicators show a weaker outlook.

A significant reduction in consumer discretionary income is also impacting the economy.

The high cost of living has become a serious issue. The cost of everything (food, housing, fuel, commodities, construction costs, etc) is rising to levels that make many people unable to satisfy their basic needs.

Governments are under pressure to support those in need while also stimulating economic activity.

The Consumer Price Index continues to increase and inflation — which is already at a 40 year high — is expected to continue to accelerate.

The new normal for M&A and capital markets

M&A and capital market deals' volumes rose greatly in 2021, including a number of equity raisings and Initial Public Offerings (IPOs). This activity was largely driven by growth plans at the beginning of the pandemic, followed by a number of balance sheet recapitalisations afterwards.

Institutional investors were largely supportive across the majority of 2021 on equity raisings, typically following their money and demanding pro rata allocations at a minimum. Shareholders in general supported conservative balance sheet positions, although many capital raisings were aimed at funding growth plans.

Shareholders and Regulators activism

Off the back of a global turmoil, shareholders and regulators have become more active and alert.

Accountability for any dilutive decision, significant expenditure or culturally questionable initiative is now real, and consequences are quick to evolve. We have seen a number of examples in the market of class actions and regulatory intervention, arising effectively as a result of the pandemic, and sanctioning "judgement calls" made at turbulent times with limited information available and on limited timeframes.

Recent changes in the legislation in New Zealand and Australia requiring listed companies to keep the market updated of material information their board and senior team "know or ought to have known" have made the test a lot more stringent in this respect. The test requires not only active management of the affairs of the company, but it is also now essential to develop the right policies to escalate information to the boardroom. Not knowing of something important happening in the organisation is not an excuse. And the "hindsight" applied to the judgement calls made by directors and senior officers, when some of these issues result in a loss to shareholders, makes this test particularly challenging.

Australia has changed its approach as a result of the turbulent times we have been experiencing, requiring "knowledge, recklessness or negligence" for the companies and their officers to be liable for civil penalty proceedings in respect of continuous disclosure failures. These changes follow from a temporary relief granted through emergency powers during the pandemic critical period, aiming at balancing the need to encourage public disclosure while allowing for uncertainty and the innate difficulty in making predictions in a volatile environment.

However, while these changes raise the evidentiary burden on class action claims, when a claim for breach of continuous disclosure obligations arises, it is normal to see at least allegations of negligence. The real impact of the changes on financial guidance and other disclosure with high degree of volatility are therefore yet to be seen in Australia. New Zealand has not yet followed this approach, despite a number of voices calling for a similar reform to address similar issues in our country.

The road ahead

In this same context, while the times are ripe for strategic reviews, as companies recalibrate and adapt to the new environment, there is also nervousness around the decisions that need to be made. A number of reviews are actually initiated due to shareholders' pressure, demanding change and results. Shareholder activism is evident, on a broad range of areas, including board composition, strategic initiatives, environmental, social and governance (ESG) issues and corporate culture. We have seen large corporates considering and pursuing consolidation and divestment plans as part of simplifying their structures, and businesses returning capital to shareholders.

And while there are plans for the future, activity is dropping globally, reflecting the shift in the macro-economic environment.

In 2022, we have seen a decline on deal levels, which we can expect to continue. This has been particularly evident in the last month or so, with players becoming more concerned with the uncertainty at a global level and companies being more conservative with their growth plans.

Creeping inflation, geopolitical conflict and subsequent market volatility are expected to continue into 2022, with an added focus on prolonged inflation, a significant decline in consumer confidence and raising interest rates.

Retail investment, private equity and M&A

While off the back of the onset of Covid, retail share investments peaked globally, this seems to have been the natural consequence of record low interest rates, not many alternative options available and greater accessibility to retail trading platforms (like Sharesies, Hatch or Robinhood).

In June 2020, Sharesies trading made up 4.8 per cent of NZX traded value, while in 2022 it has normalised averaging 1.3 per cent of NZX traded value. Still a much increased number against the data pre-pandemic.

Private equity took advantage of the strong markets and availability of "cheap" funding in the last 18-24 months.

But their exit strategies are challenged by the new normal.

As a result of the uncertainty in the market, in 2022 we are seeing many M&A transactions struggling to take off. The flip side of this uncertainty is that we are also seeing a number of opportunistic bids arising, particularly, in the listed space, for companies trading at levels significantly lower than historical multiples.

In a climate of heightened uncertainty, prebid stages in both private and public deals become more important. There is more focus on process control and rules of engagement.

Different focus for due diligence and aggressive strategies

Due diligence is also changing, with different and new areas of attention for buyers.

Regulatory compliance, supply chain and distribution channels' sustainability and resilience, and ESG issues, are areas of increased interest. Again, regulatory action or investigations, particularly in regulated industries (like insurance and financial sector) are slowing down some processes, adding complexity to otherwise vanilla transactions and giving bold bidders an additional competitive advantage in the current market.

The above can result in novel and sometimes aggressive strategies, particularly in highly-contested processes. Both bidders and shareholders are taking more active positions and pressuring boards for the results they want. In cases, some bidders and shareholders are actually by-passing the boardroom and engaging directly with each other to agree a deal.

A flawed strategy some may say, as it definitely shifts the bargaining power from the company to a controlling shareholder(s), at the risk of compromising the long-term plans of the business and/or the more complex strategies that may be under consideration or development by the board, and which must take into account the best interest of the company as a whole (and therefore including a number of constituencies).

So what next?

While many challenges exist, and some of the trends that developed as a result of the pandemic and geopolitical issues are here to stay, there is plenty of cash available in the system that can translate into more M&A and capital markets activity.

Investors continue to support quality companies that are cashflow positive, with stable earning profiles that can manage a high inflation environment.

In listed companies, placements seem more suited to the current volatile market conditions and we may see more of those in the coming months. In this respect, fair allocation policies will remain an essential consideration for new issues of shares.

New Zealand is now firmly on the radar of large global investors, private equity and private owners are looking at exit strategies, opportunistic bidders are on the hunt for a good deal, and businesses are focusing their strategies on divesting non-core assets.

The result is that there is still a lot of competitive tension in the market, and we expect this to continue for a bit longer, even if not at the levels or speed of 2021.

• Silvana Schenone is a corporate partner at MinterEllisonRuddWatts She is also the incoming managing director and co-head of investment banking at Jarden — a position she takes up in the fourth quarter of 2022.