Michael Pollard: Signs of recovery in local M&A

Photo / Richard Robinson

Opinion

Simpson Grierson corporate partner Michael Pollard reflects on the state of the corporate deal market.

The last few years have been challenging for New Zealand's corporate advisory market with the Global Financial Crisis (GFC) taking its toll on activity and transaction volumes. After a surge of capital raisings in the first half of 2009, issuances have scaled right back.

The M&A market has remained relatively light throughout. There are certainly signs of recovery with M&A activity at least rebounding a little since the last quarter of 2010. However, the deal pipeline remains below the levels experienced in the two to three years pre GFC.

Capital Markets

NZX statistics shows that $7.28 billion of listed capital was raised in 2009 and $3.2 billion raised in 2010. $535 million was raised in the three months to 31 March which suggests that 2011 will not be a vintage year.

Key catalysts for capital raisings in 2009 and which remained relevant for 2010, included:

•the deterioration in corporate balance sheets resulting from reduced earnings and increased impairment of investments;

•decreased access to domestic and international bank debt and international debt capital markets; and

•in some cases, the desire for a "war chest" to allow acquisitions and/or maintain a more conservative capital structure should economic conditions continue to deteriorate.

With many balance sheets now patched up, the banks lending again and war chests in place, capital markets volume looks more likely to flow from transaction financing requirements and the roll-over of existing debt.

Debt Capital Markets

There have been few debt issuances in 2011. Notable examples include Genesis' issue of capital bonds (up to $275 million) and Auckland Council's issue of secured notes ($200 million). Debt issuances in 2010 included Meridian ($200 million), Auckland Council ($350 million) and Greenstone ($147 million).

Broadly speaking the debt market appears to be open for quality issuers (investment grade) although there remains uncertainty around the depth of the market. International debt markets are currently experiencing significant issuance with risk aversion currently greater in Europe than in the US.

This is not surprising given the sovereign debt concerns currently being faced by Portugal, Greece and Ireland. Interestingly, there remains robust interest in hybrid debt security issuance of lower rated issuers in the US market.

Equity capital markets

There remains little excitement around the domestic IPO market. IPOs were undertaken in 2010 by Ecoya ($10 million) and DNZ Property ($45 million). There have been indications of potential floats in 2011 from jetpack manufacturer Martin Aircraft, children's buggie maker Phil & Teds, Masterpet, fleet management system developer Imarda and Jucy car rentals.

Ongoing rumours continue for IPO exits by some private equity funds, particularly where assets have been held through their natural investment life cycle. Rumours surround assets bought in the middle of the last decade such as Griffins, Envirowaste and Hirepool.

If staged and structured appropriately, the domestic market appetite and capacity should facilitate each of these IPOs.

Perhaps the greatest level of excitement surrounds the potential for Crown selldowns of their SOE stakes in Solid Energy, Meridian, Genesis, Mighty River Power and also Air New Zealand.

Any such transactions will certainly not be implemented until after the 2011 election at the earliest and political overtones will undoubtedly influence the extent of selldowns.

The most sensitive issue appears to be the voters' concern about selling the Crown jewels to overseas investors. Pandering to this will affect the extent of any sell-downs, having regard to the limited capital available in New Zealand.

The IPO market has been disappointing for some time.

An article by Brian Gaynor in March this year noted the limited number of NZ listings over the last ten years relative to Australia (89 vs. 1390) and, in particular, the downwards trend in frequency. Of real concern is any resultant conclusion that this indicates New Zealand's failure in developing suitable candidates for listing.

But also relevant is the rise of private equity which has seen a huge number of potential IPO candidates bought and kept private, and a lack of any depth in NZ institutional demand / reliance on the fickle retail market.

This tends to see some appetite to take larger assets offshore (eg Kathmandu) and counts against one of the key advantages of listing -access to predictable capital.

Ultimately, the IPO market will have to be ready to receive these assets and pricing will need to be better than what they might fetch in the secondary M&A market which remains awash with available capital at present.

The market looks relatively receptive at present, and the NZX 50 (Gross) is up approximately 6 per cent since the new year.

Secondary Equity Capital Markets

There were a number of rights issues and placements throughout 2010, with a small number of capital raisings by Rubicon, Auckland Airport, NZ Windfarms, Mercer Group, Hellaby Holdings and Windflow Technology (rights issues), and Ecoya, SmartPay and Sealegs Corporation (private placements). Transaction size has been small.

M&A

The GFC has had a huge impact on M&A. Deal volumes have been significantly reduced as a result of the lack of available debt funding potential, purchasers being more focused on ensuring existing businesses are able to survive the downturn, and a mismatch between vendor pricing expectations and what purchasers have been prepared to pay.

Observations from the M&A market over the last few years show that:

•private equity-backed transactions in particular have been very quiet and, most notably, there has been an absence of leveraged buy-outs due to private equity funds experiencing decreased access to debt financing;

•trade buyers have come back into the market, no doubt because private equity has been quiet and because more of the M&A volume has tended to offer strategic acquisitions; and
•there has been a notable absence of any sizeable deals, although the mid-market (where deals require less leverage) has been relatively active.

We have seen M&A volumes recover slightly through 2010 and the first quarter of this year, as some of factors mentioned above resolve themselves and as the banks' appetite for lending has improved.

There are no obvious statistics available for the total M&A market but the recently published New Zealand Private Equity and Venture Capital Monitor records 2010 private equity and venture activity (acquisition and divestment) as $403m (equity) relative to highs in 2006 and 2007 of over $1.4 billion. Deal volumes remain significantly down also.

Recent M&A activity includes the $605 million acquisition of Tegel by Affinity Equity Partners, and the acquisition of a majority interest in Scales by Direct Capital (both private equity transactions). Helicopters NZ also sold to Canadian Helicopters Group for $160 million.

Ongoing interest by private equity firms is expected, since they appear to be sitting on large pools of available capital which need to be invested within the life of the relevant fund.

Perhaps that they will not be as competitive as they were in the mid part of the last decade with debt not so freely available, but they will no doubt be participants in all suitable processes.

Key processes in the New Zealand market include those relating to the remaining assets of South Canterbury Finance, comprising its share in corporate diary operation Diary Holdings and the residual part of its finance book. Guiness Peat Group's New Zealand assets (comprising Tower, Turners Auctions and Turners and Growers) are also expected to come onto the market with the proposed realisation process underway. Whitcoulls remains on the block.

Parting Thoughts on the Outlook

Most organisations are hopefully beyond the challenge of addressing continuity. Whilst profitability in many sectors remains tight, opportunities for growth in 2011 will be there, especially for those organisations with strong balance sheets that can finance deals without needing to significantly increase their leverage.

Succession issues will likely still drive much of the mid-market but, as confidence and the availability of debt finance returns, well-capitalised businesses will be looking for opportunities. This is particularly the case with private equity funds sitting on large pools of committed capital.

The perception remains that these are "vintage years" for investment. Consolidation certainly remains a driver of activity.