Chairman of CSFB investment banking in Australia, Peter Cameron, gives his outlook for the Australian markets in 2004. He is joined by Campbell Lobb from CSFB's local equity capital markets team, Ben Gray from corporate finance, and Patrick Eng from securitization.
What is the general outlook for Australia's capital markets?
Cameron: 2003 was a busy year for us and other service providers in Australia with some real innovation coming out of the market to counter an overall drop in deal volumes. This year should bring more of the same with an increase in equity issuance and merger and acquisition activity. This will be driven by a continuation in the level of business confidence in the economy, which has been sustained through some major geo-political shocks over the past 12 months. There was some suggestion last year that momentum in the capital markets would slow, but that hasn't been the case.
What can we expect from the primary equity markets?
Lobb: The utility sector is poised to present the biggest IPOs for the first quarter with TXU in Melbourne lining up for a float, and Duke Energy considering either a trade sale or an IPO. Pacific Brands and others are anticipated in the first six months. Generally, it is shaping up to be a year of IPOs. Investors need to find places to spend their mandatory retirement inflows and fund managers are re-weighting their portfolios towards riskier equities. The other factor driving the market will be private equity firms selling assets.
Are you referring to private equity firms exiting investments through IPOs? Why do you expect this activity to increase?
Gray: The conditions are favourable. These private equity firms tend to hold assets for three to five years and this year many of them will be ready to fulfil their exit strategies. This trend started in the second half of last year with three financial sponsor-led deals for Invocare, JB Hi-Fi and Repco. Repco was bought by private equity investors from Pacific Dunlop two years ago for A$250 million. The IPO was valued at A$600 million.
Do you see private equity firms stepping up their bid for Australian targets?
Gray: Definitely. Private equity firms are involved in about one-third of all M&A deals globally but in Australia the ratio is much lower. This will change. There is now a large number of European and foreign funds with operations here, or with plans to enter the market soon. CVC has been active since 1998 but there are also the likes of Pacific Equity Partners, Catalyst Investors and Newbridge Capital. CVC and Ironbridge Capital bought Mayne's hospital interests last year and Newbridge bid for Australian Leisure and Hospitality (ALH) but lost out when Foster's decided to take ALH public.
Cameron: The heightened profile of these private equity firms is changing the way mergers and acquisitions happen in Australia. Unlike strategic buyers, these firms won't do hostile takeovers and they tend to insist upon due diligence access to information beyond what is available under continuous disclosure. Though, in general, I would say that the practice of bidders putting pressure on target companies to be forthcoming with information through the use of due diligence style bid conditions is becoming more widespread (recent example including Goodman Fielder, Anaconda and Novus). Private equity firms are also changing the nature of how acquisitions are financed.
How so?
Gray: They are prepared to use publicly listed subordinated debt which is similar to high yield debt in the US or Europe as part of the financing structure. Historically the only source of subordinated debt was very expensive unlisted mezzanine debt which was more like equity.
We arranged the first deal for Repco's leveraged buyout, and last year we helped Newbridge to assemble A$175 million in sub-debt as part of their A$1.3 billion bid for ALH. We also recently underwrote a large publicly listed subordinated debt instrument for CVC/Ironbridge's acquisition of Mayne Hospitals.
Another example of where sub-debt worked as part of the financing mix was in Burns Philp's takeover of Goodman Fielder early in 2003. This was a highly leveraged transaction with a total of A$2.5 billion in debt and A$200 million of this was publicly listed subordinated debt. These deals are typically unrated which goes to show that investors are prepared to step down the credit curve to pick up the extra yield. This acceptance means that acquirers can consider much bigger transactions than they would have in the past.
Turning to hybrids in general, will we see more corporate issuance of these securities in 2004?
Lobb: Most likely. Companies are often motivated to issue sub-debt because they have balance sheet constraints or shareholders are unwilling to dilute their equity. This latter reason is what motivated the hybrid issues during 2003. Particularly as issuers are effectively getting cheap equity by using hybrids. The question is whether investors understand the true debt nature of these instruments. Most aren't convertible and others have resets, which allow the issuer to delay conversion.
What about the securitization markets, will we see more asset classes emerge this year?
Eng: Residential mortgage backed deals dominated the market last year with over A$40 billion of assets securitized. This trend will continue for the first half of this year because of the continued momentum in housing finance. By the second half of the year rising interest rates will probably start to affect the industry and issuance will slow down. There will also be some commercial mortgage backed deals coming to market but otherwise I don't see the emergence of too many new asset classes.
What about Foster's whole-of-business ALE transaction, do you see this being replicated?
Eng: This was certainly an innovative transaction which involved securitizing Foster's pub assets. It required investors to take on operational risk, which was a first in Australia. But these types of deals are difficult to structure because you have to have a specialized asset which has a natural monopoly and high barriers to entry in its particular industry. Essentially you are securitizing the cash flow of the business, so you need to find a company that generates strong and stable cash flows. The structure may apply to hospitals or utilities but so far the market hasn't identified a transaction similar to the ALE deal.
