Alex Large, head of equity capital markets at JPMorgan in Australia, says Australian companies will continue to return money to shareholders while there remains a lack of investment opportunities. He also speculates on the success of the proposed Australia Pacific Exchange and reviews the IPO pipeline.
Why has this reporting season been such a good one for Australia's corporates?
Large: Mainly because the domestic economy is so strong and this is having a positive impact on revenues. The global economy has also been growing strongly and this has helped Australian companies with export-related revenues, which have also benefited from a drop in the Australian dollar in the second quarter. High commodity prices have strengthened the metals and mining sector.
Which companies/sectors have surprised the market with better-than-expected results?
Large: A lot of companies have beaten consensus estimates but if you want to single out one sector that has outperformed then it would be the metals and mining sector - companies as BHP Billiton, Blue Scope Steel and Newcrest Mining are obvious standouts. These companies have beaten expectations significantly due to increased commodity prices and higher sales volumes.
What are companies doing with their surplus earnings?
Large: With company balance sheets on average being strong, and with little pressure to re-pay debt, we are seeing a growing trend to return earnings to shareholders through special dividends or share buy-backs. Companies feel that this is the best use of the cash in the absence of better investment opportunities.
Why is there a lack of investment opportunities?
Large: There are always solid investment opportunities for the right firm but overall there is more limited room for major acquisitions and expansions in the domestic market than in some countries because the market is relatively mature and consolidated. The other option is to invest offshore but Australian institutions have become more skeptical about companies with ambitious international growth strategies after several high profile overseas losses across a number of sectors. Clearly there are success stories - Westfield is a good example - but management teams have had to be patient to prove their success. So with this perceived lack of investment opportunities, companies are either paying down debt or returning cash to shareholders.
Is there any evidence that these dividends are being re-invested in the market?
Large: Yes, it certainly appears like the money is being redistributed into the market. In addition mutual fund flows into equities have positive all year. This is part of what is supporting the market and why it continues to hit new highs. In addition there hasn't been a huge amount of IPO or new issue activity to absorb the cash.
Is the ASX trading independently of global markets, or does it track the ups and downs of other indices?
Large: It changes over time but the broad trends over long periods are similar. If you look at a chart of the ASX against the S&P500 measured in local currency terms, the ASX has been perfoming well against the S&P500, particularly in 2004. As a result we are still hitting market highs while other stock exchanges in the UK and US are still well below their highs. Even more marked decoupling has taken place between the Australian market and the rest of Asia. These were closely aligned through 2002 and up to the middle of 2003 but then the Asian markets shot up, outperforming strongly except for a blip in April this year when there were concerns about China's economic growth.
What do you think of the proposed launch of the Australia Pacific Exchange (APX) announced in early September? Why should it survive when other rival stock markets haven't?
Large: As I understand it, the APX is being modeled on London's successful Alternative Investment Market (AIM). It took some time to take off, but AIM is now attracting a growing number of local and overseas companies to its board, including some Australian companies. Such companies must be natural candidates for the APX. In Australia, the concept of a second exchange aimed at small to medium sized companies is not new and attempts to compete with the ASX haven't always been successful, but that doesn't mean the APX will not succeed.
The challenge for new exchanges is how to differentiate themselves from the existing offerings. AIM had a helping hand in that it is backed by the London Stock Exchange, whereas the APX will have to compete with the ASX. The APX is also expected to have as high disclosure standards as the ASX, which may deter some small companies. On the other hand, APX's listing fees will be a lot lower than the ASX and this will certainly appeal to SMEs. In addition the concept of a sponsoring broker who commits to writing research should be a positive. Creating trading liquidity is key. A liquid market attracts more participants which in turn creates more liquidity and suddenly you have a virtuous circle. I think the first the few months for the APX will be crucial to its success, but it's healthy for companies to have listing alternatives like this.
What does the IPO pipeline look like for the rest of the year?
Large: The pipeline isn't as strong as the first quarter was, but still has a number of very interesting prospects that will be closely watched. Babcock & Brown and Tech Pacific Holdings are likely to be the two largest listings in the next few months. They are both expected to raise about A$500 million - significant but still below the A$1.26 billion Pacific Brands float that happened in the first quarter. We expect the pipeline to build though; as I mentioned earlier, investors' cash holdings are high and the market is at its highs - that typically has the effect of attracting new floats.
What primary or secondary deals did JPMorgan work on in the first half that the firm is particularly proud of?
Large: We did six deals in the first half, but the one we point to is the A$76 million placement and entitlement offer for Alesco. Although this deal was not that large in dollar terms, it was complex and needed precision execution. Alesco put the proceeds towards its A$230 million purchase of roller door manufacturer B&D Doors from private equity firm Catalyst Investments and management. The deal was significant because the sellers were running a dual-track IPO/M&A process; while Macquarie and UBS were trying to build an institutional book, we were advising Alesco on their purchase strategy. As it turned out there wasn't sufficient institutional support for an IPO and Alesco was successful in the acquisition, at an attractive price for them. The offering was large relative to the company's market cap - representing just under 25% of the company's value - so judging the market right was crucial. B&D Doors also represented 40% of Alesco's EBIT, so it was a significant purchase. We had to ensure that there was market support for the acquisition from a strategic perspective as well as from a valuation perspective. We have done other deals this year too, notably four transactions in the property sector. With Andrew Pridham joining the firm as head of investment banking earlier this year and the more recent appointment of Tim Church to head up the real estate team last month, we will be building a significant presence in this area.
