What to expect
PE sponsor buy-side opportunities: secondaries and carveout transactions to dominate activity in 2024
On the buy-side, we have three key predictions – fewer take privates, more secondaries and the emergence of corporate carve-out transactions.
- Take privates: with the growth of take-private transactions in the last five years, both domestic and global sponsors found an opportunity to deploy significant amounts of equity by acquiring high-quality and well-recognised companies at attractive valuations. Unfortunately, we do not expect this trend to continue. As at time of writing, the ASX200 is trading at nearly record highs which, coupled with a typical 30% takeover premium, is making executing take-private transactions increasingly difficult. While certain opportunities will present throughout the year (particularly for good companies experiencing share price declines due to short-term factors), our expectation is that PE sponsors will largely avoid listed markets in 2024.
- More secondaries: historically, PE exits via secondary buyouts were considered 'panic sales' driven by managers with fixed closed-end funds running up against the clock and therefore under pressure to negotiate fund extensions or liquidation of their investments. While the rise of continuation funds has to some extent provided relief, we don’t think that the level of exit activity by PE sponsors in the last 12 months is sustainable, which means that secondary buyouts will likely remerge until the IPO windows open. For PE bidders acquiring synergistic assets via existing platforms, understanding the competitive landscape early and developing an ACCC strategy is critical in an environment characterised by increased competition / antitrust scrutiny from the ACCC in Australia and regulators offshore.
- Corporate carve-outs: the current macroeconomic environment has seen many corporates reevaluating their strategies and non-core assets. In turn, this presents prime carve-out opportunities for buyout-starved PE investors with the focus and capital to drive growth and operational improvement. Perpetual Limited is a case in point, with an approach by Washington H. Soul Pattinson leading to a strategic review and an array of sponsors reportedly lining up for sale processes for its corporate trust and wealth management business units. Ramsay Health Care's divestment of its offshore hospital joint venture with Sime Darby to a TPG Capital backed acquirer late last year is another.
Expect more in 2024 across healthcare, financial services, tech and other sectors. Cashed-up PE sponsors are uniquely well placed to capitalise in complex situations like these – whether as part of a bolt on to a complementary portfolio company or as a new platform play – offering the agility and execution capability necessary to move quickly and fend off hesitant strategic buyers in this market. As ever, complex disentanglement requirements come with the territory, with buyers (and sellers) needing to contend with the ongoing challenge of separating customer and supplier arrangements, shared services and, increasingly, data.
PE sponsors will take advantage of improved exit conditions
After a relatively subdued 2023, we are predicting that 2024 will prove to be the year of the exit with improving macroeconomic conditions providing the ideal environment for the exit of a number of high-quality assets.
Accordingly, it's a timely reminder of steps that sponsors who are looking to exit should progress to get their assets 'sale ready':
- Payroll: payroll compliance continues to be a significant pinch point in transactions, particularly where the asset involves a large Australian-based workforce. Obtaining warranty and indemnity insurance coverage for payroll compliance is dependent on appropriate diligence being conducted. Accordingly, sponsors should give early consideration to engaging advisors to undertake sell-side payroll diligence, a process which in some cases can take several months.
- Management equity plans: sponsors should review the terms of their MEPs and ensure they are appropriate for the exit contemplated. For example, will they be able to rely on the drag mechanisms and structurally, do the plans (where they have an exercise price) permit a 'cashless' exercise. Engaging appropriate advisors to review the plans early on will smooth out the exit process, for example, by effecting necessary amendments to the plans prior to commencing a sale process or otherwise structuring the sale around the existing terms.
- Power of attorney: where assets are held with other shareholders (outside of MEPs) – some of whom may no longer be involved in the business – it is often a good idea to obtain a power of attorney from those shareholders to effect the sale. This practical step ensures that once the final terms are agreed, there is no delay in chasing multiple shareholders.
Debt financing: higher volumes for issuances in 2024
Leveraged debt for event driven activity by PE sponsors remained expensive in 2023 due to high base rates and uncertainty in the syndicated loan market. Concerns over the availability and liquidity of accounts that typically invest in syndicated loans were tested, which created distribution risk challenges for underwriters and placed pressure on their underwriting fees. However, we have seen this trend moderate over the last six months, with renewed optimism for higher volumes of issuances in 2024. The flurry of repricing transactions across the European and US ‘term loan b’ capital markets is expected to flow to the APAC market and create downward pressure on margins. We anticipate that the Australian ‘term loan b’ market may finally re-open this year, particularly as a funding source for the number of large cap M&A transactions slated to occur in 2024 (eg I-MED, Perpetual, Novotech, Waste Services Group and AirTrunk).
While there is some suggestions that base rates have peaked and may be trending downwards, for the immediate term we foresee that PE Sponsors will remain prepared to exchange higher leverage and financial covenant flexibility (seen on unitranche financing solutions) for lower priced 'senior bank' or 'stretched senior' debt structures. PE sponsors may also continue to achieve a 'blended' mix of different pools of liquidity to (slightly) push opening leverage multiples north at a (slightly) higher cost of capital as seen by bringing together 'Aussie and Asia' banks or 'bank and institutional' funding structures. We also anticipate that PE sponsors will increasingly be looking to private credit for non-cash pay interest solutions in the form of holding company and mezzanine financing arrangements.
There is absolute certainty that the private credit market will continue to accelerate in growth, driving intense competition for direct lenders across the APAC region. Private credit again played a key role in market-leading transactions in 2023 (eg Advent International's purchase of Zimmerman and TPG Capital's purchase of InvoCare) and we expect this trend to continue in 2024.
Regulatory: increased scrutiny and conditionality from FIRB adding to an already complex foreign investment regulatory framework for PE sponsors
It has been reported that the Australian Treasurer has directed FIRB to more strongly scrutinise the tax arrangements of foreign PE funds buying and selling Australian assets. Since 2023, this has been reflected in new and additional tax conditions in FIRB approvals for PE acquirers.
Previously, PE acquirers usually received these types of tax conditions:
- 'Standard' tax conditions – essentially requiring compliance with Australian tax laws.
- Requirement to notify and engage with ATO in advance of any future disposal of the target.
- In some cases, requirement to provide ATO with details of acquirer's and target's immediate post-completion capital structure.
Increasingly, PE acquirers are receiving an additional set of tax conditions. These may include (in general terms) a requirement to notify the ATO, in advance, of any of certain related party, capital and debt restructuring and intra-group transactions that occur within a specified period post-transaction.
At the same time, PE acquirers must give the ATO all tax advice relating to these transactions (subject to the ability to make a claim for legal professional privilege or accountant's concession), as well as all step plans, diagrams, agreements, financial models and documents explaining the commercial rationale of these transactions.
Fund formation: new SEC Rules on private funds likely to reshape the regulatory landscape and best practice for the private funds industry
Last year, the US Securities and Exchange Commission (SEC) adopted new rules (with various transitional effective dates) under the US Investment Advisers Act of 1940 (the Rules) to regulate the US private fund industry. While not directly applicable to domestic PE sponsors (who are not US private fund advisers or have private funds domiciled in the US), given the international nature of fundraising and the global investment outlook of Australia's largest institutional and sovereign investors, these changes will drive global trends in the private funds industry for 2024.
Under the Rules, SEC-registered advisers will be prohibited from providing preferential side letter terms unless enhanced disclosure requirements to investors are satisfied. This will impact the ability to include carve-outs to MFN provisions and provide preferential treatment to certain investors where there is a strategic or commercial reason to do so – for example, for the largest, cornerstone investors in a fund or those who have invested across multiple of the sponsor's funds – because the preferential terms will ultimately become disclosable to future investors. Further, the regulated funds will now be required to obtain either a fairness opinion or valuation opinion in the context of GP-led secondary transactions, as well as being required to comply with enhanced quarterly investor disclosure requirements (including greater transparency of fees, expenses and fund performance).
These changes demonstrate the SEC's stated focus on investor protection and transparency. Despite the fact the Rules are currently being challenged, investors and regulated funds are working towards implementation. If and when the Rules take effect, we expect:
- they will likely drive changes to market practice globally, as institutional investors with global investment platforms will become accustomed to greater access and disclosure of preferential / side letter terms during the fund raising and negotiation process; and
- while Australian investors should expect to receive the benefit, including increased disclosure, when investing in funds that are subject to the Rules, the Rules may also result in managers being less willing and able to offer the largest Australian investors the range of preferential terms with which they have become accustomed.