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PRIVATE EQUITY OUTLOOK 2019

Trends, predictions and insights on the Australian private equity sector

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IntroductionWe are delighted to present our report on the outlook for Australian private equity in 2019. This report is informed by discussions with private equity funds and other industry participants and draws on recent experience of specialist team members across our private equity practice.

2018 was a strong year for the private equity sector. According to the Australian Private Equity & Venture Capital Association Limited (AVCAL):

▪ the amount of capital raised by buyout funds was higher than any time in the past decade and resulted in dry powder exceeding $9.2 billion;

▪ 58 private equity deals were completed; and

▪ assets under management have steadily risen to now being 3.5 times higher than in 2005.

Looking ahead, we expect another strong year of private equity activity with GPs looking to deploy their record levels of capital in new and existing companies.

This report contains our predictions on the trends that will shape the year ahead, as well as, the sectors that we expect to attract keen private equity interest in 2019. We also share our insights on upcoming regulatory reforms, the fundraising environment and trends in acquisition finance and tax.

We hope you find our report to be a helpful resource and look forward to working with you in 2019.

Best regards,

Matthew Nelson MATTHEW NELSONPARTNER | SYDNEY PRIVATE EQUITYP +61 2 9334 8769E [email protected]

Private Equity Outlook 2019

About HWL EbsworthHWL Ebsworth is a leading Australian law firm with offices in every Australian State and Territory. Our private equity team provides valuable legal advice and strategy to private equity sponsors at every stage of the private equity life cycle. We have extensive experience in fund establishments and structuring, buy-outs, bolt-on acquisitions, growth capital investments, exits, competitive auction processes, leveraged finance and refinancing, taxation and warranty and indemnity insurance. Beyond our technical expertise, we offer clients unrivalled value for money, a deep understanding of the private equity sector and a proven record of executing complex transactions.

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Predictions for 2019Based on our analysis of the Australian market and discussions with industry experts, we expect the following trends to shape the year ahead:

M&A ACTIVITY EXPECTED TO REMAIN STRONG

Private equity investment and deal activity is expected to contribute to a strong M&A market in 2019. After a solid fundraising year, local funds will look to deploy record levels of dry powder which will lead to fierce competition for quality deals. This competition will be elevated by the continuing participation of global private equity funds and strategic acquirers seeking opportunities in an Australian economy that is characterised by 28 years of consecutive economic growth and lower average EV/EBITDA multiples than North America, Europe and Asia.

ECONOMIC HEADWINDS TO AFFECT PRIVATE EQUITY SECTOR CHOICES

While the RBA is unlikely to raise interest rates until 2020, high levels of household debt, low wages growth and falling house prices are likely to weigh on consumer spending. This will negatively impact valuations and interest in companies with exposure to the consumer discretionary and property investment sectors. PE funds holding portfolio companies in these sectors may delay exits until the climate becomes more favourable or accelerate trade sale plans before spending softens further.

PUBLIC-TO-PRIVATE BUYOUTS TO CONTINUE

Local and international private equity interest in public-to-private opportunities will continue in 2019 with a number of ASX-listed targets already fielding offers from PE suitors. Examples include TPG’s proposed acquisition of vet clinic chain Greencross and KKR’s bid for MYOB. Global buyout funds will see value in Aussie listed companies, especially given the low Australian dollar, relatively cheap debt and a range of mid-cap companies with share prices at historic lows. Large Australian funds such as BGH Capital and Pacific Equity Partners with plenty of dry powder will compete for larger take-private opportunities; while smaller and mid-market funds are likely explore small and mid-cap opportunities.

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ELECTION SEASON MAY DAMPEN DEAL ACTIVITY IN THE FIRST HALF OF 2019

The upcoming federal election and a looming state election in New South Wales are expected to dampen mergers and acquisitions activity during the first half of 2019. Private equity funds will be keeping a close eye on the outcome of both elections as they will have an impact on tax policies and government plans for spending in the health, aged care and education sectors. Based on prior experience, FIRB is also likely to enter caretaker mode while we await the federal election result, meaning that major or contentious decisions are likely to be postponed until following the election. This will be particularly relevant to private equity funds that fall within the definition of a ‘foreign government investor’ and have deals subject to FIRB approval.

EXITS VIA IPO REMAIN VIABLE BUT EARLY 2019 WILL BE BUMPY

Market volatility is expected to continue during the first half of 2019 as the banking royal commission is due to release its final report in February and the market will wait to see the outcome of the federal election in May. Investors will also be hoping that the trade negotiations between the US and China are resolved before a 90-day truce expires in March. However, IPOs in the smaller to mid-market range (i.e. less than $500 million) are less likely to be affected by such volatility unless their underlying businesses have a direct interest in those events. As the majority of private equity backed IPOs fall within this range, IPOs are expected to remain an option although IPOs have in recent times fallen away as the preferred exit route. Nevertheless, dual track processes will continue to be used as private equity funds seek to maintain competitive tension and maximise exit valuations.

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REAR VIEW MIRROR: THE IPO MARKET IN 2018

2018 saw a drop in the number of IPOs as a result of market volatility and a string

of pulled floats. Trade tensions between the US and China, heavy losses in major

stock indices and the fallout from the banking royal commission all played a part

in weakening market sentiment. Amid this backdrop, a number of proposed floats

failed to hit the boards, including PEXA’s decision to abandon its IPO in favour of a

trade sale and Prospa’s indefinite postponement of its proposed IPO.


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Regulatory reforms in 2019


ROYAL COMMISSIONSRecommendations from the Royal Commissions into Aged Care and Financial Services industries will set in motion reforms and new compliance obligations for industry operators, leading to potential PE acquisition opportunities.

ASX LISTING RULESThe ASX has proposed a broad range of amendments to the ASX listing rules which impact entities seeking to list as well as listed entities. The public consultation process will end on 1 March 2019 with the reforms likely to take effect on 1 July 2019.

PROPOSED TAX CHANGESLegislative proposals to widen the definition of Significant Global Entities and change the refundable component of the R&D tax incentive scheme are expected to be settled in 2019.

MODERN SLAVERY ACTSFederal and NSW legislation will take effect and impose reporting obligations on many portfolio companies regarding steps taken to respond to the risk of modern slavery in operations and supply chains.

ASIC FEES AND COSTS DISCLOSURE REGIMEASIC will release its consultation paper on proposed changes to the fees and costs disclosure regime, which would impact many LPs in private equity funds.

COPYRIGHT ACTFrom 1 January 2019, new copyright duration laws came into effect along with new standard terms of copyright protection - portfolio companies should take note.

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Sectors to watch in 2019The consumer discretionary, food and agriculture, industrials, healthcare and business services sectors saw the greatest levels of private equity investment across industry sectors in H1 2018 (as shown on the following page). While these traditional favourites will remain popular in 2019, our discussions with private equity funds indicate the following are the sectors to watch in the year ahead.

AGED CARE

The Royal Commission into the aged care sector will unfold in 2019 and is expected to increase pressure on operators to improve standards of care. The commission’s recommendations are likely to increase compliance standards and associated costs, which will impact smaller operators the most. Faced with higher standards and lower profits, smaller operators may look to sell and present acquisition opportunities for private equity acquirers looking to enter the market at lower valuations. ‘Buy and build’ strategies are expected to play a part as the aged care sector has many single facility operators, which could be consolidated to benefit from economies of scale.

An example of this approach was Archer Capital’s roll-up of 44 aged care facilities to form Allity, which is now Australia’s fourth largest private sector provider of residential aged care services.

BUSINESS SERVICES

With growing weakness in consumer discretionary spending, private equity funds are increasingly looking at alternate opportunities in the business services sector. A strong track record, high-quality earnings from repeat customers and the ability to scale feature on the private equity shopping list. One fund that recently capitalised on this opportunity is Mercury Capital, which acquired a stake in MessageMedia, a marketing and communications company.

INTERNET OF THINGS

Private equity funds looking for the next big thing are actively seeking opportunities in the burgeoning Internet of Things (IoT) sector. According to Bain & Company, the combined markets for IoT are expected to grow to $520 billion by 2021, which is more than double the amount spent in 2017. Anacacia Capital is an example of a local fund moving to capitalise on the IoT opportunity with the shift to smart cities through its acquisition of a majority stake in technology and parking meter group Duncan Technologies. Beyond investment opportunities, IoT will continue to disrupt industries and give rise to new challenges around privacy and security, which will impact all portfolio companies whether being IoT businesses or not.

HEALTHCARE

M&A activity in the healthcare industry is expected to remain robust in 2019 with private equity funds playing a key role. Private equity buyout activity will be two-fold: (1) Targeting acquisitions of both listed and unlisted healthcare assets operating cash-generative businesses with growth potential; (2) Exiting investments in healthcare portfolio companies to capitalise on high purchase price multiples being paid by strategic acquirers.


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Private Equity-Backed Buyout Deals in Australia by Industry (H1 2018)

Source: AVCAL 2018 Yearbook

25%

25%

17%

13%

4%

4%

13%

Consumer Discretionary Food & Agriculture

Industrials Healthcare

Business Services Clean Technology

Other

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Fundraising2018 was another strong fundraising year with more than $5 billion raised by Australian private equity funds. Some of the largest funds that closed last year, included:

Fund Fund sizeBGH Capital I $2.6 billionCrescent Capital Partners VI $800 millionAdamantem Capital I $600 millionMercury Capital III $600 millionPacific Equity Partners - Secure Assets Fund $500 million (first close)Anacacia Private Equity III $300 million

In terms of fee structures, the usual ~2% management fee and 20% over return thresholds remain the general norm. While, larger investors in private equity funds may have success in securing lower management fees compared to smaller investors, the best performing funds have typically been able to resist these pressures on the basis that fund performance justifies their fees. However, there are signs of movement in other areas such as hurdle rates, discounts for investors in a first close and invitations to LPs to participate in co-investment opportunities.

According to AVCAL data, as at September 2018, there were around 10 Australia-based private equity funds in the market. With a strong economy and robust M&A market, we expect a positive fundraising environment in 2019.

ANNUAL AUSTRALIA-BASED PRIVATE EQUITY FUNDRAISING, 2017-2018 YTD

(AS AT SEPTEMBER 2018)

Source: AVCAL 2018 Yearbook


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14

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 YTD

Aggregate capital raised ($Billion) No. of funds closed

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Trends in acquisition financeUnitranche - an alternate solutionDebt structuring options in Australia are evolving with the emergence of unitranche debt. While common in the US and European markets, unitranche is a relatively new form of debt in Australia - it is a combination of senior and mezzanine debt in a single debt instrument and is typically offered by debt funds. Unitranche debt terms typically provide for a single interest rate (being a blend between a senior and junior interest rate), single covenant package and bullet repayment. Private equity borrowers like them for the greater flexibility they offer, while lenders receive a higher rate and prepayment protection. To the extent that a working capital facility is required, this would typically be provided by a bank on a super senior basis. Expect to see more of these debt structures in 2019.

Rise of non-bank lendersNon-bank lenders are increasingly featuring in leveraged buyouts and offering borrowers an alternate source of funding. While the big 4 banks continue to hold the largest portion of the loan market (circa 90%), it is expected that Australia will follow a global trend that is seeing a rise in market share for non-bank lenders. Some market participants suggest that, within a few years, as much as 50% of the leveraged loan market could be provided by non-bank lenders.

Intermediate Capital Group’s Australian Loan Fund is an example of a debt fund that has been active in this space.

RegulatorsIn the last couple of months, there have been a number of negative statements by both the RBA and Bank of England in relation to rising debt levels, leveraged loan issuance and the rise of a “shadow banking market”. While some investment banks consider such risks to be overblown, it is clearly an area of concern for the regulators.

It will be interesting to see whether this increased focus from the RBA (in the Australian context) on the leveraged market results in any further pull back from the traditional senior lenders and whether any regulatory response to the rise of non-bank lenders (in both the context of leveraged loans and the broader debt markets) emerges.


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Tax in focusStreamlined assurance reviews by the ATO have commenced

Significant global entities can now include trusts and partnerships

Audits of R&D tax offset claimants and reductions in the R&D tax offset

Elimination of a number of tax benefits received by foreign investors

Previously foreign resident companies can now be Australian residents

The ATO has commenced its streamlined assurance review of taxpayers with turnover above $250 million under what is known as the “Top 1,000 Tax Performance Program.”

The compliance approaches will seek to ensure these taxpayers are reporting the right amount of income across four selected income years based on a number of criteria including overall tax performance, type and size of business activities, tax risk management and governance, and co-operation with the ATO during the review. The taxpayer will be given a short window to make any voluntary disclosures before the review is commenced.

At the initial stage, the ATO will ask questions which relate to the alignment between accounting and tax results, tax governance and risk management, significant and new transactions, and tax risks flagged to the market.

PE outfits with consolidated income above $1 billion will now:

a) need to consider the application of the multinational anti-avoidance law, namely whether they have artificially avoided an Australian permanent establishment;

b) need to be wary of a 40% “diverted profits tax,” on profits diverted offshore in the form of higher expenses to related parties, which would otherwise have increased Australian tax payable;

c) be subject to higher penalties for false or misleading statements, late lodgement or tax schemes; and

d) be required to prepare general purpose financial statements.

Portfolio companies which self-assess and claim the R&D tax offset will be closely monitored by the ATO. The ATO has audited a number of companies and reversed the tax offset in 2018. This focus will continue into 2019 as the government commits more resources to the ATO and Department of Industry, Innovation and Science. Portfolio companies will be well-advised to review existing arrangements to ensure compliance as the ATO has taken a narrow approach to granting the R&D tax offset.

The R&D tax offset has also been reduced. For companies with annual turnover <$20 million, the offset rate will be 13.5% plus the company’s tax rate. For all other companies, the offset rate will be between 4% and 12.5% plus the company’s tax rate, depending on the R&D intensity.

Stapled structures

Foreign investors will now be prevented from converting trading income into favourably taxed interest income under certain stapled structures. This will reduce previously calculated after-tax rates of return.

Thin capitalisation

Foreign investors will also be prevented from using double-gearing structures, through multiple layers of flow-through entities, to convert trading income into favourably taxed interest income.

Foreign pension fund investors

The withholding tax exemption for foreign pension fund investors in respect of interest and dividends will be limited to portfolio investments (subject to transitional rules). Accordingly, these investors will need to reconsider the exit timeline for their investments.

Foreign incorporated companies will now be Australian tax residents where the central management and control of the company is located in Australia.

Accordingly, portfolio companies (including their subsidiaries) incorporated offshore may need to reorganise their existing corporate governance framework to avoid triggering unintended Australian tax consequences. For example:

▪ dividends paid by such companies may no longer be exempt from Australian income tax;

▪ capital gains from the sale of such companies may no longer be reduced;

▪ such companies will be subject to CGT on all CGT events; and

▪ such companies may be brought into the Australian tax consolidation regime.


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Contacts

MATTHEW NELSONPARTNER | SYDNEYP +61 2 9334 8769E [email protected]

DAVID WOODFORDPARTNER | MELBOURNEP +61 3 8644 3683E [email protected]

ROBERT GIBSONPARTNER | SYDNEYP +61 2 9334 8744E [email protected]

ROWAN MCDONALDPARTNER | SYDNEYP +61 2 9334 8948E [email protected]

NIMA SEDAGHATPARTNER | SYDNEYP +61 2 9334 8921E [email protected]

PAUL BROWNPARTNER | SYDNEYP +61 2 9334 8943E [email protected]

JAMES LONIEPARTNER | SYDNEYP +61 2 9334 8762E [email protected]

THOMAS KIMPARTNER | MELBOURNEP +61 3 8644 3532E [email protected]

GRANT HUMMELPARTNER | SYDNEYP +61 2 9334 8681E [email protected]

MATTHEW WILSONPARTNER | SYDNEYP +61 2 9334 8523E [email protected]

PETER KAYPARTNER | MELBOURNEP +61 3 8644 3728E [email protected]

Mergers & Acquisitions

Tax

Funds

Equity Capital Markets

Finance

SHAUN CARTOONPARTNER | MELBOURNEP +61 3 8644 3615E [email protected]


CAMERON JORSSPARTNER | BRISBANEP +61 7 3169 4704E [email protected]

YAN LI WANGPARTNER | MELBOURNEP +61 3 8644 3618E [email protected]

SARAH CARROLLPARTNER | MELBOURNEP +61 3 8644 3474E [email protected]

KATE MCKEOUGHPARTNER | ADELAIDEP +61 8 8205 0534E [email protected]

BRENDAN EARLEPARTNER | MELBOURNEP +61 3 8644 3469E [email protected]

JAMIE RESTASPARTNER | ADELAIDEP +61 8 8205 0581E [email protected]

SAM DWYERPARTNER | MELBOURNEP +61 3 8644 3558E [email protected]

JEREMY MCCARTHYPARTNER | MELBOURNEP +61 3 8644 3481E [email protected]

DAVID CLARKEPARTNER | SYDNEYP +61 2 9334 8644E [email protected]

ADELAIDELevel 21Westpac House91 King William StreetAdelaide SA 5000P +61 8 8205 0800F 1300 464 135

BRISBANELevel 19480 Queen StreetBrisbane QLD 4000P +61 7 3169 4700F 1300 368 717

CANBERRALevel 5HWL Ebsworth Building6 National CircuitBarton ACT 2600P +61 2 6151 2100F 1300 769 828

DARWINLevel 9Mitchell Centre59 Mitchell StreetDarwin NT 0800P +61 8 8943 0400F 1300 307 879

HOBARTLevel 985 Macquarie StreetHobart TAS 7000P +61 3 6210 6200F 1300 377 441

MELBOURNELevel 26530 Collins StMelbourne VIC 3000P +61 3 8644 3500F 1300 365 323

NORWESTLevel 321 Solent CircuitNorwest Business ParkBaulkham Hills NSW 2153P +61 2 9334 8555F 1300 369 656

PERTHLevel 11Westralia Plaza167 St Georges TerracePerth WA 6000P +61 8 9420 1500F 1300 704 211

SYDNEYLevel 14Australia Square264-278 George StSydney NSW 2000P +61 2 9334 8555F 1300 369 656

Disclaimer

This report contains general information and is not intended to be comprehensive nor to provide legal, tax or other advice or services. This report is not a substitute for such advice or services. If you require or seek advice, you should obtain such advice from your own professional adviser. Whilst reasonable effort has been made to ensure the accuracy of the information contained in this report, this cannot be guaranteed and HWL Ebsworth shall not have any liability to any person or entity which relies on the information contained in this report.

private equity outlook 2019 - amazon web services · internet of things (iot) sector. according to...

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