Around this time last year, we released a thought piece on valuation titled “what is the right value?”. Since then, COVID-19 has had a material impact on the economies of the world with implications for the approach to company valuation. While the pandemic may not have changed the fundamental concepts of valuation, there are a range of factors to consider in relation to assessing the appropriate valuation in a COVID affected world.
Benchmarking analysis
Recap: What multiple of earnings would investors pay compared with known precedents in a market
References from precedent transactions are useful to inform company valuation to the extent businesses and their environments are comparable and there is sufficient data to reliably draw conclusions. Benchmarking against pre-COVID precedent transactions should be undertaken with caution while there is a mix of temporary and lasting impacts across global economies and markets that may result in historic valuation references disconnecting from the current environment.
As an illustrative example, if you were willing to pay 10x EV/EBITDA for a company in 2019, would you still have the appetite to pay the same multiple now if the EBITDA being multiplied is impacted by government stimulus, short term supply/demand disruption and lasting impacts on the company’s economic drivers? If your answer is yes, what would be the appropriate EBITDA profile to apply this multiple to (i.e. LTM, forward or a “maintainable” hybrid)?
While we continue to see precedent transactions as an important valuation data point, the current environment requires a more intuitive approach, taking into account the potential factors that may distort the referable earnings base and/or the appropriate capitalisation rate or multiple.
Recap: Used to assess relative value against publicly traded peers
Public market trading has been turbulent since COVID-19 hit global markets in March 2020, leading up to the announcement of a vaccine in November 2020. While turbulent trading is not uncommon in a normal year, the rate of volatility experienced during this period was particularly extraordinary (subject to sector exposure).
Consequently, drawing valuation perspectives from the public markets in 2020 has been challenging and at times, less predictive of ultimate company value than it would have been during pre-COVID periods. Moreover, there is ongoing uncertainty around post-COVID global economic recovery that may result in continued volatility for some time yet.
Erratic swings in valuation are more often observed in the public markets (compared to private) due to the liquid nature of small parcels of traded securities. Careful consideration should be given when using these data points to interpret valuation references for private or majority stake public transactions.
Intrinsic valuation analysis
Recap: Technical analysis to assess the embedded value of future cash flows (or assets), typically focused on discounted cash flow modelling
Global interest rates are currently at all-time lows and the combination of unprecedented fiscal stimulus has effectively created a zero-cost money environment. As interest rates and growth rates are key inputs into intrinsic valuation models, further consideration should be taken when applying current market data points to assess intrinsic valuation.
Interest rates
Global interest rates are at levels lower than historic norms and consequently, using the current 10-year government bond yield as a proxy for risk-free rate may understate the true cost of capital. Whilst there are arguments that this is the “new norm,” due consideration should be taken when applying these inputs to inform the cost of capital and value (particularly when valuing cashflows in perpetuity). Company boards and shareholders can often lag in their decision to adjust hurdle rates and target asset prices as familiarity typically has a strong influence in this decision-making process.
Growth rates
There is high conviction across many industries that businesses (and cashflows) will ultimately return to “normal”, however the key considerations here on valuation is 1) when and 2) at what levels. These considerations make it challenging to appropriately price in the risk of cashflow uncertainty (particularly into the cost of capital).
An investor may either apply an additional risk factor to the cost of capital (rebalancing WACC to a more traditional level), or undertake a more practical exercise by assessing the risk through cashflow scenario analysis to determine valuation outputs under various recovery outcomes. An example to address the above questions through the latter approach may include:
Given this approach may place reliance on forecasting unpredictable outcomes (e.g. the Melbourne’s extended lockdown), it is imperative to ensure that forecasts are continually updated to the extent that valuation outputs are reflective of the everchanging operating environment.
Capacity to pay analysis
Recap: Technical analysis to assess the value a buyer or set of buyers can afford to pay while preserving or enhancing their shareholder value
The considerations here are company and industry specific, as different sectors have experienced mixed responses to the pandemic and consequently their capital return requirements. While broad inferences can be made about certain industries in relation to the new environment for growth and risks (e.g. technology vs travel), the reality is that each company’s response to the pandemic is unique and so is their capacity to invest (in context to other uses of capital).
Strategic value assessment
Recap: Assessment of extra market and competitive factors for the relevant investor or buyer set, may incorporate views on synergy value (cost and revenue synergies can be discussed)
Consumers and businesses alike have evolved in response to the pandemic. Throughout 2020 consumers have changed their way living and consequently, businesses have adapted their strategic focus and the way in which they operate (e.g., consumer trends shifting to online).
Many businesses are now operating more efficiently (i.e. headcount reductions, forced technology adoption) and synergies that existed pre-COVID may now be harder to find. Consequently, boards and investment committees would be well advised to place more scrutiny on strategic premiums and increase their emphasis on the realisation of synergies as part of hurdle rate assessments.
Conclusion
Forming a view on value in this environment remains a technical, analytical and resource intensive task as the considerations required are bespoke to each company, situation and purpose. Compared with the pre-COVID world, there is an increased requirement to take a step back and think about the valuation inputs and outputs required to adjust for potential COVID distortion.
There is always a need to be prepared and perhaps now more than ever, as relying on familiar metrics from the past may not be conducive to the most appropriate or optimal decision for today. If you are wrestling with the topic of valuation please feel free to reach out to one of the Record Point team and we can help you navigate through the situation to find the right path forward.
Global IPO market
The onset of COVID-19 created a period of uncertainty in capital markets and amongst investors globally at the beginning of 2020, impacting IPO activity for the first half of the year. Whilst COVID-19 has continued to impact economies worldwide, global investor activity has rebounded strongly with several large IPOs coming to market and an abundance of new issuances in the pipeline as capital remains in excess with yield hard to find.
Australian IPO Market
In recent months, Australia’s IPO market has kicked off a period of strong activity with the country delivering the busiest month for new listings this year in October, up more than 100% over August. On an even more positive note, the pipeline of new listings is likely to drive strong activity through to the end of the year and into 2021.
Despite this, we will still see 2020 being well down on prior years as the impact of the early COVID-19 deferrals and cancellations will not be fully offset by the late surge.
Australian companies are increasingly looking to the public markets for liquidity, where a string of successful floats has built confidence around execution risk. Trading valuations are often outcompeting interest from strategic and private equity acquirors, noting the ASX benchmark is up 40% from COVID-19 lows. These dynamics have created a large opportunity for investors to gain exposure to new listings across a broad range of sectors and sizes. Examples of IPOs exploring an ASX listing include $1 billion+ businesses such as software platform Nuix and Brookfield’s Dalrymple Bay Coal Terminal.
Australian IPO Outlook
The outlook for the Australian IPO market is tied to the prospects of economic recovery and the currently unknown impact of easing stimulus measures across the country. Additionally, the US election and drawn out transition is a key event that may impact global trade conditions and subsequently flow through to investor sentiment, having driven an uptick since Biden was called by the US TV networks.
The recent easing of COVID-19 restrictions in Victoria, along with stated intention to for borders to re-open before Christmas will fuel greater business activity, supporting investor sentiment and confidence.
In recent years we have seen the rise of alternative payment and consumer fintech players that have dominated market headlines with the rapidly scaling platforms demanding large revenue based valuations. More recently, investors are showing signs of reduced appetite to support this growing category with examples such as Laybuy experiencing a strong selloff.
In recent investor discussions we have had consistent feedback that investors are looking beyond the technology centric issues seen recently to more traditional businesses that are likely to do well as the economy moves to a new normal. A series of megatrends linked to COVID-19 are front and centre in sectors such as e-commerce, health and beauty, meal delivery, alcohol, and home improvement.
Pre-IPO capital
Pre-IPO capital is capital raised by a private company in the lead up to a future planned IPO. Pre-IPO investing is typically undertaken with a limited set of information that is far less onerous to prepare than a prospectus, targeted to a small group of sophisticated investors.
When a company undertakes a pre-IPO raising, there will usually be guidance provided on the likely timing of an IPO, with caveats around the prevailing business and no guarantee when or if the company will undertake an IPO, or what the IPO share price will be. Investors should be aware that there is a higher risk involved with pre-IPO capital raises. To reflect this, pre-IPO capital is usually offered at a discount to the anticipated IPO price. For the company, the placement is a way to raise funds and offset the risk that the IPO will not be as successful as hoped.
Pre-IPO investment opportunities are usually restricted to high net worth individuals, professional investors and investment funds.
Pre-IPO trends and investment characteristics
Australia has seen an uptick of pre-IPO investments in recent years, a trend that is expected to continue. The market has seen companies attempting pre-IPO rounds of funding to prove up their growth model and support capital requirements in the face of COVID-19 capital shortcomings.
Feedback from brokers suggest pre-IPO investors are looking for:
Pre-IPO convertible notes
A common instrument utilised for pre-IPO funding in the Australian market is the issuance of convertible notes, which allow investors to convert their debt to equity at a discount to the IPO price. Several recent Australian IPOs have followed pre-IPO convertible note issues, for example Manuka Resources (ASX:MKR) in July 2020, where the existing notes converted at a 24.1% discount to IPO offer price.
Given the abundance of IPO opportunities currently available, convertible notes are becoming an important investment class to allow investors to join a company’s register early, at a discount and provide a short path to potential return on investment. For the company, raising pre-IPO capital allows them to deliver on the growth of a business, which is critical to support the value underpinning the ultimate IPO.
Investors should be careful to actively diligence the business and the probability of an eventual IPO proceeding, including any pre-IPO restructuring implications. In addition, convertible notes may incorporate a valuation cap, which is a hard cap on the conversion price for noteholders regardless of the price per share on the next round of equity financing.
Recent transactions have seen convertible notes typically priced at 20-25% discount on expected IPO pricing with a coupon accruing 7-10% in the interim period.
If you are considering taking advantage of the current bullish investor sentiment to raise capital in the public or private markets, please feel free to reach out to one of the Record Point team to discuss the alternatives available.
COVID-19’s arrival has marked a dramatic change for the world, giving rise to a humanitarian crisis and volatile conditions for financial markets and economies globally. Further uncertainty lies ahead with countries bracing for further waves, whilst juggling difficult policy decisions that typically have opposite effects on the health crisis vs economic crisis. COVID’s impact has largely been indiscriminate, though there have been some resilient sectors – one clear example being cybersecurity.
Before the pandemic we were witnessing several technology trends play out. These included the bifurcation of cloud and on-premise software, the rise of artificial intelligence and machine learning, and the need for traditional software to be retooled or re-imagined. In pursuit of the seemingly unlimited potential of the digital world, corporations have embraced these trends, however in doing so have inadvertently exposed themselves to new risks in the cyber world.
These risks have been well documented. An example is Equifax’s breach in 2017. Hackers stole credit files on 147 million customers, leading to US$700 million in fines for the company. Yahoo also famously suffered numerous data breaches from 2012 to 2016 (including one in 2013 that affected all 3 billion of its users). Finally, Facebook was recently fined US$5 billion for its privacy violations in relation to the Cambridge Analytica scandal. Perhaps what is more concerning is that adversaries are becoming more relentless and sophisticated, expanding their volume of attacks through different mediums.
The vulnerabilities of governments and corporations, along with privacy and consumer data protection now taking centre stage has created significant tailwinds for the cybersecurity industry. The path for innovation and investment across existing vendors and new entrants has opened up, with the market evolving into a fast-growing US$120 billion industry (forecast to grow to US$168 billion by 2023)1.
Throw in COVID-19 and companies need to be as alert as ever. The pandemic has shifted workforces globally to working from home, thereby dramatically increasing the attack surface and vulnerabilities. Cyber threats and adversaries have demonstrated no conscience, indiscriminately targeting vulnerable sectors (e.g. hospitals and other critical institutions where technology bandwidth has already been stretched).
Attackers, including state nations, have opportunistically exploited “hysteria” in relation to COVID-19, leveraging tactics such as phishing campaigns, social media and malicious websites. These tactics are all additive to the existing threat landscape which includes malware, distributed denial of service (DDOS) and botnets to name a few. Some alarming examples include:
In response to this, governments and corporates have heavily relied on a myriad of cybersecurity solutions and vendors. We have seen a significant uptick in demand of cybersecurity tools to assist with the work from home environment. Key examples include virtual private networks and multi-factor authentication.
However, despite all the tools available, employee education plays a key role in combating risks in the digital world. While phishing schemes can vary in complexity and size, the reality is that cyber criminals require very little resourcing to generate an exponentially large number of campaigns. Research suggests that half of personal data breaches are a result of human negligence. Employees need to be diligent in diagnosing and reporting potential harms, for example spending the time to identify suspicious email addresses and domain names.
COVID-19 may not be the catalyst for all change, however we expect it to accelerate change. With that, cyber innovation and its benefits will continue to flourish. We are already seeing the likes of Zscaler, Crowdstrike and an ecosystem of start-ups flourish as companies continue to transition towards the cloud. Virtual security operation centres will need to mobilise and an increased adoption of managed security service providers as a cost-effective cyber solution is likely to play out.
More recently, we have witnessed the Australian government announce a A$15 billion boost to protect Australia against state-sponsored hackers. There have been several public allegations and finger pointing, all of which contribute to an uncertain new environment but highlight the critical role cybersecurity plays in the modern economy.
If you are interested in the cybersecurity or broader technology sectors and how they impact your business or investment plans, please feel free reach out to one of the Record Point team for a discussion.
Notes
(1) Represents global cybersecurity market (Source: Gartner Forecast: Information Security and Risk Management, Worldwide, 2017-2023, 3Q19 Update)
(2) As of June 2020
The COVID-19 pandemic has created the most uncertain and unpredictable economic environment in memory for businesses in Australia and around the world. As a business owner or manager, irrespective of the size of your organisation, proactively dealing with operational issues, heightened tracking, scrutinising of the financial position and performance of the business has become an imperative part of planning, pivoting and ultimately for many, surviving the inevitable challenges that lie ahead.
Financial modelling provides decision makers with essential data points for a business “health check” and the critical information to support important business decisions. From our discussions with clients during the COVID-19 lock-down, it became apparent that there is a wide gap in how businesses approach their financial modelling, and we also found that many businesses are actively upgrading and enhancing their capabilities.
In this blog, we have highlighted some common areas where the current environment is requiring deeper thinking about modelling and forecasting.
Engaging with a broader group of stakeholders
Many businesses have traditionally done their financial modelling for a reasonably narrow group of stakeholders such as the owner or CEO. The modelling process is often undertaken by an accountant or financial analyst and the output of the model remains unchanged for years.
The current environment calls for a broadening of all of these items. Financial models need to consider that there is a broader range of users of the critical forecast information including owners, directors, managers, financiers and potential investors. Owners and managers may be focused on cash flows, revenues, costs and working capital whereas financiers may be focused on capital structure, solvency, liquidity and covenants. The process for compiling the forecasts should be reconsidered including involving more line managers and other relevant contributors to enhance confidence in the assumptions and develop the appropriate sensitivity analyses. Given the uncertainty of the economic recovery, we expect that forecast reporting is likely to look different going forward than it did in the past for many businesses.
Greater granularity
Some businesses with less sophisticated modelling functions or small accounting/reporting teams generate their forecasts by utilising outputs from their accounting software and exporting them into Excel with high-level go-forward assumptions (such as revenue growth rates and earning margins). These and similar approaches are relatively simple and may have been adequate in the relatively steady-state pre COVID-19 environment.
Many businesses are now finding that the current environment necessitates greater granularity in their financial modelling which may require significant modelling changes. Key to this process is better analysing each of the components of revenue and modelling their key drivers separately, and similarly, where practical, compiling bottom-up reconstructions of material cost items. In addition, some businesses are reconsidering the frequency of their models with monthly models being expanded into weekly, and in some cases, daily forecasts.
We are not suggesting that any of this is a simple task. Businesses might decide to implement these changes incrementally over a workable period.
Scenario analysis
Scenario analysis provides the forecasting process with a range of future outcomes based on potential events or assumptions. Questions that business owners are asking include how deep and how long is this downturn going to be, what is the likely shape of the recovery for the broader economy and how will that impact their business, will they have enough cash to navigate through a potential second or third wave of COVID-19, and how much funding will they require to build up their working capital position during the recovery?
Not all financial models were created with the flexibility to run multiple scenarios, however with many significant and uncertain variables, it has never been as important to have an ability to efficiently stress test the base case forecast assumptions in order to make informed business decisions.
Integrated financial statements
There are numerous businesses with evolving forecasting capabilities that have historically focused on revenue and earnings as the key proxies for the financial health of the business. However, the current environment demands a more integrated and robust approach with a sufficiently detailed profit and loss statement, balance sheet and cash flow analysis providing the basis for a more fulsome perspective on the financial performance and condition of the business. With the current focus of analysis being on closely tracking the cash flow and liquidity of the business, there is a lot that might get lost if the full balance sheet is not adequately modelled, including the financial implications arising from changes in working capital and capital expenditures.
Capital structure
The capital structure of a business refers to the sources of capital, whether equity or debt, and the financial modelling of these items are often highly simplistic. It is likely that a large number of businesses will be seeking to raise additional capital which provides for an opportune time to enhance financial models to more accurately demonstrate the impact of various forms of new capital on the business. While external financiers and investors will likely establish their own financing or “leveraged buyout” models to track the sources and uses of new capital, businesses need to be able to run their own analysis and sensitivity tests to retain control of their risk profile, ability to obtain funding and impacts on shareholder returns.
Conclusion
With the unexpected economic shock that materialised as a result of COVID-19, many businesses found themselves with inadequate financial modelling capabilities and with insufficient information readily available to quickly make important business decisions. When modelling in a COVID-19 environment, businesses should consider investing in their capability and will benefit from expanding the group of stakeholders involved in the forecasting processes, additional granularity and detail, incorporation of multiple scenarios, expanded and integrated reporting across the profit and loss statement, balance sheet and cash flow as well as the ability to model potential capital structure changes.
Record Point has significant experience across a wide range of industries to assist with your next capital raising, acquisition or divestment. If you are currently considering your M&A or financing options, please feel free to reach out to one of the Record Point team for a confidential discussion.
2019 was a strong year for M&A, and with supportive equity markets, low interest rates and significant amounts of investable capital, many expected that 2020 would be even better. However, the onset of the COVID-19 pandemic has changed the world dramatically and brought with it the end of the longest bull market run in history. An inability to predict the depth and length of the potential consequences from this crisis has profoundly impacted global business and investment confidence, and therefore the environment for otherwise logical and compelling M&A transactions.
Governments around the world face an unprecedented challenge of balancing the humanitarian and economic consequences of COVID-19 with only one certainty, that a preference towards one of these objectives will have severe consequences on the other. Although the current lockdowns and restricted social activity are essential from a humanitarian perspective, the result has been substantial disruption to supply chains, cashflows and the creation of funding gaps for thousands of businesses. Whilst prior to COVID-19, most businesses were focused on revenue and earnings growth, during this time and indeed post the acute phase of this pandemic, owners are more likely to focus on managing their core business and its recovery.
Consequently, M&A will become harder and it will be different. In this context, we ask the question, what should potential buyers and sellers expect when considering M&A?
Valuation
Uncertainty will be at the forefront of all valuation discussions in this environment. The inability to predict future maintainable earnings, the lack of visibility over the shape of the recovery, the contraction of trading multiples and the inevitable uptick in distressed M&A will negatively impact headline valuations. In the short-term and as was evidenced in the aftermath of the market correction during the Global Financial Crisis, this will likely widen the gap between buyer and seller price expectations, and so we should expect a rise in the use of value bridging mechanisms such as contingent pricing structures in transactions. For example, some buyers may mitigate their risk by utilising earn-outs to counter the uncertainty surrounding future maintainable earnings. How these earn-outs operate in the context of COVID-19 will become key negotiation points, particularly with reference to abnormal or one-off costs.
Due diligence
In Australia, due diligence procedures have predominantly been conducted online with virtual data rooms, however site visits and management meetings/presentations may face some challenges for the immediate future. Nevertheless, we believe that by utilising technologies (including ever-evolving video conferencing capabilities), this hurdle can be overcome. We also expect that buyers will spend an increasing amount of time on COVID-19 related due diligence, including aspects such as supply chain reliance, customer payment terms and outstanding debts, business continuity procedures, potential redundancies and employee claims.
Funding
Market volatility and the current focus by banks on existing clients and troubled situations may result in debt for new deals being far harder to come by. Whilst public companies might look to capital raisings to strengthen their balance sheets and build a war chest to fund M&A opportunities, it will be harder for private companies to access capital for M&A. That being said, financial sponsors have ample dry powder and are opportunistically and selectively looking for ways to deploy capital. Buyers may need to consider over-equitising with a view to refinancing once debt markets normalise. Furthermore, deferred pricing structures could also play a part in reducing the upfront funding requirements for acquisitions.
Documentation
We expect to see a divergence of buyer and seller positions with respect to allocation of deal risk in M&A documentation. Sellers are motivated to minimise the risk of completion not eventuating, whilst buyers want to retain flexibility to pull-out of transactions through broadly defined material adverse change clauses. Change of control consents or assignments may become more problematic if counterparties are seeking avenues to terminate or vary their agreements with the company. The negotiation of warranties and indemnities may become more prolonged, compounded by COVID-19 exclusions that warranty and indemnity insurance providers are seeking. Given the range of challenges and diverging positions that buyers and sellers will encounter whilst negotiating legal documentation, we recommend that all parties ensure that the key legal and commercial terms are well understood upfront to avoid the negotiation prolonging excessively or falling over at the end.
Regulation
The COVID-19 pandemic has had wide reaching impacts on all elements of government and business as a result of the inward focus required to deal with this crisis, and as such, we expect that the time required for regulatory approvals (e.g. competition approval from the ACCC and foreign investment approval from FIRB) will be materially elongated. That being said, there are currently no indications that the fundamental approach of these regulatory bodies with respect to approvals will change. In the case of FIRB, buyers and sellers alike should note that the threshold level for FIRB approval being required has reduced to zero, which means that substantially more mid-market transactions will require approval.
Opportunities
Whilst the current crisis has undoubtedly slowed down M&A, there has already been increased activity in certain areas such as capital raisings, as businesses seek funds to not only strengthen their balance sheets, but also to be prepared for acquisition opportunities as valuations fall and/or distressed opportunities arise. In the coming months, we expect that restructurings, be they distressed or strategic will drive a number of corporate carve-outs into play. Additionally, we may see an increase in cross-border activity particularly given the relative stability and resilience of the Australian market, coupled with a weak Australian dollar. Sellers with target businesses resilient in the current environment and opportunistic buyers, may find themselves with a diverse range of opportunities to pursue.
Record Point believes that now is the time for advance planning and preparation in relation to any M&A strategy. Engaging with advisors who understand the market and the changing dynamics that businesses are facing will be instrumental in facilitating transactions. Whilst the uncertainty of the current environment may cause buyers and sellers to reconsider opportunities, for others, these times present a rare opportunity to deploy capital at attractive valuations, and to execute on meaningful and potentially transformative M&A transactions. If you are currently considering your M&A options, please feel free to reach out to one of the Record Point team for a confidential discussion.
Whether it is the latest news, the empty shelves in supermarkets, the eerily quiet streets across major cities or the work-from-home and home-schooling arrangements, the daily lives of people around the world have been indiscriminately impacted by the COVID-19 crisis. Similarly, the bullish sentiment of global financial markets that we have long been familiar with now seem like a world away as equity markets plummet amid a backdrop of volatile trading, while debt markets temporarily stall.
The Government in Australia and across the world are responding aggressively (at varying rates) as they desperately play a balancing act of enforcing social and commercial restrictions to “flatten the curve,” consequently driving a sudden economic slowdown, whilst at the same time attempting to hold these economies together through fiscal and monetary stimulus (along with other measures). Time will tell whether Government responses will be effective. For many businesses here in Australia, COVID-19 will test their ability to survive and unfortunately, many will succumb.
With the unprecedented and unrelenting pace of change in the situation, it is understandable that some businesses have become swamped in unending news flow and struggle to keep up with daily administrative and logistical requirements to maintain operations. In this regard, and while acknowledging that each business is different, we would like to iterate 4 key messages to business owners during these unprecedented times:
Be calm and move quickly
Challenging times call for strong leadership from business owners. They have the burden of balancing the needs of various stakeholders (employees, shareholders, landlords, customers etc.) with the sustainability of the business. Employees in particular are looking for strong leaders to set a pragmatic and results-orientated tone, mitigating uncertainties and anxieties they may be experiencing personally.
Be Connected
Work-from-home arrangements and the promotion of social distancing makes operations, logistics and coordination more challenging. However, it is at these times of uncertainty when clear and direct communication and engagement matter the most, and unlike prior major downturns, we now have access to technologies that enable us to retain and even increase our “virtual connectivity” with colleagues, customers, suppliers and advisors. We expect that the increased use of systems like Zoom and Microsoft Teams is likely to have a lasting impact and will continue beyond this crisis.
Be prepared
There will inevitably be difficult and urgent decisions that need to be made under stressful and perhaps emotional conditions. While it is difficult to make such decisions when things are changing quickly and new information is continuously coming to light, taking no action is not a viable option. Depending on the depth and length of this downturn, we expect a significant number of businesses will be required to consider their capital position. This makes it critical to be well prepared with flexible, scenario-driven financial modelling for stress testing while regularly assessing any available pools of capital to the business. We can see a scenario where capital providers (including banks) will be swamped with enquiries, making preparedness and early engagement even more important.
Be well advised
Connecting all the dots can be overwhelming, and few business owners have the ability to cover all the commercial, operational, financial, legal and tax implications of their journey ahead.
Australian regulators are trying to assist businesses, and company directors need to fully understand the “safe harbour” rules and recent relief legislation to protect themselves if the business is in financial distress.
Business owners also need to be aware of the costs and benefits of intentional voluntary administration which could protect the business through a protracted downturn.
Alternatively, businesses may seek to raise capital to shore up their balance sheet or pursue a merger or acquisition to add scale, each of which requires expert advice to execute effectively in this environment.
Summary
COVID-19 is causing a rapid change in the social and business landscape. The survival of many Australian businesses will be tested, and they will require strong leadership, increased connectivity, timely preparation and potentially external support and advice in order to navigate through the challenges ahead.
At Record Point, we are following COVID-19 developments very closely and regularly talking to our clients about strategies to support their businesses. If you are looking to understand what COVID-19 may mean for your business, please feel free to reach out to one of the Record Point team for a confidential discussion.
Following a busy 2019, the Record Point team is looking forward to more of the same this year. Before we look at what’s in store for 2002, let’s take a quick look at how the markets shaped up in 2019.
M&A Market
In 2019, the public M&A market was healthy notwithstanding ongoing geopolitical and economic uncertainty. M&A activity in the resources sector continued to dominate and was led by Wesfarmers’ acquisition of Kidman Resources which completed in September 2019. Other active sectors included financial services, health and aged care, TMT and infrastructure. While cash continued to represent the most common form of purchase price consideration, a number of deals used “stub equity” as a way of providing target shareholders an opportunity to have a continuing equity interest. Foreign bidders remained highly active representing approximately half of all bidders, however, there was a notable drop in Chinese and European bidders, offset by an increase in superannuation funds such as AusSuper participating alongside private equity firms in high profile transactions.
One of the key trends was private equity investors driving a number of public-to-private transactions, including BGH Capital’s acquisition of Navitas and tussle for Healthscope (ultimately acquired by Brookfield), KKR’s acquisition of MYOB and TPG’s acquisition of Greencross. A further major transaction involving private equity was KKR’s acquisition of iconic biscuit manufacturer Arnott’s for A$3.2bn.
The private M&A market was similarly robust with high levels of competition and strong valuations being achieved for high quality, growing businesses.
Equity Market
After a disappointing 2018 when the ASX200 index dropped 7%, 2019 was the strongest year for Australian equities of the decade. It ended up 18% for the year compared to an average annual return of 2% over the decade (excluding 2019).
Interestingly, in mid-2019, for the first time the index surpassed its peak level from October 2007 prior to the GFC-led crash. The large 2019 returns were achieved notwithstanding slowing global economic growth, a continuing US-China trade war, ongoing Brexit battles, low domestic consumer confidence driving challenging retail conditions and a stalling domestic property market. Nevertheless, equity markets were supported by low interest rates driving up asset valuations, unattractive bond yields and in Australia, billions of dollars continuing to flow into the superannuation system.
IPO Market
The IPO market in 2019 will likely be remembered for the string of IPOs which received publicity when they were terminated due to lack of investor support at targeted valuations. Examples include Latitude Financial Group, Onsite Rental, Education Centres of Australia, Property Guru, MPC Kinetic and Retail Zoo. The number and aggregate size of ASX IPOs declined and investors, flush with investable capital and starved of IPO issuances, showed a clear divergence in appetite to invest in existing listed companies (both their traded equities and follow-on equity raisings) as opposed to investing in IPOs.
The positive news is that there were a number of successful IPOs towards the end of the year, including Nitro Software and Tyro Payments, and the pipeline of upcoming ASX listings continues to build which bodes well for 2020.
What’s in Store for 2020?
Notwithstanding the uncertainties arising from the coronavirus outbreak at the end of December 2019, we are optimistic that M&A markets will continue to be strong.
As always, there will ultimately be a large number of known and as yet unknown factors influencing markets in 2020. We are not going to attempt to speculate on the answers to the unknowns surrounding current economic and geopolitical events. Like how much impact will coronavirus have on valuations and which sectors will be most heavily hit (and for how long)? How long will the US-China trade war go on for and who will be the long-term winners and losers? What will be the long-term impact of Brexit and the 2020 US elections on markets? Will a sense of calm and stability return to the volatile Middle East? We simply can’t say.
However, at a broad and thematic level, we continue to have conviction that fundamentals are supportive of continuing healthy M&A markets. Valuations remain buoyant, balance sheets are strong, interest rates are low, equity and debt markets are open and there is a large surplus of investible funds searching for higher yields in an otherwise depressingly low return environment. These are all key ingredients to provide decision makers with confidence to pursue M&A deals and we expect significant investment activity from financial parties (such as private equity, domestic and international pension funds, family offices / high net worth individuals) in both private and public companies.
Successful business owners are regularly on the look-out for opportunities to partner with high quality, sophisticated investors to help achieve their business objectives for growth and expansion. With the local IPO market experiencing a period of instability (see our October blog), businesses can increasingly benefit from exploring and evaluating private capital options to fund growth or access liquidity. In 2020, we expect the significant investor demand for attractive investment opportunities seen in 2019 to continue.
Australian corporates generally have sound balance sheets and are actively seeking to supplement low organic growth options with higher returning, synergistic growth options. Furthermore, there is a significant amount of surplus private equity and venture capital funds competing for a limited number of quality investment opportunities. Additionally, the low interest rate environment is driving family offices and high net worth (‘HNW’) individuals to search for higher yielding assets.
For business owners, selecting the right partner often depends on who can provide the most capital at the cheapest rate, however it may be equally important to find a partner who can assist from a strategic or commercial angle. Cheap capital is not the only consideration driving a business to greater success and partners are finding it increasingly important to differentiate their capital proposition from others. There a range of considerations a business owner should evaluate to assess which investor type may be an appropriate partner.
Strategic Corporates
Finding the right partner for growth is not simply about finding the partner with the deepest pockets, rather there are a range of additional considerations such as identifying partners who can provide valuable expertise, insights, solutions or networks to address the many challenges a business may face, including product and customer development, new market entry opportunities and potential synergistic growth opportunities with other portfolio companies.
By partnering with another business, companies can differentiate and diversify themselves to achieve business growth and expansion in Australia’s competitive business landscape. Strategic and joint partnerships using innovative investment structures provide business owners with options to retain ongoing / majority ownership interest in their underlying businesses. However, business owners should be cognisant that following a strategic investment, businesses may lose their perceived independence by aligning with one industry player and may also inadvertently limit their exit options to ultimately sell the business down the track. Business owners can implement clearly defined shareholder protections and rights to mitigate these risks and retain a suitable level of control and flexibility.
Financial Sponsors
“Dry powder” (an informal term used to describe the cash available for investment opportunities) has continued to grow in recent years and is now at an all-time high. Private equity managers, venture capital investors and superannuation funds continue to search for ways to deploy the estimated US$14.8 billion of dry powder in the Australian market (according to the Australian Investment Council) by identifying innovative deal structures and alternative asset classes.
With significant private capital available, financial sponsors may be attractive partners for business owners that would prefer to remain private with a sophisticated investor onboard who is motivated and incentivised to continue to increase the value of the business. Business owners should consider the level of ownership selldown they are willing to accept as financial sponsors generally seek a significant (and often controlling) ownership stake and will invest with a targeted hold period on the basis of reasonably high return expectations that may not always align with long-term founder objectives.
Family office and high net worth Investors
HNW investors are increasingly looking to diversify their investment portfolios outside of traditional investment classes of listed equities and real estate and into alternative investment classes including direct investment in private companies. Investment objectives for HNW investors are often more passive in nature and can provide a suitable funding solution for private businesses requiring small to medium sized capital injections.
HNW investors may be attractive to companies operating in niche markets or to start-up / early growth businesses which have an insufficient track record to secure institutional investment. Businesses may also benefit where the initial investment required is too small to attract institutional funds.
Summary
With a low interest rate environment and a record level of investible dry powder in the market, it is currently an opportune time for private companies to assess the benefits of taking on a strategic or financial partner to assist them to execute their growth strategy.
If you are looking for a capital solution or a new partner to support the growth of your business, please feel free to reach out to one of the Record Point team and we can help you navigate a path forward.
For more Information
Record Point is an independent corporate advisory firm located in Sydney, Australia and San Francisco, United States. Our team of professionals serves public and private companies across numerous sectors with a particular focus on healthcare, technology, consumer and industrials. Our team has more than 50 years of experience successfully leading and executing in excess of A$30 billion in transactions. Contact us to discuss your next strategic move on +61 2 9078 8250.
Whether you are a long-term business owner, entrepreneur, company director, private equity professional or any other shareholder you will no doubt have to visit the question of “what is your business worth?” at some stage.
In particular, at the time of a merger, acquisition or other capital activity this can be one of, if not the most challenging question that must be answered i.e. “what is the right price?”
In hindsight, the answer is that the value is the price at which a willing buyer and seller are prepared to transact (just like when you sell your house); however, how do you know whether you are making the right decision on either side of the transaction?
In order to assess the valuation of a business, there are a range of tools and techniques that should be applied to make an informed judgement. Before visiting a company valuation, however, it is important to understand that these tools are only as accurate as the information being utilised, requiring careful preparation before any analysis is performed (discussed further below).
Broadly the most common valuation methodologies fall under the following categories:
The valuation lens
To make and assessment of value it is important to understand the purpose of the valuation. With a defined purpose in mind, a financial advisor will leverage their experience to interpret various data points using the tools above to assess a value range. The following common situations contain unique factors that may result in different valuation outcomes for the same business:
Of note, there is an important difference between minority and majority based valuations, which is evident in the control premium ascribed where an acquirer pays to gain control of the cashflows (and assets) of the business, also often allowing them to access synergy value.
Whether a company is publicly traded or held privately may also impact the valuation, particularly in a minority transaction. When benchmarking a private company against a set of (typically larger) public company comparables, there is usually a discount applied to the public trading multiples to reflect the smaller size (typically higher risk) and lower liquidity.
Be prepared
As businesses don’t always operate in a perfect world environment, it is best to be prepared in advance for what may happen, rather than waiting and reacting in the moment.
We see the benefits in any value discussion when clients undertake a strategic review of their business and assess the options and alternatives to unlock value, which may also incorporate a sale readiness assessment to avoid some of the mistakes often made when selling a company as discussed in our prior Blog https://www.record-point.com/the-three-most-common-mistakes-in-preparing-to-sell-your-company/.
We recommend that our clients keep each of the key valuation inputs up to date to allow them to react quickly and with confidence, to assess the appropriate parameters of value for any given situation. Key steps include:
In summary
Ultimately, valuations are highly technical, analytical and resource intensive, and even the most comprehensive corporate valuations include some subjectivity and qualitative consideration.
If you are wrestling with the topic of valuation please feel free to reach out to one of the Record Point team and we can help you navigate through the situation to find the right path forward.
For more information
Record Point is an independent corporate advisory firm located in Sydney, Australia and San Francisco, United States. Our team of professionals serves public and private companies across numerous sectors with a particular focus on healthcare, technology, consumer and industrials. Our team has more than 50 years of experience successfully leading and executing in excess of A$30 billion in transactions. Contact us to discuss your next strategic move on +61 2 9078 8250.
There has been a lot of recent commentary about the Initial Public Offering (“IPO”) of Latitude Financial Group (“Latitude”). By way of background, Latitude was previously the Australian lending operation of GE Money which was acquired in 2015 by a consortium of private equity investors. In an environment where terms like “fintech” and “buy now, pay later” are getting a lot of investor attention, Latitude’s second run at the Australian Securities Exchange (“ASX”) was highly anticipated as the largest IPO of the year, however its owners terminated the IPO when it did not receive sufficient investor support. Similarly the anticipated ASX IPOs of Onsite Rental (equipment rental), Education Centres of Australia (education provider), PropertyGuru (South East Asia-based online real estate classifieds), MPC Kinetic (pipeline and energy construction) and Retail Zoo (owner of Boost Juice) have recently been terminated leading to some speculation on the impact these might have on other pending IPOs in the 2019 and early 2020 pipeline. It is in this context that we thought it would be useful to take a step back and look at the status of the Australian IPO market in 2019 more broadly.
For the first three quarters of 2019, the ASX200 index performed strongly, increasing by 18.5% which was in-line with strong returns achieved by most other major global markets, and it continues to trade near the highest level in over 10 years. Similarly, the forward PE ratio of the ASX200 index, representing the ratio of price to anticipated earnings, continues to trade in the high teens reflecting strong and resilient public market valuations.
Over the same period, there were 37 IPOs on the ASX and an overwhelming majority have delivered good returns for investors, including 18 of the largest 20 IPOs. Positive performers include software companies such as FINEOS (+25%), ReadyTech (+18%) and Whispir (+1%), although Life360 has struggled, down ~25% from its IPO price.
Notwithstanding the above, 37 IPOs for the first 3 quarters of 2019 is far few than in 2018 and 2017 with 76 and 69 IPOs for the same period respectively. In addition to the number of IPOs declining, the aggregate size of the IPOs, representing the new capital raised, declined from $6.7 billion in the first three quarters of 2018 to $2.9 billion in the comparable period in 2019. Furthermore, in the final quarter 2019 there are currently expected to be up to 14 IPOs coming to market, which compares to 26 and 36 IPOs that ultimately listed in the last quarters of the previous 2 years. It is fair to conclude, that whilst the 2019 performance of the market and newly listed companies has been strong so far, IPO activity has meaningful declined.
Capital flowing into the ASX is heavily influenced by the Australian superannuation environment. As at the June 2019 quarter, approximately 51% of the $1.8 trillion of superannuation investments were invested in equities (almost half of which were in Australian listed equities) with almost $34 billion of new contributions entering the system in that quarter alone. Based on that information alone, it may seem unintuitive that more strong companies are not coming to market in order to raise capital and take advantage of the seemingly continuous flow of new superannuation capital seeking investment.
A key takeaway is that there is a divergence between investors’ appetite to invest in existing listed companies (including strong support for their follow-on equity raisings) as opposed to investing in new companies coming to market. There are many reasons why recent IPOs have not been successful, including market volatility and uncertainty, lack of earnings visibility and ultimately insufficient investor demand, making it clear that cornerstone IPO investors are being very cautious with their assessments of the quality of IPO candidates and their management team and are looking closely at the underlying business models and the achievability of forecasts. Another factor is that some private companies have become comfortable to bide their time through this period of uncertainty, taking advantage of low interest rates and an abundance of debt capital to support their growth strategies.
Despite the recent decrease in IPO activity, we continue to believe that the ASX is in good shape and is “open for business”. There are 5 companies who have targeted IPOs with proposed listing dates in November and we will be watching these closely. We expect that investors, who are flush with investable capital and have been starved of IPO issuances, will be supportive of investing in strong companies with aligned and motivated management at sensible valuations.
If you would like to discuss raising capital or realising value for your business, please get in touch with any of the Record Point team.
For more information
Record Point is an independent corporate advisory firm located in Sydney, Australia and San Francisco, United States. Our team of professionals serves public and private companies across numerous sectors with a particular focus on healthcare, technology, consumer and industrials. Our team has more than 50 years of experience successfully leading and executing in excess of A$30 billion in transactions.
Contact us to discuss your next strategic move on +61 2 9078 8250.
www.record-point.com
Welcome to the first Record Point website blog. Going forward, we will be sharing our thoughts on topics which we think are relevant to anyone with an interest in the world of Mergers & Acquisitions. Whether you are a founder, shareholder, investor, manager or adviser, we hope that you will find these posts interesting and informative.
In Australia, there are about 2,200 listed companies, many of which get a lot of news and attention, however there are more than 2.7 million registered companies (and growing every month), the overwhelming majority of which are privately owned. While not all of these are operating businesses, it is nevertheless a surprisingly large number for a country with a population of only c.25 million.
Each one of these businesses has its own story. Inevitably a considerable amount of sweat and tears was invested by its founders and early employees to establish the business by finding and developing relevant products or services, implementing processes and controls, finding customers, generating revenue, watching expenses and dealing with a wide range of daily challenges. With the challenges comes reward for those who find a successful formula. Besides becoming a source of employment and income, being part of a successful and growing business can be an opportunity to create considerable value along the way.
While there are a large number of ways to create value, there are a limited number of ways to realise that value. Most founders, shareholders and managers have little experience with this, and they should carefully consider whether it makes sense for them to appoint an adviser that they trust to guide them through the process. Selling a business might well be the single most important financial transaction for a founder, and to mitigate what might otherwise be a highly stressful period, any self-respecting advisor will work with the company and its key stakeholders to ensure they are well prepared before initiating any sale process or engaging with potential acquirors or investors.
If you would like to discuss how best to go about preparing your business for sale, please get in touch with any of the Record Point team.
For more information
Record Point is an independent corporate advisory firm located in Sydney, Australia and San Francisco, United States. Our team of professionals serves public and private companies across numerous sectors with a particular focus on healthcare, technology, consumer and industrials. Our team has more than 50 years of experience successfully leading and executing in excess of A$30 billion in transactions. Contact us to discuss your next strategic move on +61 2 9078 8250.