The M&A Landscape In a Post-Pandemic World
The Deals Boom
IPO and merger and acquisition activity in the global and Australian market has been going through a super cycle in 2021. In the first half of the year, a Goldman Sachs study showed that throughout Australia and New Zealand, there was a record of $148 billion of deals completed, about 2.6x the five-year average over the same period. Whilst volume by number of deals completed is down from 1H2019 compared to 1H2021, higher valuations have been contributory to this record value of deals completed.
Private equity funds, superannuation funds and infrastructure investors have been key drivers of this activity. Potentially big-ticket deals, such as IFM’s bid for Sydney Airport, Santos’ merger with Oil Search and Wesfarmers acquisition of API have all been in the news. Typically, deals activity declines in line with exogenous events, such as Covid-19, due to Boards hesitating on overextending in weak economies. However, what can be seen now is optimism for the future, with cheap credit, government stimulus and an expected consumption rebound, cashed-up boards are increasingly likely to seek growth through M&A. By the same token, positive future sentiment has also led to a rejections boom, with boards rejecting bids with valuations below pre-pandemic levels.
The Rejections Boom: Termism & Optimism
Differing levels of optimism and long-term thinking by boards has led to a rejections boom. Unprecedented in the local market, boards have rejected offers in excess of $50bn in 2021. On the defence side, boards are pointing to pre-pandemic valuation levels, inferring that bids (often at a premium of more than 30%) have undervalued their companies. One can point to the recent “unsolicited, indicative, conditional and non-binding’ bid by IFM Investors, by way of Scheme of Arrangement (which requires board approval), of $8.25 per share (a 42 per cent premium to where Sydney Airport was last trading). Sydney Airport rejected this bid, which would have been a $30 billion offer (including debt), citing that Sydney Airport was a “strategic asset” and not opening the books to the Consortium to do their due diligence. This deal, if completed, would become the largest take-over in the country’s corporate history, overtaking Westfields Corporation’s $US24.7bn takeover in 2017/18 [as at 1 August 2021]. Citi analysts noted the equity raise last year in August of Sydney and its dilutive effects (19% share count increase). The bid valued the airport at 26.3x pre-Covid earnings (EV/EBITDA) and 20x forecast earnings for 2025. Whilst there has been a rejections boom because of below pre-pandemic valuation bids, entities such as the Sydney Aviation Alliance, argue that “any assessment of Sydney Airport security prices before the pandemic is of limited relevance given the company’s materially changed circumstances and challenging outlook.” Although this deal is more complex, with factors including limited ownership rules implied by the Airports Act (1996), it exemplifies how forward sentiment influences decisions to accept or reject deals.
A New Metric?
Some have argued a new valuation metric should be introduced when considering post-pandemic valuation levels. One common multiple used in valuation is EV/EBITDA. Perhaps the EBITDA can be adjusted to incorporate Covid-19. That is Earnings Before Interest, Tax, Depreciation, Amortisation and Covid-19 (EBITDAC). Whilst originating a joke and unlikely to be implemented in any serious manner with ASIC referring to the non-IFRS measure as “hypothetical” and “likely to be misleading”, discussion of the measure indicates a transitory view of the virus. The permanency of the virus is not and cannot be known. With new strains developing each year, and lockdowns being the primary policy method in confronting the virus, Sydney Aviation Alliance’s assessment that pre-pandemic valuations may be of limited relevance is likely to be true. Nevertheless, shareholders are now faced with the choice of whether to take the short-term gain of accepting bids often in 30% of the current valuations, or back current boards to see out Covid-19 and potentially reap returns in excess of current bids over a longer timeframe. Throughout 2020, hostile bids became more popular as a result of bid-ask spread widens, with the takeover / scheme of arrangement split reaching 45:55, up from 17:83 in 2019. With bid knockbacks, increasing takeover / scheme of arrangement splits, and growing valuations, boards pursuing M&A deals may face decreasingly accretive deals in the future.
On the IPO side of things, again activity relies on continued market optimism which, indicated by the number of deals completed in H12021, has been very strong. EY Oceania head of M&A, Duncan Hogg, expects IPO activity to soften in Q3, citing Covid-19 fatigue, the country’s battle with the delta strain and resultant lockdowns, and the struggles of some larger IPOs, including Nuix and Adore Beauty. Since Nuix was listed, it has fallen 69.04% (as of 30.07.2021). Currently subject to an ASIC investigation, an AFP investigation into its former chairman over options and questions over its IPO process, Nuix’s outcome and performance may have the potential to alter investor sentiment. The performance of Nuix and Adore likely shook IPO markets in May, with Pepper Money underperforming on debut and others such as Best and Less, Aurora Healthcare and Australian Venue Co having their IPOs pulled. Economic factors, such as potential inflation, transitory or otherwise, likely leading to future cash rate rises will largely influence market activity. Nevertheless, Hogg amongst others expects to see a significant period of M&A activity over the next six to 12 months.
Sam Subramaniam is a Research Analyst with the University Network of Investing and Trading.
GT Law: https://www.gtlaw.com.au/knowledge/mergers-acquisitions/takeovers-schemes/analysis-australian-public-mergers-acquisitions-2020
Disclaimer: The views expressed in this article are solely that of the author’s, and do not necessarily reflect the position of UNIT nor the University of Melbourne. The advice given is general in nature and does not consider an individual’s personal financial circumstance. Transacting off this information is done so at one’s own risk, and individuals are encouraged to consult a finance professional before making investment decisions based off of this article.