Tech enabled businesses to dominate M&A in 2021

Podcast Transcript

Therese Raft

Welcome to a new season of Navigating the New Normal. Grant Thornton's podcast exploring trends in business and the market place. Today I am joined by Paul Gooley, Head of Corporate Finance in Sydney. Paul and his team recently released their seventh edition of Deal Tracker, a great piece of research looking at 18 months of deal activity in Australia, including the incredibly disruptive 2020 Welcome, Paul.

Paul Gooley

Good afternoon.

Therese Raft

So, Paul, not everyone is going to be familiar with Deal Tracker. What is it? Where is the data coming from? And who is it relevant to?

Paul Gooley

Deal Tracker is a publication, as you said we’ve being doing for it's probably up to 10 years now, and it tracks Australian deals, corporate deals over $5 million enterprise value, across the Australian market with Australian counterparties. Because it’s been going for over 10 years, and this is the seventh edition, we've got close to 10,000 deals in the database and it’s really relevant to all market participants who are looking to understand trends in deal making but also evaluation data. It also includes - every edition includes analysis off the public markets and what's been happening in motion the capital raisings and how the markets have been performing for the 18 month period that we use for each of the editions.

Therese Raft

So there's really nothing else quite like it in the Australian marketplace.

Paul Gooley

Yeah, we think so. Because not only do we grab data from public sources in our research sources, there's also been a fair bit of propriety information in there as well, which we use from our knowledge of transactions in the market. And it really gives you an understanding, I guess, of what's happening in M&A in Australia. One of the difficult things in Australia is to get good valuation information. So the report does go into valuation and a fair bit of detail in terms of what multiples have been paid and given also that we have seven years – sorry, 10 years of data on that – you know, you get some good long term trends on multiples and how they move in terms of different industries, but also on different sizes of deals, et cetera.

Therese Raft

And this most recent one, the data runs to mid-2020. So that catches the first six months of the year when borders were shut and businesses were asked to close their doors or to work remotely. What was the impact of COVID on deal activity?

Paul Gooley

You know, if everyone can cast their mind back to that February / March period in 2020 obviously the market really took a hit. And, a lot of transactions, probably the majority of transactions at that stage went on hold. Most of those have obviously come back now with a fairly strong second half of 2020. But there was a period there, probably between February and March, clearly, in this present edition up to June, where there was a very limited activity, probably the lowest we've seen for many years. That, though in the presentation is contrast to the first – well, to the whole of 2019 – which was a record period. Particularly the last quarters of 2019 were particularly strong. So the overall 18 month period of about 1400 deals is pretty consistent with what we've been seeing in previous editions. But that was really a story of a very strong 2019 and a very weak, I guess low volume, first half of 2020.

Therese Raft

So I'd really like to ask you about FIRB and foreign investment.

Paul Gooley

Now obviously FIRB rules changed back in March 2020 and the one important changes there was the threshold for deals went to nil value. So that's really held up – particularly in the mid-market in the lower mid-market – that's obviously held up a large number of deals that required to go through FIRB where they wouldn't normally. It did have an impact, I guess, on timing, particularly around completion and certainty on completion. But from my experience, it hasn't stopped deals. It's just added a little time to the process. Those thresholds came down on 1 January, with the rules changing, getting a bit harder in certain areas and increasing the fines. But given the thresholds have gone back, it will obviously improve, particularly mid-market transactions who won't need to go through FIRB in relation to those thresholds.

So, I say there is a positive that those change had come off. I don't think we've lost transactions from it, but what probably happened is that some of those transactions got delayed. And you see our numbers in the report, particularly on cross border, it was slightly down on trends from previous editions, and I think probably a lot of that is just in that initial February / March period or the March to June period – at least some of those transactions probably got stalled from completing because of FIRB. But they would have probably completed in the third and fourth quarter once FIRB approval was received.

Therese Raft

And I guess, I suppose, in terms of Australia as a destination for foreign investment, how much of the deal activity in Australia actually comes from overseas?

Paul Gooley

Yeah I think, I mean, the reports have been pretty consistent around that sort of 30% mark and that's similar to this report. So, there's been some good strong trends over the years we've been watching it. So, the 10 years I've been doing this, it has been increasing, and you definitely see it on the ground. I think the other thing that's happened in recent years is that the size of deals that get done from Find Buyers and the processes that are run now, particularly the lower mid-market - so deals under $50 million – do attract numbers off overseas buyers and that really goes to the sophistication, I guess, of global participants in doing M&A, but also the global search for investments. And that aspect is probably something that we'd expect to really give our market a potential boost, because if Australia comes out of COVID in a good position – at the moment it's looking like one of the best performers globally. If it does come out like that, there's going to be a lot of interest to invest in Australia, given out strong economic conditions and the way we have dealt with the health crisis. So it actually could be a fairly good period for inbound investment if we are able to keep out our health conditions as they are, and then obviously once the vaccine occurs, really get some growth into the economy again.

Therese Raft

That would definitely be a positive outcome. Now I've read the report and you show some industry trends over the years. Over the last 10 years you have, I noticed that there were some particularly resilient industries that continue to perform well despite the disruption that was 2020. Were there any that particularly stood out to you?

Paul Gooley

It was consistent with all of our previous editions. The industrial sector, and that’s a very wide sector in Australia, the industrial sector still dominates the deal landscape, particularly in the corporate side, were representative of 35% of deals. That’s consistent and it goes to the nature of a lot of our businesses are in that industrial space, but also there has been long term, sort of, consolidation in that space, particularly around niche manufacturing, etc which is still very popular with foreign buyers.

The sector to watch, though, and it's pretty clear, I guess, and this not just in private markets, but particularly public markets as well, is the IT / technology sector. If you look at the data that's jumped significantly with corporate buyers, but even more with PE purchases well, where it's now dominating the PE market and definitely, that's what we're seeing on the ground. A lot of the funds are really focused at the moment, not only on technology but businesses that can be enabled through technology - so more traditional businesses but have a technology bent to them. So, there's definitely been a very large move to technology, and clearly the COVID conditions have assisted those businesses in many areas. But we would see that as a really big trend this year, and really, that's the focus. Anything that has technology enablement to it is attracting interest. And obviously the valuations are extremely, extremely high in relation to some of those businesses, particularly if they've gotten the subscription models to their to their business models. So we would likely see that continue. And I would expect that this year technology again will dominate probably both the private equity investors but also probably the corporate investors as well.

Therese Raft

So it's interesting that you've mentioned technology and industrials. Both happen to feature in government policies around the modern manufacturing initiative. Do you think this will help to boost and generate more interest in those sectors over the long run?

Paul Gooley

There's no doubt that the government is going to support some manufacturing in certain areas – healthcare is obviously the one that comes to mind – to shore up supply of essential products and services in case we have another crisis. So some of them will be winners out of that, and I guess there will be some transactions around that. You're seeing a fair bit of interest in protective clothing, etc. in the healthcare space and I would have thought the government will come to support some of those sectors and bring back some supply security, sorry, security of supply in some of those sectors.

One of the other areas that will probably benefit from that is infrastructure services. We’re already seeing that the government's talking about a significant infrastructure spend over the next five or 10 years. It was already a thing before COVID, but I think that will be really boosted by COVID. And when announcements come out on new projects, I think that'll assist a lot of the providers that service the infrastructure area and construction sector. So that's probably another area which is not obviously technology enabled, but will get a boost, I guess, post COVID.

Therese Raft

Definitely something to watch. If we cast our minds back again, a lot of people were making comparisons to the GFC, but really, we've never been through a period quite like this one in living memory. Were there any surprises in how the market reacted or any trends that you didn't see coming or that you found particularly interesting?

Paul Gooley

I think if we're all honest – if you go back to that, particularly at March / April period – most commentators, and I guess we were taking that view too, thought that the economy was going to come under a lot of pressure, probably at the back end of the year or the start of this year, given stimulus was likely to come off. That really hasn't played out and if anything, the volumes – the M&A volumes – both domestically but also globally in the fourth quarter were close to record highs. We're seeing that sort of level activity into 2021. So really, we haven't seen the downside and I know there's some JobKeeper and stimulus and bank moratoriums are still coming off now. There is a lot of investment money around which is shielding, I guess, some of the downsides of the lockdowns etc. and there's a lot of money in both an investment house but also in the general public and so that is sort of supporting our conditions.

There is still no doubt risks in relation to that and clearly there's still lockdown risks in our economies and still risks to our economic conditions when all the stimulus comes off. But I think that's probably the main thing that that hasn't played out as much as people thought – we thought we'd see a fair bit of distress and that just hasn't played out that way. And if anything, the economy is quite strong. And particularly if we could get the vaccine out to the vast majority the population quite quickly and get some good growth going, we could see a fair turn around and a lot of stimulus come back into the investment markets and continue to see fairly buoyant M&A markets.

Therese Raft

Now, as you say, we're very much in the beginning of 2021 and businesses are looking at their plans for the year. So if you're in the marketplace, you're thinking about what your opportunities are for deals, is there anything that they need to be considering going into 2021?

Paul Gooley

Now, if you look, I guess from a Sell Side perspective, and you're looking to sell your business, as I said it's a fairly buoyant period at the moment. Now, a lot of that interest again is in technology enabled businesses. So clearly, if you had one of those, you know this is a fairly good market to be looking to do a transaction in. But even across the general markets, I think it does – with the growth coming back into the economy – it does look like a quite a good period to consider such options. In terms of what you would need to do, I guess you've got to have a plan to be able to trade out of these COVID conditions and also have – obviously, people would have COVID plans already in place in case we have further lockdowns or issues – but generally the market is returning to somewhat some level of normality.

Deals are being done remotely. Obviously, through this period we may be able to do them in more physical nature when the borders come down. But I think most people appreciate that the borders can come up at any stage. So you need to be out to do these deals remotely, and most transactions are getting done - with only the exception, potentially being site visits, etc, that are holding deal's up. So I don't think anything really changes.

I guess, from a Buy Side perspective, as I said, there's a lot of money around, a lot of investment money. A lot of that is going towards those certain sectors that are quite attractive. But nothing has really changed from a Buy Side perspective. I would've thought, there are going to be some opportunities to consolidate. And there has been a fair bit of innovation occuring in a lot of businesses around the way they service their businesses and their cost structures.

One of the key things: there's been a lot of cost out in many businesses, and a lot of those costs have come out due to lack of…to lack of mobility, I guess, in terms of staff and travel costs, etc. But some of those costs will obviously come back. But I think there has been a bit of a shift in some of those areas, like how people live. It's smarter in the way they operate from here on in. So there will be there will be some interesting assessments of the cost structures of businesses.

And also trying to assess normalised earnings has been quite difficult given the COVID period, and trying to normalise for COVID has been one of the challenges. And I guess if we could get a few a few months or six months of non-COVID conditions, I guess that gives a bit more certainty on future cash flows and the assessment of normalised earnings.

Therese Raft

And from a personal perspective, how are you feeling going into 2021 and maybe the next couple of years in terms of deal activity and your work.

Paul Gooley

You know, as I said, I think we’re pretty surprised at how well the market has come back and the difference this year is a lot of transactions started later in the year. So that's really producing a very strong first quarter, which is usually a bit of a slower period in normal M&A transactions. So we’re feeling pretty positive at the moment and if the vaccine rollout works and the health conditions stay under control, and the lockdowns can stay away, then it looks quite positive for market conditions. Clearly the unknown is once all the stimulus comes off how hard that hits, but again that looks like it'll be industry by industry specific and so the majority of the country will be able to transact.

The other theme, I guess, is how we're going to interact with foreign buyers, given they are a key part of most transactions, and I still think that there's gonna be a lot of interest from foreign buyers. Particularly given how well Australia is trading and our trading conditions. The lockdowns or the inability to travel may cause some issues with that, because in some jurisdictions there is a requirement for them to visit and to actually have physical meetings with people. And that might sound old school, but I still believe that may be required to get transactions done if they don't have local representation. So that could cause us some trouble with foreign buyers in our transactions. But I think people will work around that. And as I said, most of the transaction can be done remotely nowadays and people have got used to that.

We'll see how that plays out. But overall, I think we're very positive about this year. And whilst everyone is acknowledging there could be risks in the future at the moment, deal conditions are very strong and we would hope that that continues throughout 2021.

Therese Raft

Paul, thank you so much for your time.

Paul Gooley

Thank you.

Therese Raft

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