Despite a suite of recent large deals, the sense is that the New Zealand mergers and acquisitions (M&A) bull market is starting to slow down, but no one is clear whether this is a short or longer term trend.
Last year reflected a continuation of the previous couple of years with a large number of businesses bought and sold privately and through takeovers of listed companies. Not surprisingly, the amount of activity reflected international trends with deal volumes and aggregate deal value well up on 2017.
Headline deals transacted privately included the sales of Hellers, PGG Wrightson's seeds business, OnePath (ANZ's life and medical insurance business), Academic Colleges Group, Manuka Health, Shell's upstream oil and gas assets and a number of sales by Fletcher Building. Takeover targets included Trade Me, Tegel, Steel & Tube, Methven and Restaurant Brands.
It is always hard to isolate the drivers behind any market activity trend, but consensus seems to reflect that deal flow was driven by solid local and international economic fundamentals, strong corporate balance sheets, substantial institutional capital looking for opportunities and an overriding sense of cautious optimism.
Private equity still looking to buy
Private equity funds are still driving a substantial amount of deal flow with approximately 50 per cent by number of the biggest 30 deals in the market during 2018 involving a private equity fund buying or selling the relevant business. Private equity funds typically focus on growth and turnaround opportunities. Investment is usually more active during the positive phase of any economic cycle with the funds looking to benefit from cyclical growth fundamentals.
Private equity investments are seldom sector-specific as compared to trade buyers, which typically focus on strategic acquisitions within their sectors of expertise. The Hellers, Academic Colleges Group, Manuka Health and Trade Me deals are examples of private equity transactions, but the key observation is that the private equity funds still have lots of dry powder and are looking for opportunities.
The cautious optimism theme warrants further exploring. We know from experience that all bull markets eventually come to an end, and history has suggested that New Zealand experiences 10-year peak-to trough-cycles.
The fact that the current bull run has to end at some stage weighs on the minds of the investment community. Coupled with this are the obvious concerns flowing out of the US-China trade war (and US politics more generally), a possible Chinese economy slowdown and Brexit.
Given low central interest rates, the traditional monetary policy lever of a rate cut looks like an unlikely cure for any future slowdown.
The nervousness that sits just below the surface resulted in sizeable stock market corrections last October with major indices falling markedly and the NZX losing nearly 10 per cent of its value.
Surprisingly, that lost ground has since been regained and the bull run has continued. Remarkably, the NZX 50 index is now nearly 9 per cent above the pre-correction high.
This nervousness tends to result in some fits and starts in deal flow. For instance 2015 was a massive year — perhaps the first of the post-GFC era, with a large number of deals done by private equity funds. 2016 seemed like more of a year of consolidation — strategic deals dominated with the most notable being the aborted Fairfax/NZME, Sky Vodafone and UDC deals coupled with the partial sale of Kiwibank and the sale of Sistema — mostly strategic trade deals.
The 2016 jitters wore off however in 2017 and 2018 with deal flow bouncing back; 2019 year-to-date seems to reflect a change in mood relative to the past two years, but it is early days still and the statistics may prove this wrong. The froth came off in the back half of 2018. Most of the deals done last year were brought to market earlier in the year. There have been fewer deals around in the last few months and those transacted have had more of the strategic trade theme particularly when considered with the takeovers of Methven and Restaurant Brands which closed this year.
Deal flow for the rest of 2019 is unclear. Having said that, the deals that have been announced are notable. In addition to the takeovers just mentioned, we have seen the announced sales of Westland Dairy to Yili, Vodafone to Brookfield and Infratil, and TipTop to Froneri.
Given the sheer size of these deals, the statistics at year-end will likely show another great year for M&A even if the rest of the year is slow.
The mood however seems to reflect that the prevailing focus is on deals showing a solid strategic rationale (like 2016) or defensive growth characteristics — businesses which don't depend on a bullish economy to grow. We expect to see a sensible slowing then in deal flow.
All quiet on the IPO front
No discussion on deal flow is complete without covering the IPO market. Reflecting trends in Australia, the IPO market has been dire here with not a single material IPO since the Oceania IPO in May 2017.
Last week saw the announcement of the proposed IPO of Cannasouth, established with a view to the commercialisation of cannabinoid compounds, but with a raise proposed of only $10m, this is not going to turn the dial.
Many will recall that the Government kick-started the capital markets back in 2013 with the mixed ownership model and the IPOs of Mighty River Power, Meridian and Genesis. This resulted in a wave of IPOs in subsequent years. However, there have been no IPOs for two years and the only obvious material 2019 IPO candidate is Napier Port which announced an intention to list a few months ago.
Again, it is hard to be definitive about the reasons, but it appears that companies aren't choosing the listing option in light of better pricing being available in the private markets, concerns about pricing and earnings transparency in the context of the potential slide in global and local stock market indices, the typical need to hold a substantial share of the company being brought to market for up to two years post-IPO and the increased regulatory scrutiny.
This has rekindled nervousness about the long term health of the NZX. The absence of IPOs needs to be considered in the context of the number of takeovers annually. There have been well over a dozen decent sized deals in the past couple of years and when we take account of companies dropping off the exchange for other reasons (like Xero migrating to the ASX and the failure of CBL which saw investors lose nearly $800m), there are good grounds for nervousness.
This has spurred the NZX to consolidate its three markets into a single board of listed companies and to rewrite the listing rules. It has also teamed up with the Financial Markets Authority and initiated the Capital Markets 2029 review — a rebirth of sorts of the Capital Markets Development Taskforce a decade or so ago.
Ripple effect from banking showdown
A key sensitivity for the business community is the potential impact of the Reserve Bank's proposal to increase the amount of high quality capital which the local banks are required to hold as security for deposit holders.
This has been pitched by the Reserve Bank as a rebalancing of the "rewards" enjoyed by the major banks by bringing those rewards back in line with the risks undertaken.
The projected impact of these requirements differs from the "minimal impact" described by the Reserve Bank to suggestions that the increased costs would simply be passed on to customers by way of increasing mortgage rates and decreasing deposit rates.
However, as the major banks are seen as some of the more profitable organisations in the country, there is a likelihood that they will endure some pressure (whether political or social) not to be seen to be passing these costs on directly.
That pressure is not necessarily all good news, because if the banks are unable to pass on costs directly, it is likely we will see a reduction of the flow of capital into New Zealand, which will likely lead to the rationing of credit. This means that the banks would narrow their focus and some sectors may find that their access to funds will be limited.
There is obvious concern for the agricultural sector already and distressed credit is not expected to get much support.
The reduction in credit is likely to have a dampening effect on the economy and will no doubt impact deal flow. This rationing has opened the doors to other market players who are willing to participate in those areas where bank funding is becoming more difficult.
Direct lending funds (or credit funds) have become a significant feature in offshore markets in the past few years and there is an increase in the frequency of capital being offered in New Zealand by these players in the last 18 months. The credit funds are providing opportunities to borrowers who are finding it more difficult to access more traditional bank credit, albeit at a higher cost.
In conclusion, there is still a sense of cautious optimism. Ultimately however, sentiment rules the capital markets and you cannot help but wonder what major economic or political event is going to undermine this and wake up the bears.
● Michael Pollard is a corporate partner and Dominic Toomey a finance senior associate at Simpson Grierson.