The postponed Valemus IPO sent chill winds around law firms last month and has some interesting implications for PE firms pondering exit strategies. However, it is not all bad news on the PE front. TPG Capital and Carlyle's proposed A$2.7bn acquisition of Healthscope promises be the largest private equity buy-out in Australia to date and there has been a steady level of other PE action, propelled primarily by secondary market activity. Private trade sales have increased in the past four months, with recent examples being Champ's sale of Study Group to Providence in a $660m deal and Quadrant offloading ATF back to Champ and acquiring Media Monitors in a management buyout.

Minter Ellison partner Callen O'Brien told ALB that companies waiting to exit have had to resort to private auctions in the face of a volatile stock market. "Vendors got excited last year when the IPO window finally opened up again. There was an influx of floats and exits," O'Brien said. "But before the backlog accumulated over the previous 18 month slump had time to all clear, a sudden drop in global confidence shut the window abruptly this March."

With the exception of some small to medium sized speculative deals in mining, exploration, IT and pharmaceutical companies, the IPO market has been quiet over the past four to five months and companies seeking to exit via an IPO have often been met with low and unstable prices. This disappointment, of course, was capped off by the Valemus postponement which set a discouraging tone for other potential float candidates such as REDgroup, Rebel Sport, and Aston Resources, which would have been watching Valemus carefully. However, as ALB was going to print Aston was reportedly still proceeding with its IPO.

Dual track and trade sales

Many companies disappointed with the IPO market have found better offers from private bidders. Clayton Utz partner Niro Ananda says there is an increasing trend to adopt a dual track sale process.Pursuing both platforms simultaneously entails several strategic advantages. The most obvious is a higher price, driven by competitive tension between the two processes. "There is pressure on potential trade buyers to offer an acceptable price, because they know the seller can always opt to list the company," Ananda says. "The vendor is afforded with greater flexibility in choosing the right exit option."

Trade buyers can often afford attractive tenders. "The buyers are comprised primarily of other private equity funds  or corporates.  We are also seeing increased participation from overseas corporates, in particular from Asia. Corporate trade buyers often envisage the acquisition will produce corporate synergies, for example by sharing management functions," Ananda says. "As a result, they are often prepared to offer a higher price."

A trade sale also enjoys logistical benefits. Norton Rose's Australian head of PE Nick Humphrey says trade buyers are more experienced from a process point of view. "The management team has probably gone through the process before and knows what has to be done in the transfer," Humphrey says, "Due diligence and other systems required from the change in hands are already in place. The can be sealed much more quickly."

The shift from IPOs to private sales is a common trend across PE markets in the post-GFC global economy. Humphrey told ALB that last year, one third of PE deals in the US were trade buyouts. The continuation of PE activity, albeit through another channel, can be explained by the simple axiom that market volatility, though potentially scaring away speculative investors, should not affect the underlying attractiveness of businesses which are fundamentally sound.

There is some concern that the surges in private sales have been driven by pressure on managers to prove their vintage. "There are a lot of managers, especially mid-market, who have been sitting on big portfolios for five or six years and are pressured to prove their portfolios," Humphrey says. "They have to sell their existing assets [so] they can raise new funds." However Humphrey says fear that unscrupulous managers are selling assets between themselves are mostly unwarranted, because the assets that have been sold on the market are genuinely good ones.

The growing trend for exits to pursue the dual track-process does not necessarily mean a doubling of the workstream for lawyers. "There are significant overlaps and cost savings, for example in due diligence, so it's not like lawyers can cost for two different transactions," O'Brien says. "The additional work generated depends on how far a company goes down the IPO platform before pulling the pin, and most are being pulled just before the final float."

Backlog
Private auctions have certainly helped to clear some of the excess, but there remains a considerable backlog of shelved assets waiting for stability to return to the stock market. O'Brien says some portfolio companies, especially larger ones, are simply not suited to private sales and have their natural home in listed markets.

Others assets suited for private sale simply cannot find the right buyer. "There are many assets which have been ready to exit in the past 12 months but cannot reconcile the gap in buyer and vendor expectations in terms of valuation," O'Brien says. "Vendors are demanding a value from pre-GFC levels and the purchaser is unwilling to pay that given the slump in the debt and equity market." The gap is closing now as vendor expectations become more realistic and debt become more readily available, but the mismatch in price expectations means many assets remain on the shelf.

Ananda says that inactivity does not equal stagnancy in the backlog room. "Rather than adding to their portfolios, private equity firms are redirecting their focus to their existing portfolios, injecting money into portfolio restructure and growth." Assets which are parked are not stagnating, but continue to grow and accrue in value.

Different dynamics

O'Brien  told ALB that banks, and especially domestic banks, are increasingly willing to lend, but generally liquidity is still limited. Compared to pre-GFC dynamics, a PE market starved of debt is a very different beast.

Restricted capital has concentrated most of the trade sales activity to the mid-market. "There is a noticeable absence in large transactions north of $500m, but deals in the $200-300m [range] have continued to flow in," Ananda says. While the Australian mid-market has always been active, its importance relative to the big ticket deals that dominated the market prior to the GFC has increased dramatically.

An increasing proportion of acquisitions have been equity funded. "The debt market is still tight," Humphrey says. "We are seeing many more 100% equity buyouts rather than leveraged ones."

Vendors are also seeking humbler beginnings and pursuing, at least initially, minority ownership. "There are lots of buyers who want to get a footprint in, but don't have sufficient funds to secure a controlling interest," O'Brien says. The long-term plan is to buy out the majority at a later stage. Many are happy just to remain in the minority as long as they have negative control in important areas under shareholder arrangements, for example to force an exit or drag along rights." 

An alternative is to pursue bolt-on acquisitions. "Rather than going for a large entry point acquisition, purchasers are looking to buy a smaller entry point asset and grow it through further bolt-on acquisitions," Ananda said.

The current dominant paradigm of mid-market trade sales resembles PE patterns in Australia in the early 2000s. "There is less focus on financial structure, more on operational activity, "Humphrey says. "We are seeing the Australian PE market return to its roots." 

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