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There is a growing impetus for sponsor-led Australian M&A activity over the next 12 months, given record levels of dry powder, historic returns from vintages deployed in recent periods of challenging economic conditions, and an expanding universe of opportunities for sponsor-led buy-out activity, according to a new report from leading international law firm Herbert Smith Freehills.

The firm’s inaugural DealMakers Report: The Australian M&A Market 2023 draws on an empirical study the firm has conducted of deal dynamics and terms across a sample from the more than 120 Australian private M&A transactions that it advised on in 2022. The report provides deep, data-driven insights into the Australian market that should inform how dealmakers approach the year ahead. It also sets out the firm’s predictions for the next 12 months.

Key findings in the report include:  

  • In 2022, mean and median private M&A transaction values ─ A$764m and A$105m, respectively ─ were down against 2021.  
  • However, comparing 2022 mean and median private M&A transaction values to the 2019 data, 2022 displayed 260% and 127% growth in transaction values, respectively. 
  • Financial sponsors were a bright light, with buy-outs representing 36% of transaction volume and 22% of transaction value, and exits representing 24% of transaction volume and 19% of aggregate transaction value. 
  • In 2022 there was a discernible ESG driver at play in 21% of transactions reviewed in the report.
  • Energy and related infrastructure were the dominant sectors for ESG-driven transactions, representing 16% of transactions ─ this is indicative of the demand for exposure to the energy transition. Anti-bribery and corruption was the most common issue dealt with via ESG-specific warranties, featuring in 14% of transactions.

HSF partner and author of the report, Adam Charles, explained, “Rising interest rates, surging inflation, stalled supply chains and the war in Europe made for difficult dealmaking conditions in 2022. Consequently, 2022 deal values were down against 2021. However, it still proved a strong year having regard to historical data, before the easy money-fuelled deal-making of 2020 and 2022. 2021 in particular was a outlier year for Australian M&A, so it is not surprising to see activity levels in 2022 somewhat subdued in comparison. 

“Financial sponsors did well in 2022, particularly given that they, along with institutional investors, were underrepresented in significant areas of transaction activity. For example, corporate carve-outs represented 32% of transaction volume, yet sponsors and institutional investors featured as a buyer in only 5% of those transactions.” 

Mr Charles explained that there was reason for optimism in terms of the outlook for M&A.

“Financial sponsors are now sitting on an estimated US$1 trillion in dry powder, and there is a need to get funds out the door. This, matched with historic returns from fund vintages deployed in recent difficult economic periods and an expanding universe of buy-out opportunities available, will drive capital deployment.

"An uncertain economic outlook will also cause sponsors to explore buy-outs previously considered too complex and unattractive to sellers in the seller-friendly market that has prevailed recently. On the sell-side, the economic climate is expected to cause corporates to revisit their portfolios and be open to opportunities not previously explored ─ all of which will drive activity. 

"Recent examples of sponsors making takeover offers directly to target shareholders, and bypassing target boards, is arguably an example of these forces at work."

The report also predicts more sponsor participation in complex corporate carve-outs, sector consolidations via multiple buy-outs undertaken concurrently and mergers.

Mr Charles commented, “Traditionally, sponsors have generally utilised a buy-out model. A number of factors may drive a near-term evolution to this model, with sponsors considering and transacting more minority deal structures and preference, convertible and warrant instruments.

"Assuming a 'risk off' attitude prevails on the buy-side, watch for bidders pushing deal terms further in favour of the buy-side. For example, we expect a movement in relation to recourse to the seller where transactions are insured. Whilst 87% of 2022 transactions involved some form of recourse, only eight percent of those transactions involved recourse in relation to warranties or indemnities that were not insured. Given the value impact of this setting in a tightening economic environment, we expect sponsors to be increasingly reluctant to be exposed to this risk and push it to sellers.”

According to the report, 2023 is also set to see increased activity for sponsors in the venture capital space, and those that can move quickly will benefit.

“There should be greater deal activity in the venture-capital backed tech space, as Australian tech founders and boards review their exit and liquidity strategies. This will generate opportunities for consolidation to address cash burn rates, and exits to corporates and sponsors,” said Mr Charles.

"The near-term competitive dynamic is likely to cause transaction timetables to drift. In turn, bidders with a demonstrated capacity to transact quickly will find themselves able to pursue, on a bilateral basis, opportunities that may not otherwise be realisable. Corporates and sponsors with industry pedigree and greater risk tolerance will be best placed to capture these opportunities."

As a final prediction, Mr Charles explained that ESG considerations would continue to play an important role in M&A.  

“We expect to see more ESG implications for deal terms in future. The impact of ESG matters on deal terms in Australia is more advanced in other major M&A markets, where warranties have been expanding to cover industry standard, best practices and soft laws. Look out for this to have a creeping influence on Australian activity,” he said. 

Find out more and request a copy of the full report here

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Adam Charles

Partner, Melbourne

Adam Charles

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Emily Coultas

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