M&A trends in 2021

In brief:  

Now is the time to identify your business’s strategic requirements, and whether a transactional strategy can assist you in achieving them.

1. Consider getting your house in order (i.e. transaction ready).
2. Engage a lawyer with experience in M&A transactions because it’s worth it in the overall deal costs and values.

Working in the M&A space sometimes feels like being the proverbial canary in the mine shaft.   I have the opportunity to see broader economic and social trends playing out in real time, often before they reach the newspapers and journals.  Capital really does have weight and when it starts to move around it can be an exhilarating and sometimes hair-raising ride.

Last year in the depths of the first lockdown, we predicted that 2021 would see an upsurge in transactional activity and this has been the case in spades.  As we pause briefly to catch our breath at the start of H2 for 2021, I begin to wonder what is coming next in the M&A and capital markets space.

My strong feeling is, it will be more of the same.  In this note, I explore some of the main trends we are seeing in the current market and what your business can do to prepare for or manage these:

• Equity as a service
• Valuations: continuing uncertainty; extremely high in certain areas such as technology
• Protracted deal timelines
• ESG: the importance of being earnest
• The importance of cultural fit to deal success.

What is driving transactional activity in Australia?

At one level, the uptick in transactional activity can be simply explained by the fact many businesses are cashed up and looking to deploy that cash in transactions.  Strong corporate governance, low volatility, and low interest rates, all in the context of Australia’s relatively sturdy performance during the pandemic, have paved the way for a buoyant private M&A market and IPO capital markets.  Market confidence has certainly not been dinted by the current pandemic spike.

However, there are also more fundamental factors driving business activity in Australia in 2021.  The pandemic has forced many businesses to transform the way in which they do business, often in fundamental ways.  This includes addressing gaps in technology, platforms, marketing strategies and infrastructure in general.  While this transformation was already underway pre-pandemic, these trends have accelerated rapidly since then.  M&A is a fast way to address these gaps in a rapidly shifting market.

Unsurprisingly then, most businesses surveyed early in 2021 expected to pursue more deals in 2021/22.[1]  Some of these businesses are in a position of growth, and are poised to acquire quality assets to plug their capability gaps, or take opportunities to enter new markets.[2]  Companies adversely affected by the pandemic tend to be looking for transactions to help recovery, for example, to boost their technological capabilities, or develop innovative ideas or products.  Those businesses most severely affected are undertaking defensive strategies to protect their core business, such as demergers, divestment of non-core assets and portfolio reviews.

These surveys also match the real world experience.  Anyone with time on their hands to read the business news of late will be aware of recent takeover activities, in diverse sectors such as energy, aged care, financial software, food delivery,[3] and there are also a myriad of undisclosed and confidential proposals that aren’t yet hitting the headlines.  Weakened targets are identified by analysists, and private equity groups are ready to take advantage.

In terms of transactions, access to and ability to analyse datasets is more important than ever in the due diligence phase of transactions, enabling a more precise understanding of the target company and the transaction risks, and more confidence in valuations.

Much of this activity is domestic.  Australia’s economic performance during the pandemic has set domestic businesses up as attractive targets for M&A activity.  Buyers for divestments are also mostly marketed towards domestic buyers.

Platforms and deals| How do deals get done these days?

Once upon a time (not that long ago), fundraisers engaged an AFSL-carrying corporate adviser.  The fundraising business paid a significant fee to the corporate adviser, partially reflecting the significant regulatory costs involved.

While this model still makes sense at the top end of town, at the other end, there is a move towards disintermediating advisers by using online platforms to bring the investment community into direct contact with fundraising small businesses looking for growth capital.

Online platforms have automated some of the mechanical aspects of transactions.  For example, standard form contracts are now freely available online.  Consequently, the role of the lawyer in deals is shifting, from providing a product (documents), to providing expertise and guidance, protecting the client from the wild west of the faster-moving transactional internet environment.  A properly experienced legal adviser gives context to the specific transaction, and ultimately helps guide the business to the correct and best structure.  This type of advice only comes with experience in the market.

Key tip:  Businesses looking to transact fundraising online need a legal adviser with corporate market experience.  Retaining an unsophisticated legal advisor is a risky move.

What does this mean for M&A?

1. Equity as a Service | Employee Share Schemes

Forget Afterpay, equity is rapidly becoming the new currency in the current market.  This is perhaps most obvious at the startup/early stage end of the spectrum, where cash-strapped Founders typically offer share options to employees and advisors in lieu of salary.

However, we are also seeing an upsurge in equity participation by larger or more established companies, offering shares as currency to reward, retain and attract key staff and high performers.  This is particularly important in areas where there is a relative shortage in key industries such as technology.

The race for talent has never been more brutal as businesses race to take advantage of the rebuild momentum.

Key tip: Employee share schemes are a highly regulated area, both for tax and securities law.  Keypoint offers a fixed price and cost-effective package for businesses looking to put in place an employee share scheme.

2. Equity as a service | Shares as a partnering currency

Many businesses are using equity as a partnering currency, for example in non-cash partnering arrangements like a joint venture or another business alliance.

This is particularly common when a business wants to achieve a digital transformation. Strategic business alliances enable smaller companies to access large-scale resources, traditional companies to innovate, and partners to concentrate on their core competencies.[1]  For technology-based companies, the business and industry relationships are extremely important drivers of success.

Key tips: Consider if a partnership arrangement will achieve your strategic needs, especially with regards to digital transformation.  Partnership alliances can also be an opportunity to test the cultural fit of a company before moving to a full merger. 

Hire a lawyer with experience specifically in joint venture agreements.

3. Valuations – uncertain, and often high | Protracted deal timelines

Ongoing uncertainties in valuations continue to plague the market, and valuations are rising, largely due to the ready supply of cheap capital for the more robust larger companies, the presence of cashed-up private equity groups, and competition for high quality assets.  Valuations are particularly high in certain industries such as IT.[2]

Responses by deal makers to manage the high valuations include stock swaps, which acts as a buffer for both parties against high valuations.[3]  Deals in the current environment also tend to be drawn out.  This is partly to manage high valuations, and partly because many businesses need to undergo pre-sale restructures in order to divest non-core assets. Many businesses are unprepared to enter into the deals that they envisage.

Key tips:

If considering a transaction, think about ways of deferring parts of the purchase price, eg earn-outs and other transactions beyond a simple “cash on completion” deal.

Also it may be worth taking advice on strategic future of the business, and determine if any transactional options are a good fit for the business. 

If you are a possible seller, consider vendor due diligence.

If your business may be attractive to a buyer, consider what steps would structure it to prepare for a sale.

4. The importance of Environmental Social and Governance (ESG) issues

ESG issues, especially climate change, are increasingly important in the assessment of deal value creation and risk management.  More than 30% of companies surveyed by Deloitte said they would be willing to pay a premium for a target with high level ESG attributes.[4]   However there is an early warning that businesses should avoid simply divesting their “dirty emitters”, (ie pushing the problem onto other businesses), and instead share the responsibility, and opportunity, to make transitions to reduced emissions.[5]

Key tip: Quite simply, think about ESG issues, and how to quantify them in due diligence.

5. Cultural fit and deal success

Many businesses are partnering with other businesses to provide capability gaps, often bringing  digital transformation to a business.  Such business models only work well when the cultures of the partnering businesses fit well.  Many deals fall over because of incompatible systems and expectations.  When two businesses converge to create a new business ecosystem, communication is vital.  Workers at all levels need to understand the reason for the change, and the value it brings to the businesses and to the individuals.  In value deals, the purchaser will bear the brunt of an ill-conceived cultural disruption to the business.

Key tip:  Buyers, include an assessment of a target business’s culture in the preliminary due diligence process. 

[1] Deloitte. The Deal in Focus | What’s ahead for M&A in Australia? P6.

[2] For example, Woolworths’ foray into the wholesale food industry, in its recent acquisition of PFD Food Services.

[3] For example, recent targets of takeover proposals are Oil Search, IRESS, Z-Energy, Japara Healthcare.

[4] Deloitte.

[5] Deloitte reports that the change in forward P/E multiples for IT is > 40.0x between March 2020 and May 2021.

[6] See for example the recent all scrip Square/Afterpay merger.

[7] The deal in focus | Heads of M&A survey 2021 p6.

[8] AFR 22 July 2021, Go where emissions are, Carney tells investors.  James Thomson.