What to expect from M&A in 2022

From AFR January 8, 2022 Anthony Macdonald?and?Kanika Sood

?Interest rates will rise in 2022 but target companies and bidders are keen for another year of frenzied deal making. In 2021, Australian-announced deals totalled a record-setting $318 billion, as pent-up demand from 2020 and a strong economic recovery snowballed with buyer and seller confidence to deliver headline-grabbing deals. That number is nearly times 2020’s total deal volume, and nearly thrice pre-pandemic levels, according to Dealogic. From?Square’s $39 billion marriage with Afterpay?to?CSL’s $16.4 billion pre-Christmas bet on Swiss Vifor,?investors had plenty of dealmaking to keep them busy throughout the year.

Here’s what they should expect from M&A in 2022.

·??????Rates will rise but M&A drivers remain strong

Most investment bankers think interest rate rises tipped for 2022 won’t hold a candle to other powerful factors driving M&A, including board confidence and cash looking for a home. This is because rate increases will be small, keeping them at the lower-end of the scale in historical terms.

“The rate rises that people are expecting to see, when they happen, are moderate moves. Not moves back towards the double-digit interest rates of 30 or so years ago. In investments that are being made now, acquirers are typically assuming forward curve rates which encapsulate expectations of increased rates,” said Nick Brown, UBS’s co-head of M&A.

Erin Tinker, Barrenjoey’s M&A head, and Alex Cartel, Citi’s head of corporate finance and advisory, think in the same vein. “It’s clearly going to continue into 2022 because client aspirations are strong, they are looking at success of parties that have done M&A [last year], access to capital continues to be free and there are almost unlimited amounts pools of capital chasing a finite set of opportunities,” Mr Cartel said.

Whether 2022’s M&A volumes can match 2021’s, bankers aren’t quite sure. However, they do have their eyes peeled for some “elephant deals”.

·??????Red hot sectors

2021 brought deals across the board. Think?Transurban-Westconnex, Brookfield-AusNet, Woolworth’s Endeavour spin-off, Afterpay-Square, the API bidding jostle pitching heavyweights Wesfarmers and Woolworths against each other, and it’s clear there were big deals across the board.

For 2022, the bankers are betting again on market-wide activity but keeping a close eye on infrastructure, healthcare – where core-plus infrastructure funds that are prepared to look beyond traditional roads, rail and port targets are now investing – COVID-resilient technology names and renewables.

We hear big companies will still have appetite for ESG-driven portfolio optimisations, “green metal” miners may catch acquirer’s attention, and REITs (real estate investment trusts) are ripe for consolidation. Also back on the schedule are old-school businesses such as industrial and mining companies, whose due diligence COVID-19 restrictions may have hampered.

Even so, infrastructure M&A activity may be more mixed than last year. “I’d turn it the other way and say there aren’t too many sectors that are set for inactivity, other than the listed infrastructure market which has now largely been privatised,” said Aidan Allen, Jarden’s head of investment banking. “So things might slow down a little in the listed space, but even then there will still be significant activity in infrastructure buoyed by decarbonisation and energy transition and capital chasing core plus assets.”

And energy companies may shunt their capital market trips towards individual asset sell-downs. “We are going to see this continuation of energy companies selling down positions to seek new capital to fund upstream growth objectives and not relying on the capital markets,” Rothschild?&?Co Australia chief executive Marshall Baillieu said.

·??????Scrip vs cash

Scrip starred in many of 2021’s headline-grabbing deals, including Afterpay-Square and Santos-Oil Search, as hostile bids all but disappeared. Citi’s Mr Cartel and UBS’s Mr Brown reckon scrip will remain popular this year.

“Scrip transactions make sense in the current environment. Firstly for synergistic combinations that many corporates are looking at, secondly in terms of being able to strike transactions based on relative valuations [of the bidder and the target] and lastly because markets and valuations of many potential acquirers are at an all-time high,” Mr Brown said.

·??????Elections

While elections won’t stop dealmaking, they may make overseas buyers more cautious.

“I don’t subscribe to the fact that there’s a major pause in M&A activity around the elections. The only impact can be with foreign buyers as they have to go through the FIRB process. Nobody wants their acquisition to be used as a political football,” Mr Cartel said. Yet companies will be watching both parties’ policies on things such as carbon emissions and skills shortages. Rothschild’s Mr Baillieu said capital investment decisions are one to watch for 2022.

“There is no lack of cash and companies are choosing to acquire growth instead of growing organically. M&A activity has been high, but we are not seeing that business confidence from a capital investment perspective, and the forthcoming election will add another twist to that,” he said.

·????????????????Offshore buyers will return, but locals will drive bid premiums

Richard Hersey,?Morgan Stanley Australia’s head of M&A, says while overseas buyers were not absent in 2021, their country of origin changed. “The majority of large Australian M&A activity is cross border in some way. We’re clearly seeing changes in the nature of offshore acquirers, it’s skewed towards North American, Japanese and European acquirers, as opposed to the Chinese acquirers that you may have seen a few years ago,” he said, adding local companies were also actively seeking overseas targets.

At UBS, Mr Brown reckons North American companies will be the most active overseas buyers this year, and confidence among them for the Australian economy was strong. JPMorgan was already seeing greater cross-border interest from bidders in December, paving the way for last year’s relatively unloved sectors like mining and industrials for M&A deals this year, said Mark Carlile, JPMorgan’s vice chairman for ANZ mergers and acquisitions.

“It’s much easier in tech, for example, to do a cross border deal because you don’t necessarily have to go and physically see things. You can understand the business and do a deal without the need to travel so much,” Mr Carlile said. Yet Jarden thinks it will be cashed-up Australian bidders that will drive up bid premiums. “Conditions are there for more cross border M&A activity but to the extent we see real contestability in this market, it will still be largely driven by local participants, private capitals [and] funds with expanded mandates.” Mr Allen said.

·??????Big super funds

Almost every banker expected superannuation funds to become a bigger force in M&A. This year, to name a few deals, AustralianSuper bought a stake in Optus and Aware Super was part of a consortium that bought Vocus. Super will continue to flex its muscles, going into new areas.

“It’s shifting up from real assets, hard assets to more operationally focused assets. You saw super this year go after Infratil. You’ve seen them really look and participate more directly in particularly core plus space,” Jarden’s Mr Allen said. Morgan Stanley is betting on superannuation funds to become active in overseas M&A as their growing scale forces them to look for a bigger opportunity set.

·??????Private equity

Private equity firms continued to raise new funds in 2021, and they deployed some of their war chests into Australian assets in 2021, such as?KKR consortium’s $5.2 billion takeover of Spark Infrastructure. Yet, they weren’t shopping with the frenzy that watchers expected them to exhibit.

“We didn’t really see that happen. And that’s partially because private equity were first naturally focused on the COVID impact on their own [existing] investments and then the markets and asset prices recovered very quickly, so their window of opportunity was, in some ways, lost,” Mr Cartel said. Almost everyone’s betting on private equity to bid with fervour in 2022. At Rothschild, the firm gets is expecting its private equity client equity to increase in 2022.

And don’t forget, while PE was not as active a lot of other private capital was, including unlisted business and institutional investors. “Private capital accounted for 25 per cent of all public M&A on average over last 10 years. In 2021 it was 36 per cent. We expect this to continue, there’s a lot of dry powder,” Barrenjoey’s Ms Tinker said.

·??????Pre-bid stakes, exclusivity

Many M&A bidding wars in 2020 ended with final bids that were far beyond the target’s last traded prices. With bidders and targets expected to be equally interested in M&A this year, investors can expect more pre-bid stakes and aggressive attempts at locking in due diligence exclusivity. “We talk about raids regularly, and whether they’re the appropriate course of action is situation-dependent. Getting to 19.9 per cent is always an achievement when it happens,” UBS’s Mr Brown said.

“But our dialogue with prospective bidders, given the competitive environment for assets, is very much about what can you do to give yourself a competitive advantage in a potential bidding process. And pre-bid stakes are an element of that.” Barrenjoey’s Ms Tinker says bidders will likely further use pre-bid stakes in 2022 to get momentum for their bids. She also expects competitive bidding processes to stay, as the already-large institutional investors pool their capital to bid in consortiums and as strategic decisions drive M&A.

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