24 May 2022
In the 15 years since the global financial crisis (GFC), a key feature of developed economies’ monetary policy has been ultra-low interest rates. In pursuit of higher yields, this has seen Australian investors – like their global peers – seek out opportunities from a broader range of asset classes. This, argues Uyi Ighodaro, Division Director at Macquarie Capital, has forced them to get comfortable with investing further up the risk curve in order to generate higher returns.
"Sovereign wealth funds, pension funds, insurance funds and others are moving away from a pure focus on fixed-income assets like government and corporate bonds – as well as publicly listed equities and cash," explains Uyi. "To secure higher long-term returns for their clients and investors, they are incorporating some higher-risk alternative asset classes – including private equity (PE), infrastructure, credit and real estate – within their portfolios."
The numbers highlight the appeal: between Q1 2016 and Q4 2020, PE achieved 106 per cent returns, versus the 30 per cent achieved by the ASX 2001.
In line with this trend, more infrastructure investors have ventured into PE-type activities – looking to supplement traditional investment focus areas like building ports, highways and energy production assets with investing in more operationally intensive assets across healthcare, transportation and other sectors.
Infrastructure-focused PE funds have emerged as noteworthy winners. During financial year 2021 (FY21), Australia’s top five deals in terms of value involved infrastructure assets, representing 66 per cent of total deal value during the 12 months2 . Year-on-year, Australian PE deal volume grew from 124 during FY20 to 134 in FY213 . Buyouts represented almost half of all deals during FY20, and more than one third during FY214.
Examples of recent deals include EQT Infrastructure’s $A2.4 billion ($US1.7 billion) acquisition of Icon Group5, Australia’s largest integrated cancer care provider; Brookfield’s purchase of Victoria-based electricity and gas distribution company AusNet Services6 for $A10.2 billion ($US7.2 billion); and the IFM Investors-Global Infrastructure Partners tie-up to buy Sydney Airport7 for $A23.6 billion ($US16.6 billion).
With growing activity and ample liquidity on one hand, yet tightening macroeconomic conditions and worsening global geopolitical tensions on the other, what can we expect from Australia’s PE market in the short term?
Uncertainty caused by rising inflation, interest rate increases and the invasion of Ukraine has introduced volatility into Australia’s financial markets, prompting some PE firms to exercise increased vigilance in the short term. Overall, however, geopolitical and short-term macroeconomic events generally have a limited long-term direct impact on PE investments, says Uyi. With a three- to five-year investment horizon, many look beyond short-term disruption to find buying opportunities. For example, a dislocation in asset pricing caused by a market sell-off in late-2021 is resulting in PE firms looking to buy high quality tech businesses at lower prices than in the heady days of last year.
Infrastructure-focused funds also hold longer-term investment horizons, typically of more than 10 years, which allows them to invest throughout different market cycles as they can afford to look through shorter-term market volatility. Recent deals in the infrastructure space include Igneo Infrastructure Partners’s $A1.76 billion ($US1.2 billion) purchase of Waste Management NZ8, New Zealand’s leading materials recovery, recycling and waste management provider; as well as the Brookfield-Morrison & Co $A3.62 billion ($US2.5 billion) tie-up to buy telecoms infrastructure builder and operator Uniti Group9.
Irrespective of the industry or type of business, key criteria must of course be met. For many PE firms, these include items like high barriers to entry, strong product differentiation, customer loyalty, business profitability and cash generation, to name a few.
Today’s market resilience can also be attributed to past learnings. During the GFC, even though asset prices plummeted, most PE firms could not transact as debt markets froze, thus inhibiting their ability to borrow. Firms with access to capital during this period saw very strong returns on their investments. “Those who had the funds and courage to wade into the fray reaped great rewards,” notes Uyi.
A number of PE firms have since raised capital specifically for dislocation opportunities, and have sought to use ample cash reserves – “dry powder” – to take advantage when opportunity knocks. Bain Capital’s $A3.5 billion ($US2.4 billion) acquisition of Virgin Australia in 2020 was one such deal; Bain swooped in when Australia’s second-largest airline became severely financially stressed after travel restrictions were imposed due to COVID-1910.
Not all deals are made under such conditions, of course. Firms will typically be more comfortable paying a premium for a well-run company, with the aim of growing it further, Uyi notes.
None of this detracts from the attractiveness of the traditional growth themes that have long been go-to choices for PE firms, and which are expected to remain so into the future. These include healthcare assets, which provide defensive growth fuelled by an ageing population, innovation, and the reality that in time, everyone needs healthcare. This defensiveness is also due to the sector’s low correlation with global macro conditions compared to some others, and the limited impact of economic swings. Technology and software should also continue their upward trajectory for similar reasons; businesses and individuals rely heavily on them, regardless of how economies are performing.
Anticipated future trends include corporate carve-outs, whereby business units are taken out of companies and set up to run by themselves as standalone entities; and public-to-private (P2P) buyouts, where listed companies become privately owned.
Aside from longer-term investment outlooks, there are additional benefits of PE for portfolio companies and fund investors. “PE brings clarity and a laser focus to their portfolio companies, the PE deal team works in conjunction with management to create additional value and deliver on a company’s full potential,” notes Uyi. “Given that PE has a three-to-five-year timeline, they can invest in new markets without the need for an immediate return, and can typically move more nimbly than publicly listed companies.”
Governance is key. Typically, there are a handful of executives on the board of portfolio companies, usually a CEO, CFO and two or three other members from the PE firm, rather than multiple non-executive directors and committees. As such, it is easier for everyone to push in the same direction, with portfolio companies receiving guidance and direction in areas like capital allocation, mergers and acquisitions, financing, and business strategy, in which PE companies traditionally take the lead.
Another benefit is the ability to leverage the skills and knowledge of third-party experts. In fact, there is a wide pool of advisors in Australia with experience in guiding such businesses. Typically, these independent advisors are former industry executives, or chairpersons who have good operating and/or governance capabilities and join the portfolio company boards specifically to complement the goals of the company’s management.
With some 80 per cent of Australians expecting that their superannuation and other investments will be invested responsibly and ethically11, PE funds that help grow these must adhere to strict environmental, social and governance criteria. Such investments not only ensure that capital is deployed to sustainable businesses – they also help improve the practices of portfolio companies. “Ultimately, PE is “transitory” capital,” says Uyi. “You buy a business, improve it and enhance its outlook – and then sell it. It’s about making businesses better.”
Yet given its overall growth trajectory, could Australia’s PE market become overcrowded?
Uyi believes this is highly unlikely. PE firms can invest in different sizes of businesses, he says, and can support an endless range of transactions and partnerships: “Ultimately, what PE does is provide capital solutions for businesses and their management teams to create value. As such, the only limitation is human imagination.”