With more private equity investors chasing deals, ASX-listed boards must be clear on their takeover tactics, writes Ben Hurley.
Three years since troubled Victorian company Patties Foods was delisted from the ASX following a private equity takeover, the company is in a much better place. Bought out by Pacific Equity Partners (PEP) for $232m in 2016, the Bairnsdale producer of the iconic Four’N Twenty pie is one of a growing number of companies private capital has removed from the ASX in the past three years (see table below).
New investment in equipment upgrades and capacity expansion — close to $70m in Australia and New Zealand in the 2018–19 financial year — has turned the company into the world’s largest savoury pie bakery. Patties’ new owners say the investment is paying off. Helped by a range of new flavours such as craft beer-infused pies, annual revenue growth has surpassed seven per cent after sitting at under five per cent before the acquisition.
Tony Duthie, managing director of PEP, argues private ownership has made it easier for the company to launch innovative new products and marketing campaigns. “In a private environment, you have more willingness and capacity to take well thought-through risks to grow the business on a longer-term basis,” he says.
Private equity on the rise
The 2019 Australian Investment Council (AIC) Yearbook, which documents Australian private equity and venture capital activity, shows private capital under management has been rising at an increasing rate since 2016, to a record $30b in June 2018. Private capital is defined as private credit, private equity (PE) and venture capital (VC). As of June 2018, there was $11.4b in “dry powder” — capital raised but yet to be allocated — ready to be deployed.
This is a global trend. The 2019 Global Private Equity Report, published by Bain & Company’s PE consulting business, says the past five years have seen “unprecedented success” for the private equity industry. More money has been raised, invested and distributed back to investors than at any other period in the industry’s history, with dry powder hitting a record US$2 trillion in December 2018.
According to the AIC, the average size of PE funds closed in Australia was up by 117 per cent compared to the previous year. And PE-backed buyout deals achieved the second highest deal value in 2018, with 75 deals completed for an aggregate $13b, up 89 per cent on the previous year ($6.6b).
Patties is one of a growing number of once-public companies receiving an adrenaline shot from private equity firms. Since 2018, private hospital operator Healthscope, adult education provider Navitas, Capilano Honey and pet care group Greencross are just some of the well-known companies taken off the ASX following private equity buyouts.
Rod Halstead FAICD, strategic director of corporate and mergers and acquisitions with law firm Clayton Utz, has more than three decades of experience advising public boards. He says he can point to around 30 take-private transactions in Australia in the past three years. “It’s a lot more than in the past,” he explains. “Subject only to there being target companies available, I can see this continuing into the future.”
Halstead says offers are usually rebuffed for two key reasons. Either the price is not adequate, or it is a situation where the directors have concerns about giving the PE firm access to confidential information during the due diligence process. This can be a significant threat in cases where the PE firm is acquiring and aggregating numerous businesses in the sector. “You may find the board of the second or third target company takes the view there are significant competition issues, and providing access to the confidential information to enable them to go forward with due diligence would be prejudicial to their own interests and the interests of the business.”
David Kirk, CEO of Fairfax Media in 2005–08, says in the face of disruptive change, public boards can fall into the trap of relying on formal annual strategy reviews, “looking at the same sorts of tables and commentary” and “working to a timetable and plan of what success looks like”.
“Many shareholders struggle with the investment and risk-taking required to manage the transition from legacy business models to new business models,” says Kirk, now chair of investor fund Bailador. “This was certainly the case at Fairfax when I was CEO.” He says it is much easier to undertake business transformations with smaller, more focused boards of private companies “without the need for short-term earnings focus and the inevitable weak-kneed sellers you get in the public market”.
Private equity firms aren’t always the most popular kids on the block, and some high-profile ASX flops haven’t helped their reputation. When US private equity groups TPG and Blum Capital floated Myer, shares sold at $4.10 through a November 2009 prospectus peaked at $3.96 before entering into a slow-motion catastrophe that has left them worth just over 50c today. Electronics retailer Dick Smith and industrial services group Spotless are other textbook examples of private equity floats that bombed in the ensuing year or two.
Yet private equity more often than not provides essential capital to help businesses grow and, in some extreme cases, ensure their very survival. The ups and downs of private equity are illustrated by the fortunes of Nine Entertainment, formerly PBL Media. CVC Capital Partners’ ill-fated purchase of the Packer family’s PBL Media ended with the private equity firm writing off its entire holding, valued at around $1.9b. But after a period of ownership by private equity funds Apollo Global Management and Oaktree Capital following a debt-for-equity swap, the company relisted on the ASX in 2013 as Nine Entertainment Company. Back in public hands, it has since become Australia’s largest media company following the purchase of Fairfax Media last year.
The traditional take of private equity as barbarians at the gate — popularised by the book Barbarians at the Gate: The Fall of RJR Nabisco, and the subsequent docudrama — can be frustrating for those involved in the groundwork when unsolicited offers to conduct due diligence appear to be rejected for illogical reasons.
AIC chief executive Yasser El-Ansary believes Australia may have seen more public-to-private transactions if it wasn’t for a negative perception of private equity firms that has “sometimes extended to the boardroom table”.
Halstead, who advises and works for public boards, also finds it frustrating. “I’ve seen cases where boards have said, ‘We are rejecting this approach because of the high level of conditionality and the uncertainty around due diligence,’” he says. “Which is, frankly, a naive thing to say because anyone who gets approached from private equity knows that’s an inherent part of what you’re doing.”
Private equity proposals need to be highly conditional because the funds typically contribute equity and then source debt from a consortium of banks, and they need to ensure that the assets and underlying cash flow can support this, says Halstead.
He has also seen cases where the private equity firm imposes conditions the board feels are excessive, such as unreasonable employment retention arrangements. “In one case, they wanted a top executive to sign up to a 10-year contract.”
Directors sometimes have concerns the private equity firm will make decisions that aren’t in the long-term interest of the company, such as over-leveraging the company, under-investing in technology, or selling the company’s real estate as was the case with Myer. New York-based private equity firm KKR was reportedly looking to sell the Arnott’s biscuits property portfolio only a month after buying it and some of Campbell’s international operations for $2.2b in August 2019.
Boards fielding these kinds of bids often concern themselves with whether management or key shareholders may be the ones wooing the “barbarians”. But in Halstead’s view, ensuring the price and conditions of the transaction are right should be the key issues. “Taking it private might be in the best interests of the entity in the immediate term,” he says.
Investors want more of the pie
Crystal Russell GAICD, principal, global private equity at the Queensland government-owned Queensland Investment Corporation (QIC), leads its Asia Pacific investment team. She points to a range of advantages private boards enjoy.
Russell says not being distracted by daily share movements and quarterly earnings updates means management has a clear line of sight to longer-term outcomes, typically with strong alignment among the team. Private boards are smaller, meet more regularly, and board members usually have more “skin in the game” after taking part in the due diligence and investing their own money.
Additionally, the skillset on private boards is more focused than in public companies, with strong expertise brought in by private equity investors and operating partners. “You may see that on public boards, but it is very deliberate in private equity,” says Russell. “For example, a lot of managers will bring on a non-executive director who has significant experience delivering in that sector or on a particular element of the growth strategy.” QIC has about $6.7b of funds under management in its private equity program. It also takes direct company exposures through a co-investment program. Allocations to the private equity asset class are generally increasing and QIC’s private equity program is growing.
Russell says investors are increasing allocations to private equity due to superior returns, but also because the asset class has shown it performs well through the economic cycle. “When you look to underwrite a private equity deal, you’re looking for it to perform despite economic conditions,” she says. “We look to invest in growing companies where value can be created through active management.”
Battling the red tape
Companies often perform better in private hands. Cambridge Associates’ Australia Private Equity and Venture Capital Index showed a horizon pooled return of 9.79 per cent in the year to June 2019, compared to 11.48 per cent for its S&P/ASX 300 Index when calculated on a like-for-like basis. But over longer-term periods, private equity pulled ahead. When averaged over five years, the private equity and venture capital index showed a 15.22 per cent return compared to 8.16 per cent for the S&P/ASX 300 index. Over 15 years, private equity and venture capital returned 11.66 per cent compared to 7.06 per cent from the S&P/ASX 300.
A range of factors can give private companies the edge. Public companies are at the mercy of shareholders who often undervalue companies they don’t understand. In the case of Patties Foods and another PEP company, LifeHealthcare — which it took private in 2018 — neither got a lot of attention from analysts when they were public due to their small scale, says Duthie. Patties had fantastic brands under its wing, but hadn’t been able to secure the liquidity to invest in them.
There is also a view in private equity circles that public boards are stifled by restrictive governance standards and a heavy compliance burden. Partners Group, which has $130b under management, argued in a 2018 white paper, The Rise of “Governance Correctness”, that this dilutes listed boards’ decision-making capabilities and stifles their entrepreneurial spirit.
Its co-founder and partner, Urs Wietlisbach, warns of too much red tape. “The trend in public markets is for companies to be burdened by increasingly restrictive laws and regulatory codes, imposing excessive and often unnecessary corporate governance standards,” he says. “As a result, many public company boards spend large amounts of time on control-related topics, often pushing discussion of business strategy to second place. This is in stark contrast to private equity boards, which prioritise ‘entrepreneurial governance’, striking a balance between strategic discussions and oversight responsibilities, and pacing management to achieve their goals.”
Changing the business landscape
The steady increase of capital into private equity appears a secular trend with no end in sight, and the growing private equity presence is impacting the broader business world. Russell says the rise of investment in the sector is leading to more exit options that don’t involve going public. The majority of QIC’s eventual exits from buyouts of middle-market companies are either strategic purchases from large corporates or sales to other private equity funds.
As competition rises and assets get harder to acquire, the time horizon for some private equity investments is extending beyond the traditional four-to-seven year holding period. Longer-term funds are emerging, holding assets for more than 10 years. This trend accelerated globally in 2018 with KKR, Partners Group and CVC launching long-duration funds, although this remains a relatively small and untested part of the market.
Mega buyout funds are emerging. Apollo, Hellman & Friedman and The Carlyle Group launched funds of US$24.7b, US$16b and US$18.5b, respectively, in 2017–18. Clashes between the cultures of public and private companies are likely to become increasingly frequent as public companies field more private offers, and private companies grow and develop company cultures that rub up against the public market’s practices.
Increased competition in the sector has the potential to change the way the market values assets. Kirk says private companies with an eye to an eventual public market exit need to be careful their value doesn’t overtake what public investors can accept, as was the case with WeWork’s catastrophic public offering in August. “We are very conscious as we invest in private companies and take them through funding rounds to keep an eye on public company valuations to ensure we never get ahead of ourselves,” he says.
Halstead says private equity-backed companies also have a looser way of handling environmental, social and governance (ESG) issues, laying down a pragmatic approach that challenges the formalised, altruistic direction public companies have been taking in recent years. “Clearly, they need to focus on environmental issues to the extent they’re relevant to the conduct of the business,” he says. “But social and governance issues are much less important, although they will always focus specifically on foreign corrupt practices.”
Still, investors and consumers place demands on companies they deal with. QIC’s responsible investment team is involved with every private equity transaction in the due diligence phase to ensure the company is examined through an ESG lens. It also works closely in monitoring and implementing ESG recommendations.
Nobody is predicting the end of the public company. Investors continue to be drawn to the liquidity and transparency of public equity, giving public companies access to enormous amounts of capital to drive new strategies and cushion against difficulties. Going public is still the exit channel many private companies look towards. But the presence of private equity will be felt increasingly in public markets, particularly with market uncertainty dampening valuations.
El-Ansary argues private capital could be what Australia needs to be more globally competitive. “I certainly hope we see more public-to-private transactions in Australia,” he says. “One way to maintain healthy competitive pressure on listed businesses and boost productivity, competitiveness and innovation is to... take them into private ownership... and allow them to recalibrate their business strategy.”
Shareholder flight leaves Patties Foods stranded
The year 2015 was a tough one for ASX-listed Patties Foods. With shareholders already wary of falling profits and the company’s lacklustre share price, a hepatitis A outbreak linked to its imported berries led Patties to recall a range of products. Shareholders abandoned the company, and by 2016 its share price had reached a new low of $1.05 (shares were offered at $1.75 in its 2006 IPO).
Now in private hands with Pacific Equity Partners (PEP), Patties has undergone an expensive transformation that would have been a tough sell to the fickle loyalties of public shareholders. PEP bought Adelaide meal solutions business Australian Wholefoods, New Zealand group Leader Food and Victorian company Boscastle, folding them into the business.
Upgrades and expansions to the Patties bakery in the coastal town of Bairnsdale, Victoria, and the acquisition early this year of a Simplot facility in Pakenham, allowed the company to claim the mantle of the world’s biggest savoury pie baker.
PEP managing director Tony Duthie won’t provide figures on the number of staff employed since the takeover, but he argues the Packenham plant — previously owned by food manufacturer Simplot — would likely have been shut down had Patties not acquired it. Patties has a board of five directors. Two are appointed by PEP and two are external directors — brothers Harry and Richard Rijs, part of the Patties founding family who publicly listed the company in 2006 and kept a 20 per cent stake after the private buyout. CEO Paul Hitchcock, who was appointed in October 2016, was formerly MD or CEO of Corporate Express, Petuna Aquaculture and Primo Group.
The tactics of takeover
With investors chasing deals, listed boards must be clear on their takeover game plan says Tracey Horton AO FAICD, former chair of Navitas. By Narelle Hooper
Navitas chair Tracey Horton was home in Perth on a Saturday in October 2018 when she had a call from Rod Jones, co-founder, former CEO, non-executive director and major shareholder of the global education provider. A month out from the AGM, Jones had uncomfortable news. He had teamed with private equity firm BGH Capital and Australian Super to privatise the business he had listed on the ASX in 2004.
Horton rang CEO of three months David Buckingham and other directors. By the Sunday, the company had advisers Goldman Sachs and Ashurst on the case and had formed a bid response committee.
The board rejected the $5.50/share takeover bid, which valued Navitas at about $2b. The company was a strong cash business with a share price trading below what the board believed was fundamental value.
As the twists and turns of takeover played out over the following nine months, Horton, an economist and former dean of the University of WA Business School, narrowly survived an attempt to vote her off the board before the board accepted a revised bid of $5.825 per share, a premium of $100m, in January 2019.
After that experience, Horton’s advice for listed boards is: be prepared.
“There’s certainly a lot of money chasing deals at the moment, and interest rates and WACCs (weighted average costs of capital) are relatively low,” she says. “The implication is that a takeover is more likely than perhaps it has been in the past. Every board needs to be aware of that and have it in the back of their heads as they’re thinking about strategy and strategic options. It was fortunate we had been undergoing a valuation exercise because it made us better prepared when an offer came along. When it happens, it all happens quickly and you don’t have a lot of time to get your act together.”
Horton advises directors to take time to understand their industry and its competitive dynamics. “Your external advisers end up being really important, because they’re there with you every day and they’ve been through these circumstances before,” she says. “Deciding how you’ll work together as a board and structure your response team is critical; also the role of the management versus board.”
Management has to run the company, so it makes sense for the board to take the lead with the deal, advises Horton. “As chair, you’re the focal point of many of the interactions and involved in the bid response committee.”
Efficient communications and information flow are vital to keep the board up to speed, but “you don’t want the whole board reading every line of every draft contract”.
Questions for directors
- What’s changing in the competitive dynamics of your industry?
- Where is your share price in terms of what the board believes the company value is?
- What are the triggers that will influence valuation versus fundamental value?
- Who are the potential buyers? Who could you buy?
- How prepared is your board for a takeover?
- Who are your potential advisers for a bid response committee?
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