Stand back: The M&A party is just getting started

At more than $50 billion in the first four months of this year, the value of M&A deals targeting Australian companies has smashed a 40-year record stretching back to 1980, where data firm Refinitiv’s records begin.

• Growing appetite for alternative assets playing a key role
• Aussie PE firms’ $13 billion cash pile looking for deals
• The growth-to-value rotation will also be affected

The broad consensus in the industry is that we are indeed in the midst of an M&A boom. The three fund managers interviewed for this series agree on that point and believe it presents compelling opportunities for Australian investors.

To get a handle on whether this is a fleeting fad or a more sustainable shift, it’s worth considering what drives M&A activity. 

Private equity was a common answer among our respondents, citing a proliferation of cashed-up PE firms - who currently sit on more than $13 billion in Australia alone, says law firm Allens – as one key driver.

In the following wire, portfolio managers and analysts from three fund managers explain what this means for investors and one of the market’s fastest-growing sectors. They also reveal some of the other catalysts which they believe indicate many more deals lie ahead.

"Debt is plentiful and cheap"

Alex Shevelev, Forager Funds Management

Markets have recovered to pre-COVID peaks. Corporate bidders are trading at their own high equity valuations, meaning less dilution for existing holders if equity needs to be raised. Debt is plentiful and cheap. Businesses that have performed strongly through the pandemic, often termed COVID beneficiaries, have lots of cash.

And organic growth may be hard to come by from here. Acquisitions might help to prop up earnings as positive COVID impacts start to wane.

And then you have private equity bidders with big new funds that are looking to deploy capital. More recently, some of these have been teaming up with our giant domestic super funds. There’s certainly no shortage of cash looking for a deal to be done.

"Value stocks could benefit," says Gerrish

James Gerrish, Shaw and Partners

Liquidity and low-interest rates are driving the increase in M&A activity, and these dynamics are also forcing investors higher up in the risk spectrum. And as part of this, along with equities more broadly, there’s also a movement into alternative assets including private equity funds.

As investors increasingly put money into PE, these funds are fuelling an M&A boom. Putting together these deals is a key job they perform for their clients.

In terms of market size, the US is the clear leader in PE, whose scale dwarfs us here in Australia - we follow trends that are set in the US. One thing that’s become really clear over the last 12 months is that companies are increasingly big even before they float on an exchange. And that means there’s a lot more PE capital going into them in the lead-up to their listing.

Many of those companies have been technology businesses that are getting massive price-to-earnings multiples when they come to market. The PE companies have then got to “recycle” some of that capital, and I think in many instances this is going into the more cyclical businesses that lagged during the worst of the pandemic.

Technology will continue to be a popular sector for investors, but if you’re a PE company that has made 10-times your money on a technology stock, are you going out there and backing it? While PE companies will probably put a portion of their returns back into early-stage tech firms, I think they’ll be looking for more stable businesses to back, in order to balance out their portfolio investments.

"It's all about rates"

Luke Cummings, Harvest Lane Asset Management

The growth in M&A activity is happening globally, and one of the main drivers is interest rates. Even before the pandemic, the dominant view was that interest rates were going to be lower for longer, and that’s really been reaffirmed post-COVID.

But one of the key differences now versus before last March is that now you’ve got this growth coming down the pipeline, of which we’ve already seen the early stages. 

The combination of cheap money and quite a strong growth outlook globally – perhaps with rising inflation – bodes well for acquisitions more broadly. And you’ve got the “animal spirits” mixed in too, from the market having obviously been more buoyant than a lot of people expected, which has, in turn, boosted investor confidence.

But I believe M&A is mostly being driven by low-interest rates. Money is so cheap currently that deals that may not normally make sense are proving attractive to multiple parties.

In conclusion

As with so many aspects of the current market, low-interest rates and an absence of inflation are key drivers of M&A activity. And further to the above commentary above, we can infer that this activity is set to continue for some time to come - given ongoing stimulus commitments from governments and central banks both at home and abroad.

Stay up to date with this series

Make sure you "FOLLOW" my profile to be notified of the upcoming entries in this series. In part one, we determined whether there is indeed an M&A boom and what this means for investors. And in part three, our three fund managers point out where the bidding war is most ferocious and single out a few of the current and potential targets.