Equity capital markets remain in flux in 2023 as macroeconomic forces dampen company valuations and investor enthusiasm. A cocktail of post pandemic challenges continues. These include high inflation, interest rate rises that now show signs of abating at least in Australia, ongoing workforce shortages, and logistical and supply chain constraints arising mainly from geopolitical conflict.
While the tide may be turning, companies seeking to raise capital face an uncertain outlook, no matter if they aim to fund growth, pursue investment opportunities or simply survive. Certain sectors offer brighter prospects than others, yet the goalposts are ever shifting. New issues are emerging for investors, institutions and regulators as digital technology transforms business models and more companies prioritise environment, sustainability and governance (ESG).
In March 2023, MinterEllison Partners James Hutton, Sudharshan Senathirajah, Steven Wang, Sarah Barker and Kate Koidl hosted industry leaders for a roundtable in Melbourne. The purpose was to discuss the evolving outlook for equity capital markets amid a range of current challenges. The group comprised (in alphabetical order):
- Nick Alexander, Managing Director, Head of Coverage and Advisory, UBS
- James Berman, Director Equity Capital Markets, Bell Potter Securities
- James Gerraty, Head of Listings Compliance, ASX
- Kate Hall, Group Executive, Company Secretary and General Counsel, Nufarm
- Mark Heaven, Chief Operating Officer, MaxCap Group
- Richard Long, Principal M&A Advisory, Deloitte
- Craig Mackey, Director Corporate Development, IDP Education
- Chris Nave, Founding Partner and Managing Director, Brandon Capital
- Martin Newnham, Chief Executive Officer, Growth Farms Australia
- Professor R.R. Officer AM
- Steven Skala AO, Vice Chairman Australia, Deutsche Bank
The session occurred in the wake of the startling collapse of the California based Silicon Valley Bank (SVB), a major lender to the tech sector, as well as the New York based Signature Bank. Seeking to minimise systemic risk to the wider financial system, the Biden Administration guaranteed all deposits. This calmed market jitters on the ASX, where several Australian companies found themselves potentially exposed. It remains to be seen if the two largest US banking failures since Lehman Brothers, which precipitated the 2008 Global Financial Crisis, mark a blip or inflection point for equity capital markets in the period ahead.
Signs of a market rebound
In his opening statement, MinterEllison Partner James Hutton observed that “headwinds continue to blow a gale in capital markets globally and here at home”. Nonetheless, participants agreed the trajectory for 2023 is more promising than 2022 when the number of initial public offerings (IPOs) plummeted.
Steven Wang of MinterEllison recounted how A$140.8 billion in total capital was raised from 241 IPOs and 1,031 secondary raisings on the ASX during a blockbuster 2021. In 2022, IPOs fell off dramatically to just 107. However, the number of secondary raisings remained largely stable as ASX listed companies sought to shore up balance sheets and raise capital to fund organic growth initiatives or acquisitions. The ASX was the top ranked exchange globally for volume of secondary capital raisings in 2022.
2023 started strongly for equity capital markets, with 10 companies undertaking IPOs in January (mostly in the minerals or energy sectors). James Berman of Bell Potter Securities said he remained hopeful and still saw potential IPO candidates being pitched in coming months. Price and valuation expectations needed to come down in line with inflation and tighter monetary conditions. Nevertheless, he added, “there’s always a market for good quality companies”, particularly in areas such as clean energy that are structurally important to the economy.
Recent deals attracting strong investor interest in the secondary market include recapitalisations for Carsales.com, Star Entertainment, Flight Centre and Ryman Healthcare. Nick Alexander of UBS also pointed to TPG’s acquisition of a 20 per cent stake in InvoCare. “Fund managers were happy to seize the opportunity to lock in an attractive return. Investors remain very happy to take advantage of market events to generate alpha where they can, as opposed to just keeping the money in cash,” he said.
Other IPOs in the works include the much anticipated raising for Virgin Australia, as well as Chemist Warehouse and AirTrunk.
Speaking from his vantage point at ASX, James Gerraty added: “I’m not going to pretend the pipeline isn’t skinny at the moment. But my experience says, you should certainly see more IPOs in the second half of the year.”
Current macroeconomic volatility has forced many companies and start-ups that had planned IPOs to postpone and look at alternatives like issuing convertible notes (short term debt instruments which customarily convert into ordinary equity). However, this has been complicated by ratchet provisions designed to protect investors from subsequent capital raisings at lower entry prices. “It’s incredibly hard to find new money for a lot of those companies that are doing a second or third pre-IPO raising to bridge their finances for another 12 to 18 months,” Berman explained.
Banking jitters from the US
As mentioned, the collapse of SVB in March sent shockwaves through the innovation and technology sectors, with flow on effects for equity capital markets. Chris Nave of Brandon Capital, Australia’s largest life sciences investment fund whose global links extend to Silicon Valley, noted that SVB had been a key provider of venture debt funding to start-ups that were expecting to go public before the IPO window slammed shut. These companies are now stranded, waiting for conditions to change. SVB was also the key transactional bank for a significant proportion of the US biotech industry.
Overall, roundtable participants felt SVB’s collapse was likely a combination of poor risk management in a volatile interest rate environment, as well as insufficient sector regulation. However, it was also felt the US government’s subsequent decision to guarantee deposits might distort incentives and create a moral hazard for investors and fund managers. While there are lessons for financial institutions everywhere, Australia’s economy was seen in far better shape than the US. “All the talk in America is about a recession; there’s not much mention of that here in our sector. We’re having a completely different discussion even though we’re a connected global economy,” Nave said.
Promising sectors for capital markets
Are there companies that can still attract capital in the public markets? The conventional wisdom is that the current inflationary climate has cruelled the appeal of the technology sector and other growth stocks. Apple, Microsoft, Amazon, Tesla and Alphabet reportedly suffered an average 34% drop in market capitalisation during the worsening economic conditions of 2022. At the same time, paradigm shifting AI and natural language processing platforms such as ChatGPT bring far reaching potential to transform business models. In 2022, equity funding topped US$2.6 billion worldwide for generative AI start-ups (resulting in more than 110 deals), according to CB Insights. Examples include Anthropic, Inflection AI and Cohere – with further waves of capital activity expected.
The roundtable observed how international education was a promising sector, as the post pandemic return of international students to Australia is not so tied to domestic economic conditions. Many EdTech companies are now looking for strategic investors. Infrastructure companies offer the attraction of providing a broad hedge against inflation, while metals and mining continue to carry the Australian market, accounting for 57 per cent of new ASX IPOs last year.
Agriculture was seen to have strong capital raising potential. Martin Newnham of Growth Farms Australia noted that farming property is often an intergenerational family investment, while some investors include agricultural assets as part of a managed portfolio. There is growing recognition, particularly among European and Canadian funds managers, that quality, sustainable Australian produce, including meat, grain and horticulture, has considerable appeal to growing middle class populations in Asia with eco-friendly tastes. Domestic start-ups are also innovating in production, packaging and supply chain logistics.
Growth in land values is another positive for investors prepared to take a minimum 10 year time horizon. Thanks to rapid developments in research and technology, the opportunities in sustainable farming practices are increasing. These include the ability to integrate renewable energy, carbon sequestration, and biodiversity projects into farming operations, supporting long-term business viability and better meeting environmental and consumer demands.
Growing relevance of ESG
A growing consideration for equity capital markets is the impact of ESG – with climate change the lightning rod issue. Leading an extended roundtable discussion, Sarah Barker, Head of Climate & Sustainability Risk Governance at MinterEllison observed that climate change should be a major concern for companies – even if their primary motive isn’t necessarily altruism. “It is not just an environmental or ethical issue. It is a financial risk and opportunity that is growing in materiality every day,” she said. These risks are manifesting now and creating economic transition pressure, particularly in Australia where average temperatures are 1.4 degrees Celsius warmer than at the start of the last century.
As more nations commit to net-zero emissions targets, companies are under pressure to not only set targets, but develop credible transition plans and demonstrate meaningful progress. Increasingly, super funds and sovereign wealth funds are selective about where they choose to invest.
Mark Heaven explained how MaxCap had formed an advisory group to integrate ESG into its investment activities. Kate Hall noted that Nufarm had already been asked by its European customers to prepare to report on its emissions in coming years so those customers could meet Scope 3 disclosure obligations. It was also noted that enforcement is tightening in relation to ‘greenwashing’ – where a public representation (including information memoranda to prospective investors) overstates a company’s sustainability credentials.
Economic returns remain the key criterion when investing capital. As Professor Officer pointed out, “I’ve talked to a number of senior fund managers and put to them the theoretical position – if you have two companies that are identical in all respects, one implements a public policy of ‘greening’ while another doesn’t, which do you pick? They say our responsibility is to our client and our shareholders. We go for the higher dividend.” However, Barker struck a chord in emphasising that ESG risks are not being efficiently priced by markets. Many fund managers are yet to become fully equipped to identify relevant risks. Alternatively, they may simply discount them as faraway concerns without understanding their potential to massively affect value.
A race to the top?
Participants noted that Australian companies in high emissions sectors such as oil and gas, metals and mining, agriculture, commercial property, transportation and infrastructure need to be pricing into transactions the rising cost of finance or obtaining insurance. For example, under initiatives such as the Net Zero Asset Managers’ Initiative and the Net-Zero Banking Alliance, leading financiers convened by the United Nations have pledged to decarbonise lending and investment practices in accordance with the Paris Agreement. The schemes already cover portfolios collectively worth about US$130 trillion.
Sustainability linked loans are another form of positive incentive, offering a basis point reduction or ‘greenium’ in the cost of financing. While the interest rate benefit can be modest, borrowers reap additional benefits from the publicity and credibility afforded to their sustainability programs.
Of relevance to exporters, it was noted that the first round of reporting requirements for Europe’s carbon border adjustment mechanism comes into effect in October. This will levy a carbon price on imports of high emissions intensity products from 2026 (such as energy, steel, aluminium, cement and fertiliser) equivalent to the European carbon price – currently around €100 per tonne.
“Our wholesale financial markets are largely dependent on funding from Europe, as are our insurance and reinsurance,” Barker said. “Therefore, you’re going to have to satisfy what the European asset owners are demanding in this space. Remember, they are subject to laws requiring them to decarbonise by 2050 and halve emissions by 2030. Their due diligence is ratcheting up and if you want to continue to get money out of these markets, you have to match them.”
Supporting markets during turbulence
Returning to the macroeconomic themes at the start of the session, Sudharshan Senathirajah of MinterEllison asked the roundtable to consider a potential recession in the US and even Australia. The key question is how policymakers should support markets during times of economic stress. During the first year of the pandemic, the ASX increased the amount an entity could raise under a placement from 15 to 25 per cent. It also facilitated rights issues and share purchase plans (SPPs) to help companies quickly raise funds. Some rules allowing for later lodgement of financial statements and the convening of AGMs were also introduced by the Australian Securities and Investments Commission.
“We were persuaded in a short space of time that this was a very serious event that needed action,” said James Gerraty of ASX. “Some companies raised replacement money if they were in trouble. Others were able to raise capital by saying they also had needs that extended beyond what they could ordinarily do under the rules.”
The ASX was criticised in some quarters for exceeding its authority, but the result was to facilitate a huge recapitalisation. “Corporate Australia is actually fairly well capitalised right now as a result of the raisings during COVID, among other things,” said Nick Alexander. “While there are some macro headwinds, most companies are in reasonably good shape and actively looking to do things. The market has shown it is prepared to support good companies with capital if required and we would expect that to happen again in the event there was some other external shock."
Another participant observed that eliminating the threshold for Foreign Investor Review Board approval was a useful lever available to the Australian government to protect companies whose share prices falter in an unlikely stock market crash. “There is still a lot of money around the world looking at Australia, so that will be an interesting moment for policymakers in terms of how they defend the integrity of the whole market.”
