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Directions in Capital Markets

07.09.2017 Daniel Scotti, James Hutton and John Elias

Equity Capital Markets

After $11.1 billion in initial public offerings (IPOs) during the first half of FY17, aggregate Australian IPOs plummeted in the second half of FY17 to $3.2 billion, less than one-third of the value raised in the same period in FY16. In the second half of FY17, nine financial issues raised 49% of the capital. FY17 saw eight IPOs each raise more than A$200 million. These were:

  • Viva Energy REIT, A$911m (August 2016)
  • Charter Hall Long WALE REIT, A$827m (November 2016)
  • Inghams Group, A$596m (November 2016)
  • Propertylink Group, A$503.5m (August 2016)
  • Bingo Industries, A$439.6m (May 2017)
  • Plato Income Maximiser, $325.9 million (May 2017)
  • Antipodes Global Investment Company, A$313m (October 2016)
  • Scottish Pacific Group, A$293.5m (July 2016)

 

Sector hotspots for FY18

Some IPOs shelved due to market sentiment

Float supply was hit when Accolade Wines (majority owned by CHAMP Private Equity, with New York-listed Constellation Brands holding a 20% stake) shelved a proposed $1 billionplus IPO in February 2017, while market volatility and retail jitters saw Wesfarmers abandon plans for a $1.5 billion IPO of its office supplies retailer Officeworks three months later. Fast food player Craveable Brands, owned by private equity investor Archer Capital, pulled its $400 million IPO in June because of equity market conditions, and retail sentiment.

 

Other vendors pushed through sentiment concerns. The listing of the Charter Hall Long WALE (weighted average lease expiry) REIT in November 2016 appeared to be a challenging process: an initial attempt to list in October, was shelved due to insufficient investor interest. Charter Hall revised the terms of the offer, including reducing the overall size of the offer, and the company proceeded with a float based on the revised offering terms (with a revised forecast 2017 dividend yield of 6.3%, compared to the initial 5.3%).

 

Solid competition from the trade-sale route

At the large end of the market, volatile markets and competition from trade buyers saw some significant sized potential IPOs shelved. For example, in March 2017, WA’s largest gas retailer Alinta Energy, which would have been FY17’s largest IPO at approximately $2 billion, was sold to a private company owned by Hong Kong’s Cheng family, for approximately $4 billion. Similarly, in November, rather than an IPO, the administrators of South Australian steelmaking business Arrium sold the company’s Moly-Cop arm (the world’s largest supplier of grinding media used in mining and construction) to US private equity firm, American Industrial Partners for $US1.2 billion.

Whitegoods retailer The Good Guys also opted for a trade sale, bought by JB Hi-Fi in September 2016, after mooting a $1 billion plus IPO; while Quadrant Private Equity-owned tap maker Zip Industries mulled a $300 million IPO, with a $500 million market valuation, but was bought by PE-backed US water treatment company Culligan International Group for $550 million in June. 

Retail Apparel Group was eyeing a $400 million IPO but a slump in earnings multiples for discretionary retailers, amid growing fears about the impact of Amazon and weaker consumer spending, saw it accept a trade bid in May, from South African retailer The Foschini Group. 

The dual-track process remains a major competitor for IPOs, particularly for PE vendors, who are increasingly asked to hold post-listing stakes of between 15%–45% in companies (with the norm at 25%–30%) when they are not natural holders of public equity. The certainty of selling 100% in a trade sale can be very appealing.

 

 

Financials a hub of activity

Demand from financial advisers, investors and self-managed super funds (SMSFs) for listed vehicles that offer a wide range of asset classes and investment strategies, to help build a diversified portfolio, has seen a surge in financial listings. In FY17 there were 12 listed investment companies/listed investment trusts (LICs/LITs) added, bringing the number of such vehicles to 102: the sector capitalisation rose by 12.3%, to $33.1 billion.

 

There were also 25 exchange-traded products (ETPs) listed, bringing their number to 162: the sector’s capitalisation surged 30%, to $29.2 billion. To contextualise this, 10 years ago, the market capitalisation of ETP assets in Australia was just under $1 billion.

 

ASX draws foreign listings

 

On the back of a successful marketingstrategy, ASX has seen a flurry offoreign companies, particularly in the technology sector, list in Australia. In FY17, the ASX welcomed 39 offshore companies from countries such as Israel, New Zealand, Singapore and the US, bringing the total number of foreign listings to 266. This number has doubled in the last four years.

In particular, marketing to the burgeoning Israeli technology sector brought 10 Israeli listings to the ASX in FY17, making 14 companies in total. Israeli companies consider the ASX as being well-connected to Asian investors, and a good market to complement their access to seed and early-stage investment by venture capital firms. ASX is seen as having a high standard of corporate governance, and being an ideal market for companies to attract growth funding.

Strong interest from Chinese companies to list on the ASX remains. FY17 saw a further six Chinese listings. However, numbers have slowed since the exchange banned the variable interest entity (VIE) structure in 2016, where a listed company could control a foreign operating company through a series of complex contractual agreements, rather than through direct equity ownership. ASX also welcomed seven secondary listings of New Zealand-listed companies, bringing this complement to 53 companies.


Follow-on raisings a mixed bag

 

In aggregate, secondary capital raisings fell in by 18% in FY17, to $37.2 billion, largely due to the absence of the large bank capital raisings that occurred in FY16. Rights issues were 58% lower, at $8.4 billion but share placements were 58% higher, at $13 billion. Follow-on offerings continued to be supported by large M&A-linked raisings. Notable placements and rights issues used to fund acquisitions included:


Boral’s $1.5 billion renounceable rights issue raising (end of 2016), as part of a US$2.6 billion (A$3.5 billion) deal to buy US construction materials rival Headwaters Corp.


Downer EDI’s $1.01 billion two-for-five rights issue to fund its $1.3 billion bid for Spotless: several institutional investors baulked at the issue, leaving underwriter UBS with a shortfall. Downer EDI ended up aquiring 87.8% of Spotless, meaning the latter would remain listed.


Mayne Pharma’s $888 million raising (a $287 million institutional placement and $601 million rights issue) to acquire assets from Teva Pharmaceutical Industries and Allergan (see case study).


 

Link Group’s $883 million rights issue to fund its $1.5 billion acquisition of Capita.


Dexus’ $500 million institutional placement to fund office property acquisitions.

Australian listed gold producer, Evolution Mining’s $401 million rights issue, to fund a stake in Glencore’s Ernest Henry mine in Queensland: Evolution paid$880 million for a 30% stake in the operation.


Electronics retailer JB Hi-Fi’s $394 million rights issue, to fund its purchase of The Good Guys.

Other significant non-M&A raisings in FY17 were: 

 

Oil and gas company Santos’ $1.5 billion raising, comprising a $1 billion institutional share placement and $500 million share purchase plan to enhance balance sheet flexibility.


Telco TPG Telecom’s $400 million rights issue to fund TPG’s $1.9 billion plans to build a mobile network, including its $1.3 billion purchase of the required spectrum.


Logistics services firm Qube Holdings’ $350 million raising (comprising a $228 million rights issue – the company’s second in two years – plus a $122 million institutional share placement) to fund the building of its first tenant warehouse and facilities at its Moorebank Logistics Park project in south-west Sydney.

 

The majority of transactions involved a discount to the prior closing price for placements or theoretical ex-rights price (TERP) for rights issues of between 6% and 15%. The sectors in which activity continued to dominate from the prior FY, were the financial, materials, industrials and property sectors accounting for over 60% of the overall issuances by sector. Rights issues remain the top issuance by deal type chosen by issuers, almost equally split between renounceable and non-renounceable rights issues.

Case study: Mayne Pharma

Mayne funded the deal through an $888 million rights issue and placement, the largest accelerated offer and placement for a listed corporate in Australia in 2016.

 

The raising was to fund Mayne’s 2016 acquisition of a suite of US generic drugs from Israeli giant Teva Pharmaceuticals and global pharmaceuticals company Allergan transformed the company.

 

Mayne Pharma gained a portfolio of branded and generic drugs that has elevated it to a substantial player globally, and significantly boosted its development capability. Mayne is now the second-largest drug manufacturer on the ASX.

The deal was significant, involving a tender process with several international competitors, overseen by the US Federal Trade Commission and it required immediate funding from capital markets for this cross-border deal.

MinterEllison’s expert advice in the placement and pro rata accelerated non-renounceable entitlement offer and the acquisition processes, helped Mayne to successfully secure an array of products, receive full financial backing of full underwriting by Credit Suisse (Australia) and UBS AG’s Australia Branch and, ultimately, boost the company’s presence in the world’s biggest pharmaceutical market.


The outlook for secondary raises

Activity in secondary raises continues to be driven by M&A transactions by ASX-listed acquirers and there was, overall, less domestic acquirer demand for equity in FY17. With organic growth remaining challenging across many industries, we expect growth by acquisition to continue in FY18 – with opportunism remaining a key driver.

We see the “hot” M&A sectors in FY18 as: health and aged care; IT and software services; food and agribusiness; financial services; and infrastructure. In the resources sector, players will be looking for acquisitions or consolidation plays. Given the industry is at the bottom of the investment boom, and not every exploration strategy has been successful, companies may be looking to play catch-up by buying resources in the ground, and/or assets near to production. These factors could drive secondary raisings activity.


The major banks may also need to raise between $3 billion and $5 billion each in additional capital due to the Australian Prudential Regulation Authority’s (APRA) recent capital changes. APRA has lifted the target for major Australian banks equity capital ratio to “at least 10.5%,” from the level of common equity tier 1 capital (CET1) of about 9.5% at the start of the year – in order to meet the “unquestionably strong” benchmark previously established. The banks will need to raise significant additional equity to achieve this, although this may be achievable by building more equity organically through retained earnings rather than mounting equity capital market raisings.




Directions in Capital Markets 2017

 

 

 

 

 


 

 

 

 

 

 

 

 

 

Changes to ASX listing rules took effect in December 2016


Under ASX’s new listing requirements, companies seeking to list can still choose between a profit test and an asset test but the criteria for both assessments have been tightened.

Companies choosing the asset test must have either $4 million in net tangible assets (NTA) or a market capitalisation of $15 million. Previously, companies required NTA of $3 million or a market capitalisation of $10 million. For all companies admitted under the NTA test, they will also need to have $1.5 million in working capital, and provide two years of audited accounts. The profit test requires companies to show consolidated profits of $500,000 for the 12 months prior to admission, up from $400,000 previously.

Other changes made to listing conditions include a new 20% minimum free float requirement, a single-tier spread test of at least 300 investors each holding at least $2000 worth of securities and a standardisation of the $1.5 million working capital requirement for those admitted under the assets test.


Back door to ASX still open

Reverse takeovers (RTOs), also known as ‘backdoor listings’ (allowing companies that may not otherwise satisfy listing requirements to enter the market by acquiring already-listed companies) are also facing a clampdown, but can request ASX to waive its new minimum issue price of 20 cents to allow an issue price as low as 2 cents.

 

Backdoor listings must comply with additional disclosure requirements, or shares will be suspended. The boom in backdoor listings was driven by a “use it or lose it” rule introduced by ASX in 2014, giving dormant shell companies a three-year limit to find a new activity, or be delisted. We believe there is still demand for RTOs but we also see the number of potential “shells” to use is waning.

Debt capital markets


Demand for Australian government securities remains strong, and recent bond tenders have generally been well received. After a debut 30-year issue in October 2016, raising $7.6 billion, Treasury’s borrowing arm, the Australian Office of Financial Management (AOFM), completed a $9.3 billion December 2021 bond issue in January 2017, and followed that with its largest government securities syndication to date, an $11 billion 10-year bond issue in February. There was strong demand from offshore investors, as the higher yields available in Australia continued to outweigh concerns that persistent budget deficits could hurt the nation’s AAA credit rating.

The AOFM had $455 billion outstanding in Treasury bonds as at the May 2017 Budget, with 24 lines on issue, and maturities ranging from 2017 to 2047. It forecast gross issuance of $80 billion in FY18, or net issuance of $33.9 billion after allowing for bonds maturing and buybacks. This would represent almost half the net debt raising for FY17, which was expected to reach $74 billion. However, on the latest figures, foreign holdings of government securities had fallen to 55% of the total outstanding stock, down from almost 80% at the start of 2012. According to the Reserve Bank of Australia, the level of outstanding semi-government bonds was stable at around $240 billion toward the end of FY17, with issuance by Western Australia and Queensland offset by maturities from New South Wales.

The secondary corporate market remains strong, enhanced by additional liquidity through the recent buyback and redemption of securities, for example:

 

Crown Subordinated Notes (approx $100 million);


Tabcorp Subordinated Notes (approx $250 million); 

Colonial Subordinated Notes (approx $450 million);

NAB Subordinated Notes (approx $634 million);



ANZ Subordinated Notes (approx $1.5 billion);


IAG Subordinated Notes (approx $357 million);


Heritage Bank Subordinated Notes (approx $50 million); and


Westpac Subordinated Notes (approx $1.7 billion).


The total bond market size has retreated by close to $4.2 billion following these buy-backs and redemptions. The excess liquidity is anticipated to lead to favourable conditions and constructive opportunities for companies to issue listed securities in the secondary market. Demand is outstripping current supply and the market is likely to continue to be soundly bid and spreads are expected to continue to rally across the curve.


Simple corporate bonds struggle 


Since the “simple corporate bond” rules took effect in November 2014, allowing companies to issue corporate bonds under streamlined disclosure standards through a simplified two-part prospectus, with reduced civil liability for directors and flexible due diligence processes, there has not been the hoped-for flurry of issuance.

After the first simple corporate bond (SCB) was issued by health services and investment firm Australian Unity (November 2015, an issue on which we worked), ASX-listed residential property developers Peet Ltd (May 2016) and Villa World Ltd (March 2017, an issue on which we worked) have
issued SCBs. The Villa World bonds are unsubordinated and unsecured floating-rate debt with a five-year maturity.

Peet was the first follow-on issuer in June 2017 and while this raising demonstrated that the structure can be a reusable issuing platform, we do not expect the SCB to enter widespread use until Treasury gives it parity with equity raising rules – that is, levels the playing field entirely so that a follow-on issue can be mounted without any form of prospectus, but simply a cleansing notice (a statutory notice a company must issue after placing new securities on the market) is
used instead.

SCBs remain a ‘watch this space’ situation in the absence of further regulatory changes.

 

Qube goes down retail corporate bond route


Logistics services firm Qube Holdings breathed life into the dormant retail bond market in August 2016 with a $200 million issue of subordinated debt, the first of 2016. Not having a formal credit rating, Qube exemplifies the companies that are natural candidates to choose a retail issue over an institutional one. As the Australian Financial Review put it at the time, a credit rating matters less in the listed debt market because ratings are actually prohibited given the agencies do not possess the appropriate licence to offer advice: so, an issuer suffers no pricing penalty for not having a rating. By contrast, institutional funds have mandates that either restrict them from buying unrated paper or limit the extent of unrated bonds they can buy. Qube sought to tap the demand for income from self-managed superannuation funds and “sub-institutional” investors such as universities, hospitals, family offices, high-net-worth investors, charities and endowments. While in a low-interest environment this demand is pressing, the dearth of issuance remains frustrating.

 

Loan market


Favourable market conditions prevailed for borrowers accessing the Australasian loan markets, with strong liquidity and a lack of supply seeing robust deals well supported. Appetite was particularly strong for borrowers in non-cyclical or defensive sectors, with infrastructure and real estate being the biggest contributors to loan market volumes. Infrastructure M&A accounted for the “whale” deals, with the highlight being IFM Investors and AustralianSuper tapping a $12.8 billion syndicated facility (October 2016) – the fourth-largest Australian loan on record – to take a 50.4% stake in the 99-year lease for New South Wales electricity distributor AusGrid. That was a big contributor to M&A-related acquisition loan activity totalling US$24.4 billion in calendar 2016, its largest contribution since 2007.

M&A activity has continued to support the market in 2017, examples being:

  • First State Super, Hastings Funds Management and a pension fund with UK-based Royal Bank of Scotland Group paying the New South Wales government $2.6 billion for the right to manage the state’s Land and Property Information unit for the next 35 years (April 2017); and
  • Macquarie Group’s infrastructure arm and a group of partners (including AMP Capital, Qatar Investment Authority and Canada’s British Columbia Investment Management Corporation) acquired a controlling stake (50.4%) in NSW electricity distributor, Endeavour Energy for $7.6 billion (May 2017).

The largest corporate transactions completed were the refinancings of Optus ($1.5 billion) and Sydney Airport ($1.4 billion), while debt repayment continued to be a major use of loan proceeds. The standout greenfield project finance transaction was the $1.7 billion non-recourse senior debt facility (December 2016) for Sydney Motorway Corporation to fund the M4 widening and the M4 East twin tube highway tunnel sections of Sydney’s major WestConnex project.

 

Kangaroo market


Kangaroo bonds – foreign bonds issued in the Australian market by international entities that are denominated in AUD and are subject to Australian securities laws – continued as a robust market, given impetus into FY17 by Apple launching its second kangaroo bond, a $1.4 billion issue, which followed its successful debut bond offer in August 2015 when it raised $2.25 billion, and Toyota Motor Credit Corporation making its kangaroo debut with a $400 million deal.

Other recent successful kangaroo bond issues include the $1 billion issue Coca Cola (June 2016) but corporate issuance has been scarce. However, in the new financial year, US telco giant Verizon stunned the market, with a $2.2 billion bond sale in August 2017. This was the
first kangaroo bond from a corporate issuer in 2017 and the second-biggest corporate bond in the Australian market, behind Apple’s $2.25 billion three-tranche Kangaroo debut in August 2015.

In between, a who’s who of supranational institutions, such the International Bank for Reconstruction and Development, the Asian Development Bank and the African Development Bank, as well as a core of European and North American agencies and semi-sovereigns such as the Province of Ontario and Province of Quebec – keeps the market pumping. South American supranationals also joined the market in FY17. We expect Verizon to presage rising interest from global corporates in the kangaroo market.

 

US Private Placement market


Australasian names – especially from the infrastructure space – remain highly sought after in the US private placement (USPP) market, with transactions often multiple times oversubscribed. New South Wales electricity transmission network TransGrid’s July 2016 transaction, comprising US$700 million ($1 billion) and A$75 million tranches, was the largest from the region. More recently, in July 2017, Ausgrid made a record-breaking debut in the USPP market, tapping more than $US1.6 billion to refinance a bridge loan taken out when IFM Investors and AustralianSuper bought into the electricity distributor last year as part of a wider $12 billion debt package. It was understood to be the biggest deal ever by an Australian issuer to USPP investors.

A host of Australian corporates continue to tap into the USPP market as a viable funding option in long maturities. CSL, Charter Hall Prime Industrial Fund, Growthpoint Properties, Brisbane Airport Corporation, Treasury Wine Estates, Orica, Asciano and QIC Shopping Centre Funds are just a few of the recent examples of borrowers in this space. Several recent Australian transactions have achieved some of the most competitive pricing ever in the market, with the A$ funding premium reaching a new low of 5 basis points.

Wider application of bonds


Although the structure of bonds is basic, the “technology” is being used in ground-breaking ways, to help solve societal issues such as climate change, gender diversity and homelessness. The Australian market is at the forefront of this change, with examples of hugely innovative uses of the bond structure outlined below.


World’s first university-issued climate/green bonds Navigation Show below Hide below

Monash University issues the world’s first university-issued climate bonds in December 2016, raising $218 million. Climate bonds (or ‘green bonds’) are created to fund projects aimed at tackling climate change. The capital raised by Monash will be spent on projects that achieve measurable sustainability outcomes and allocated to a portfolio of projects in line with the standards of the Global Climate Bond Initiative, as well as with Monash’s own pledged transition to net zero emissions.

The green bonds, which were issued in the US private placement market, were certified by the Climate Bond Initiative and have a “Green Bond” accreditation from Moody’s. They were structured to provide the market with investment options in both, USD and AUD over 15 years, 17.5 years or 20 years, raising upwards of $900m. Monash was able to secure rates well below 5% and in a strong sign of investor support, was also able to borrow for more than double the seven-year duration of standard corporate lending in Australia.

Growth in ethical investing drives issue of gender diversity bonds Navigation Show below Hide below

FY17 also saw NAB announce the first social bond to specifically promote workplace gender equality, the NAB Social Bond (Gender Equality). The proceeds of $500 million from the five-year, fixed-rate bond will be used to finance or re-finance the assets of Australian businesses that champion equality (i.e. that the Workplace Gender Equality Agency cites as Employers of Choice for Gender Equality (EOCGE)) and that meet the requirements of NAB’s social bond framework. Because the gender diversity bond shares NAB’s credit rating, it will typically carry the same yields as the bank’s regular bonds. Thus, the bonds have the same credit quality and profile as any other senior unsecured bond issued by NAB.

Organisations in the NAB Social Bond (Gender Equality) portfolio include Lend Lease, Mirvac, Stockland, Monash University, Australian Catholic University, PwC, KPMG Australia, MinterEllison and others. In addition to meeting EOCGE criteria, organisations in the Social Bond (Gender Equality) portfolio must satisfy specified social, environment and governance criteria.

The same structure is used in bank “green bonds,” such as the Westpac Climate Bonds where the bank uses the proceeds of $500 million to finance or re-finance, in part or fully, new or existing sustainable projects, such as renewable energy, energy efficiency or projects that lower carbon dioxide emissions. The climate bond shares Westpac’s credit rating, and carries the same yields as the issuer’s regular bonds, delivering a win-win outcome of funding, without investors bearing the risk of specific green project funding.

The successful issue of these bonds demonstrates the continued growth in ethical investing in Australia, a market which has doubled to $51.5 billion in just the past two years.

 

Government clean energy bonds Navigation Show below Hide below

In July 2016, Victoria became the first government in Australia to issue green bonds, raising $300 million to finance new and existing projects that deliver environmental benefits. The green bonds, issued by the Treasury Corporation of Victoria, were also the first government-issued bonds globally to receive international Climate Bond Certification. The triple-A rated bond was fully subscribed in a little over 24 hours, supported by insurance companies, fund managers and investors with a specific green or socially responsible investment mandate.

Social impact bonds Navigation Show below Hide below

The country’s first social impact bond targeting homelessness closed early and heavily oversubscribed in March after raising $9 million in less than a month. The Aspire bond, a partnership between Social Ventures Australia, the South Australian government, and not-for-profit organisations Hutt St Centre and Common Ground Adelaide, will support up to 600 people experiencing homelessness.

In April, the market saw Australia’s first social impact bond for mental health and Queensland’s first social benefit bond uniting children in out-of-home care with their families reach their target raising one month after launch. Social Ventures Australia (SVA) raised $7 million to go to the Resolve Social Benefit Bond, which provides funding for crisis care to people in NSW with a severe mental illness, and $6 million towards the Newpin Queensland Social Benefit Bond.

The $7 million Resolve Program, providing around the clock support for more than 500 people in western Sydney and the state’s central west, is expected to save the government $30 million by shortening hospital admission periods, and will offer investors an expected return of 7.5 percent a year.

In July 2017, the Victorian government announced that its first social impact bonds will focus on drug and alcohol treatment programs and young people transitioning from out-of-home care to independence. The state government is in talks with social service providers, potential partners and investors to determine how best to go about setting up SIBs to tackle these issues.

 

Case study: Queensland's first social benefit bond


MinterEllison was involved in Queensland’s first social benefit bond (SBB), which aims to reduce the number of Indigenous children in out-of-home care. The bond was launched in March by UnitingCare Queensland (UCQ) and Queensland Treasury. UCQ will work with Social Ventures Australia to raise private capital through the issue of SBBs to fund the establishment of the New Parent Information Network (Newpin) program across Queensland. The Newpin program provides an intensive support service, and is designed to safely return children to their families following a placement in out-of-home care.

UCQ has entered into an outcomes-focused agreement with Queensland Treasury, with a payment structure based on the number of children that are successfully reunified with their families. MinterEllison worked with UCQ through the request for proposals phase of the pilot project, and subsequently advised on negotiation of the Implementation Agreement during the joint development phase.

 




Directions in Capital Markets 2017



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