Neil Pathak

So far this year, we have seen a year-on-year decrease in M&A activity, although this is compared to 2021, which was a huge year for M&A. What is the current state of the M&A market?

Absolutely, 2021 was crazy in terms of workloads. I’ve been doing this nearly 30 years and it was the busiest year by far. Coming into 2022, we’re still quite busy. In the first half, we were completing on deals from last year and also moving onto new deals. 

Certainly, here in Australia, climate change and energy transition has driven, and continues to drive, a lot of M&A, particularly in renewable energy. Separately, PE firms in Australia are very active – both global and local firms. We often hear about PE firms having lots of “dry powder”. That’s true generally, but here in Australia, that’s supercharged given our compulsory superannuation system, which requires employers to contribute 10.5%, growing to 12%, of a person’s salary to pension or superannuation schemes. So, our superannuation funds (i.e., pension funds) are getting incredibly large. They’ve got to put that money to work – apart from listed equities, it’s going into PE funds, property or into infrastructure investments (and we have seen a lot of infrastructure M&A over the last two years). There is plenty of unspent money in our market looking for good homes.

That all said, times are becoming more challenging. With inflation going up, in September, our Reserve Bank increased interest rates for the fifth month in a row. So debt is becoming more expensive, and terms are harder too. Asset prices, and stock markets in particular, are declining. While bidders may have adjusted their valuations and prices downwards, targets and vendors have not. So there is a pricing mismatch now, which makes it harder to get deals done. However, by overall standards, it has still been a strong year and we expect that to continue to the end of the year. For 2023 – it is maybe harder to say, particularly if inflation and interest rates do not start to flatten out.

At the start of the COVID pandemic, there was an expectation that we would see higher levels of distressed M&A and restructuring situations. Due in large part to government support programs, that hasn’t happened – do you expect these types of deals to increase in the next year or two?

My insolvency partners have been really disappointed with the levels of distressed M&A over the past two years, which, to your point, has been a function of strong markets as well as governments providing COVID relief, stimulus funding and other emergency measures. I think banks have also been pretty good throughout that period in giving borrowers time to recover from periods of COVID-impacted trading. But now, as we move to a high-inflation, high-interest rate environment, those times are behind us. Banks will give borrowers less time to fix their problems. And, at the same time of course, government relief is falling off. This will inevitably lead to more distressed M&A. By way of example, just this last week, I have been helping a listed company with a rescue capital raising. The company had not been trading as well as it might have hoped and so their lenders wanted to see some debt repaid. This ultimately led to a capital raising to repay some of that debt – so, maybe not a fully distressed situation but certainly a challenged situation and an example of the banks being harder with borrowers. We will absolutely see more of that as interest rates rise. Companies that don’t have their balance sheet in the right place will be pushed into a distressed situation.

We’re also seeing credit funds that we work with monitoring a lot more situations, actively looking at opportunities to buy bank debt for less than 100 cents on the dollar.

Talking to dealmakers around the world, it has been interesting to hear about the different regulations around ESG in different jurisdictions. How is ESG affecting M&A in Australia?

ESG is a huge consideration for M&A now. The starting point, as I see it in Australia, is not so much regulation but rather investors are demanding that companies into which they invest are doing the right thing across a range of ESG-related matters: climate change, emissions reduction, diversity, and how they deal with stakeholders generally including employees, local communities, and Indigenous matters. Increasingly, investors are holding companies to account. Two examples that come to mind.

Firstly, AGL, Australia’s largest electricity generator, recently had its demerger/spin-off plans derailed when the founder and CEO of Atlassian, Mike CannonBrookes, bought up a significant shareholding and threatened to vote down the demerger for various reasons including that it would undermine AGL’s transition away from fossil fuels.

Another good example is that of Rio Tinto a few years back, when in the course of progressing the development of a mine, destroyed 46,000 year old Aboriginal rock caves containing ancient Indigenous artifacts. This resulted in a range of criticism, sanction, and also senior executives were forced to resign. 

These are matters which may not have been a big issue say 5 or 10 years ago but they are now really significant. I think that this means that life as a public company is increasingly hard when one not only faces all the economic and financial challenges we’ve discussed in terms of high energy prices, interest rates and inflation, but one is also constantly being critiqued about doing the right thing for all of your stakeholders. It can also be hard to please everyone all of the time. There is an enormous time and cost to manage these matters. I think we are going to see more and more companies moving into private ownership. Not that ESG standards are lower there, but privately owned companies do not have the daily focus of public markets and therefore may have a longer time horizon to progress, and improve on, ESG matters.

Over the last few years, we have seen a greater level of intervention from merger control authorities, as well as greater scrutiny of foreign direct investment, in many jurisdictions. Is this something that has affected your work?

The ACCC, the Australian anti-trust regulator, has a new chair. In fact, my former colleague, Gina Cass-Gottlieb, has become the new chair of the agency. Gina is an excellent appointment for our country in terms of her understanding of economics, markets and the law, and her judgment and considered approach to decision-making. I think she is bringing, and will bring, a more nuanced approach to regulation in this area than her predecessor. Certainly, in terms of enforcement, the ACCC has historically had a poor track record of winning contested cases in the courts. I expect that to change now: it may be that fewer cases are brought but, for those which the ACCC contests, the ACCC success rates may now improve.

On foreign investment – Australia, like in many other places in the world, is becoming increasingly regulated in this space. In the last three or four years, the detail, length and complexity of the legislation in this area has multiplied many times. Not only has the Foreign Acquisitions and Takeovers Act been amended, but there has been a whole range of new regulations and regulatory guidance supplementing the changes to the Act. There is also specific regulation relating to infrastructure assets, as well.

The Foreign Investment Review Board, together with other government departments, is looking very closely at every acquisition now, from a range of angles including national security, cyber risk, use of data, and tax compliance. And if you think of the health sector, issues of privacy for personal data are also important. It means that, in general, review periods are taking longer.

It is also increasingly common for foreign investment approvals of acquisitions to be subject to conditions around compliance including in relation to tax compliance, and, where relevant, use of data. Approvals for acquisitions in some industries, like significant infrastructure assets, are also being made conditional on the company undertaking regular/annual security assessments (and reporting on the results), having Australian directors and ensuring that sensitive data is maintained on-shore. Of course, few acquisitions in Australia are ever rejected. If they are, they’re around sensitive industries and one or two particular countries that other Western countries may also have concerns with.

One last point is that application fees for foreign investment approvals doubled just last month, from amounts that had already been significantly increased in recent years. For very large, billion-dollar transactions, the application fee itself is over a million dollars. All in all, foreign investment regulation is certainly an area that is going to have more and more focus as time goes on. It is a difficult area and is likely to continue to be subject to increasing regulation.