The good times are rolling and unlikely to stop any time soon, according to KPMG’s 2017 Evolving Deals Landscape survey.
The deal market has been strong in recent years and 84 percent of respondents expect a positive outlook to continue, fuelled by boards looking for inorganic growth opportunities as well as a broader range of solutions to fund it.
Peter Turner, Partner in KPMG Australia’s Mergers and Acquisitions team, says the current strength in the domestic deal landscape comes down to a combination of factors. Global growth is subdued and, as a result, organic growth opportunities are somewhat limited. “Boards have a mandate for growth and access to cheap capital. They‘re looking at inorganic options to accelerate growth including mergers, acquisitions and, increasingly, alliances.”
According to the 2017 Evolving Deals Landscape survey, the top three drivers of M&A include consolidating market share (41 percent), expanding customer base (40 percent) and seizing targets as they became available (32 percent). Turner points out that while boards are on the lookout, they are staying on strategy. “They are not contemplating random buys.”
He adds that KPMG is also seeing some large corporates start their own joint venture funds, especially to add innovation and technology businesses that could enhance their core offerings. This explains why in the survey, the highest number of businesses (42 percent) expecting to undertake a merger or acquisition (M&A) are in the technology, media and telecommunications (TMT) sectors.
Global growth in the number of alliances KPMG is advising on continues to accelerate. It therefore comes as little surprise to Trevor Collard, Director in KPMG’s Global Strategy Group, that markedly more survey respondents are contemplating an alliance ahead of M&A in the near future. According to the survey, 42 percent of respondents are undertaking an alliance, joint venture or other partnering arrangement, whereas only 34 percent are considering an M&A in the next 3 years. Collard notes, “Globalisation, disruption, competition and the convergence of industries are more than ‘buzz words’. They present opportunities and threats for the modern-day executive. Alliances are increasingly in the toolkit. The challenge is to be open to possibilities, alert to potential threats and flexible enough to capitalise.”
Collard cautions that negotiating joint ventures and alliances requires specific skills. “The challenges differ markedly from those of M&A transactions, with partners typically having less control and greater complexity to manage.” He explains that joint ventures also tend to be more emotional to negotiate. “However the potential benefits and the appeal of them remain compelling, including access to new markets, compliance with regulatory requirements, cost savings and the potential for faster growth.”
Joanne Lupton, Partner in KPMG Australia’s Valuations Services, agrees, adding that the low cost and amount of capital available are also facilitating a buoyant market. “The low cost of funding and supply of capital have contributed to the high prices paid recently,” she says. “And while the survey reported that 36 percent of businesses saw expensive assets as one of the biggest barrier to deal success, expected capital cost increases will likely impact future pricing.”
Lupton sees pricing as a major consideration when assessing opportunities. “The high pricing is driven by the low supply of quality assets available in the market. The question is whether pricing continues to hold, given the uncertainty in global markets.”
While 55 percent of those surveyed thought current valuations were ‘fair or undervalued’, both Turner and Lupton agree that public markets have continued to track upwards even when businesses haven’t necessarily seen significant growth. “It’s driving up valuation multiples. However, there normally comes a truth point where earning expectations have to be met,” Turner says. Fifty-four percent of survey respondents expect this to happen soon.
“Fundamentally these are good businesses but there’s a disconnect with pricing,” adds Collard. “That’s part of the reason we’ve seen IPOs like Zip Industries pulled. It couldn’t achieve the pricing they expected. Prices don’t look unsustainable, just high. But the rise in funding costs should help bring down values.”
Lupton also sees consolidation taking place. “Companies are divesting their non-core assets to focus on their growth strategies.”
They are also looking wider for new solutions or opportunities. Often the answer involves new technology, and both Lupton and Turner have seen this raise new challenges for both private equity and venture capital investors. “It’s challenging for traditional private equity firms to invest in new technologies because the deals are riskier than what they’d normally take on. And it can be a challenge for venture capital because the opportunity is potentially not risky enough – and the amounts spent tend to be much bigger,” Turner explains.
One solution to the issue was found by the Unified Healthcare Group. It raised money with a combination of venture capital and traditional private equity via Five V Capital – a traditional private equity fund – teamed with venture capital firm Square Peg Capital. “It brought together two different investors looking at the information sharing technology that sits above the traditional health market. This type of digital innovator has the attributes of a venture capital business in terms of growth and outlook, but also traditional private equity in terms of its marketplace.”
Both Turner and Collard agree that for businesses to grow inorganically, they need to broaden the scope of what they look for in investment partners or buyers. However, staying disciplined and on strategy is still key.
Another positive for Collard is that while partnerships and alliances are a lot simpler than buy-ins, he isn’t seeing any reduction in boards looking for advice. “I’d say it’s the opposite. We’re seeing more preparation. People want to get it right first time.”
Turner adds that another ingredient in the strong deal outlook is the large amount of private market capital looking for investments. “Banks continue to lend to investors in a reasonably disciplined way – it’s not like they’re over-valuing.”
He adds that a lot of the established private equity funds have also recapitalised in the last couple of years. “As IPO markets started heating up a few years ago, private equity started exiting their existing portfolios. This got them the returns they needed to go back to investors and raise more capital. Now that money is trying to find a home.”
Turner also notes that a few prominent fund executives have started their own funds over the past 18 months. “Odyssey, Adexum and Five V Capital are examples that have brought more funds to the mid-market. There’s a lot of dry powder out there.”
KPMG’s local and international deal experience means we can help businesses understand their options, the potential buyer, partner and investor universe, their individual agendas and relative benefits of each option.
At the same time, we can assist investors by helping to identify the key risks and rewards inherent in the deals in the digital space.