PRIVATE EQUITY OUTLOOK 2019

Trends, predictions and insights on the Australian private equity sector

hwlebsworth.com.au Page 1 Private Equity Outlook 2019 Introduction

We are delighted to present our report on the outlook for Australian private equity in 2019. This report is informed by discussions with private equity funds and other industry participants and draws on recent experience of specialist team members across our private equity practice. 2018 was a strong year for the private equity sector. According to the Australian Private Equity & Venture Capital Association Limited (AVCAL): ▪▪ the amount of capital raised by buyout funds was higher than any time in the past decade and resulted in dry powder exceeding $9.2 billion; ▪▪ 58 private equity deals were completed; and ▪▪ assets under management have steadily risen to now being 3.5 times higher than in 2005. Looking ahead, we expect another strong year of private equity activity with GPs looking to deploy their record levels of capital in new and existing companies. This report contains our predictions on the trends that will shape the year ahead, as well as, the sectors thatwe expect to attract keen private equity interest in 2019. We also share our insights on upcoming regulatory reforms, the fundraising environment and trends in acquisition finance and tax. We hope you find our report to be a helpful resource and look forward to working with you in 2019.

Best regards,

Matthew Nelson MATTHEW NELSON PARTNER | PRIVATE EQUITY P +61 2 9334 8769 E [email protected]

About HWL Ebsworth HWL Ebsworth is a leading Australian with offices in every Australian State and Territory. Our private equity team provides valuable legal advice and strategy to private equity sponsors at every stage of the private equity life cycle. We have extensive experience in fund establishments and structuring, buy-outs, bolt-on acquisitions, growth capital investments, exits, competitive auction processes, leveraged finance and refinancing, taxation and warranty and indemnity insurance. Beyond our technical expertise, we offer clients unrivalled value for money, a deep understanding of the private equity sector and a proven record of executing complex transactions.

hwlebsworth.com.au Page 2 Private Equity Outlook 2019 Predictions for 2019

Based on our analysis of the Australian market and discussions with industry experts, we expect the following trends to shape the year ahead:

1 M&A ACTIVITY EXPECTED TO REMAIN STRONG 4 ELECTION SEASON MAY DAMPEN DEAL ACTIVITY IN THE FIRST HALF OF 2019 Private equity investment and deal activity is expected to contribute to a strong M&A market in The upcoming federal election and a looming state 2019. After a solid fundraising year, local funds will election in New South Wales are expected to dampen look to deploy record levels of dry powder which mergers and acquisitions activity during the first will lead to fierce competition for quality deals. half of 2019. Private equity funds will be keeping a This competition will be elevated by the continuing close eye on the outcome of both elections as they participation of global private equity funds and will have an impact on tax policies and government strategic acquirers seeking opportunities in an plans for spending in the health, aged care and Australian economy that is characterised by 28 years education sectors. Based on prior experience, FIRB of consecutive economic growth and lower average is also likely to enter caretaker mode while we await EV/EBITDA multiples than North America, Europe the federal election result, meaning that major or and Asia. contentious decisions are likely to be postponed until following the election. This will be particularly 2 ECONOMIC HEADWINDS TO AFFECT PRIVATE relevant to private equity funds that fall within the EQUITY SECTOR CHOICES definition of a ‘foreign government investor’ and have deals subject to FIRB approval. While the RBA is unlikely to raise interest rates until 2020, high levels of household debt, low wages 5 EXITS VIA IPO REMAIN VIABLE BUT EARLY 2019 growth and falling house prices are likely to weigh WILL BE BUMPY on consumer spending. This will negatively impact valuations and interest in companies with exposure Market volatility is expected to continue during the to the consumer discretionary and property first half of 2019 as the banking royal commission investment sectors. PE funds holding portfolio is due to release its final report in February and the companies in these sectors may delay exits until market will wait to see the outcome of the federal the climate becomes more favourable or accelerate election in May. Investors will also be hoping that trade sale plans before spending softens further. the trade negotiations between the US and China are resolved before a 90-day truce expires in March. 3 PUBLIC-TO-PRIVATE BUYOUTS TO CONTINUE However, IPOs in the smaller to mid-market range (i.e. less than $500 million) are less likely to be Local and international private equity interest in affected by such volatility unless their underlying public-to-private opportunities will continue in 2019 businesses have a direct interest in those events. As with a number of ASX-listed targets already fielding the majority of private equity backed IPOs fall within offers from PE suitors. Examples include TPG’s this range, IPOs are expected to remain an option proposed acquisition of vet clinic chain Greencross although IPOs have in recent times fallen away as and KKR’s bid for MYOB. Global buyout funds will the preferred exit route. Nevertheless, dual track see value in Aussie listed companies, especially processes will continue to be used as private equity given the low Australian dollar, relatively cheap debt funds seek to maintain competitive tension and and a range of mid-cap companies with share prices maximise exit valuations. at historic lows. Large Australian funds such as BGH Capital and Pacific Equity Partners with plenty of dry powder will compete for larger take-private opportunities; while smaller and mid-market funds are likely explore small and mid-cap opportunities.

hwlebsworth.com.au Page 3 Private Equity Outlook 2019

REAR VIEW MIRROR: THE IPO MARKET IN 2018

2018 saw a drop in the number of IPOs as a result of market volatility and a string of pulled floats. Trade tensions between the US and China, heavy losses in major stock indices and the fallout from the banking royal commission all played a part in weakening market sentiment. Amid this backdrop, a number of proposed floats failed to hit the boards, including PEXA’s decision to abandon its IPO in favour of a trade sale and Prospa’s indefinite postponement of its proposed IPO.

hwlebsworth.com.au Page 4 Private Equity Outlook 2019 Regulatory reforms in 2019

ROYAL COMMISSIONS Recommendations from the Royal Commissions into Aged Care and Financial Services industries will set in motion reforms and new compliance obligations for industry operators, leading to potential PE acquisition opportunities.

ASX LISTING RULES The ASX has proposed a broad range of amendments to the ASX listing rules which impact entities seeking to list as well as listed entities. The public consultation process will end on 1 March 2019 with the reforms likely to take effect on 1 July 2019.

PROPOSED TAX CHANGES Legislative proposals to widen the definition of Significant Global Entities and change the refundable component of the R&Dtax incentive scheme are expected to be settled in 2019.

MODERN SLAVERY ACTS Federal and NSW legislation will take effect and impose reporting obligations on many portfolio companies regarding steps taken to respond to the risk of modern slavery in operations and supply chains.

ASIC FEES AND COSTS DISCLOSURE REGIME ASIC will release its consultation paper on proposed changes to the fees and costs disclosure regime, which would impact many LPs in private equity funds.

COPYRIGHT ACT From 1 January 2019, new copyright duration laws came into effect along with new standard terms of copyright protection - portfolio companies should take note.

hwlebsworth.com.auhwlebsworth.com.au PagePage 5 5 Private Equity Outlook 2019 Sectors to watch in 2019

The consumer discretionary, food and agriculture, industrials, healthcare and business services sectors saw the greatest levels of private equity investment across industry sectors in H1 2018 (as shown on the following page). While these traditional favourites will remain popular in 2019, our discussions with private equity funds indicate the following are the sectors to watch in the year ahead.

The Royal Commission into the aged care sector will unfold in 2019 and is expected to increase pressure on operators to improve standards of care. The commission’s recommendations are likely to increase compliance standards and associated costs, which will impact smaller operators the most. Faced with higher standards and lower profits, smaller operators may look to sell and present AGED CARE acquisition opportunities for private equity acquirers looking to enter the market at lower valuations. ‘Buy and build’ strategies are expected to play a part as the aged care sector has many single facility operators, which could be consolidated to benefit from economies of scale. An example of this approach was Archer Capital’s roll-up of 44 aged care facilities to form Allity, which is now ’s fourth largest private sector provider of residential aged care services.

Private equity funds looking for the next big thing are actively seeking opportunities in the burgeoning Internet of Things (IoT) sector. According to Bain & Company, the combined markets for IoT are expected to grow to $520 billion by 2021, which is more than double the amount spent in 2017. Anacacia Capital is an example of a local fund moving to capitalise on the IoT opportunity with the INTERNET shift to smart cities through its acquisition of a majority stake in technology and parking meter group Duncan Technologies. Beyond investment opportunities, IoT will continue to disrupt industries and OF THINGS give rise to new challenges around privacy and security, which will impact all portfolio companies whether being IoT businesses or not.

M&A activity in the healthcare industry is expected to remain robust in 2019 with private equity funds playing a key role. Private equity buyout activity will be two-fold: (1) Targeting acquisitions of both listed and unlisted healthcare assets operating cash-generative businesses with growth potential; (2) Exiting investments in healthcare portfolio companies to capitalise on high purchase price multiples HEALTHCARE being paid by strategic acquirers.

With growing weakness in consumer discretionary spending, private equity funds are increasingly looking at alternate opportunities in the business services sector. A strong track record, high-quality earnings from repeat customers and the ability to scale feature on the private equity shopping list. One fund that recently capitalised on this opportunity is Mercury Capital, which acquired a stake in MessageMedia, a marketing and communications company. BUSINESS SERVICES

hwlebsworth.com.au Page 6 Private Equity Outlook 2019

Private Equity-Backed Buyout Deals in Australia by Industry (H1 2018)

13%

25% 4%

4%

13%

25%

17%

Consumer Discretionary Food & Agriculture Industrials Healthcare Business Services Clean Technology Other

Source: AVCAL 2018 Yearbook

hwlebsworth.com.au Page 7 Private Equity Outlook 2019 Fundraising

2018 was another strong fundraising year with more than $5 billion raised by Australian private equity funds. Some of the largest funds that closed last year, included: Fund Fund size BGH Capital I $2.6 billion Crescent Capital Partners VI $800 million Adamantem Capital I $600 million Mercury Capital III $600 million Pacific Equity Partners - Secure Assets Fund $500 million (first close) Anacacia Private Equity III $300 million In terms of fee structures, the usual ~2% management fee and 20% over return thresholds remain the general norm. While, larger investors in private equity funds may have success in securing lower management fees compared to smaller investors, the best performing funds have typically been able to resist these pressures on the basis that fund performance justifies their fees. However, there are signs of movement in other areas such as hurdle rates, discounts for investors in a first close and invitations to LPs to participate in co-investment opportunities. According to AVCAL data, as at September 2018, there were around 10 Australia-based private equity funds in the market. With a strong economy and robust M&A market, we expect a positive fundraising environment in 2019.

ANNUAL AUSTRALIA-BASED PRIVATE EQUITY FUNDRAISING, 2017-2018 YTD (AS AT SEPTEMBER 2018)

14

12

10

8

6

4

2

0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 YTD

Aggregate capital raised ($Billion) No. of funds closed

Source: AVCAL 2018 Yearbook

hwlebsworth.com.au Page 8 Private Equity Outlook 2019 Trends in acquisition finance

Unitranche - an alternate solution Debt structuring options in Australia are evolving with the emergence of unitranche debt. While common in the US and European markets, unitranche is a relatively new form of debt in Australia - it is a combination of senior and mezzanine debt in a single debt instrument and is typically offered by debt funds. Unitranche debt terms typically provide for a single interest rate (being a blend between a senior and junior interest rate), single covenant package and bullet repayment. Private equity borrowers like them for the greater flexibility they offer, while lenders receive a higher rate and prepayment protection. To the extent that a working capital facility is required, this would typically be provided by a bank on a super senior basis. Expect to see more of these debt structures in 2019.

Rise of non-bank lenders Non-bank lenders are increasingly featuring in leveraged buyouts and offering borrowers an alternate source of funding. While the big 4 banks continue to hold the largest portion of the loan market (circa 90%), it is expected that Australia will follow a global trend that is seeing a rise in market share for non-bank lenders. Some market participants suggest that, within a few years, as much as 50% of the leveraged loan market could be provided by non-bank lenders. Intermediate Capital Group’s Australian Loan Fund is an example of a debt fund that has been active in this space.

Regulators In the last couple of months, there have been a number of negative statements by both the RBA and Bank of England in relation to rising debt levels, leveraged loan issuance and the rise of a “shadow banking market”. While some investment banks consider such risks to be overblown, it is clearly an area of concern for the regulators. It will be interesting to see whether this increased focus from the RBA (in the Australian context) on the leveraged market results in any further pull back from the traditional senior lenders and whether any regulatory response to the rise of non-bank lenders (in both the context of leveraged loans and the broader debt markets) emerges.

hwlebsworth.com.au Page 9 Private Equity Outlook 2019 Tax in focus

Streamlined Significant global Audits of R&D tax Elimination of a Previously foreign assurance reviews entities can now offset claimants and number of tax resident companies by the ATO have include trusts and reductions in the benefits received by can now be commenced partnerships R&D tax offset foreign investors Australian residents The ATO has PE outfits with Portfolio companies Stapled structures Foreign incorporated commenced consolidated income which self-assess and companies will now Foreign investors will its streamlined above $1 billion will claim the R&D tax be Australian tax now be prevented assurance review now: offset will be closely residents where the from converting of taxpayers with monitored by the central management a) need to consider trading income into turnover above ATO. The ATO has and control of the the application of favourably taxed $250 million under audited a number company is located in the multinational interest income what is known as of companies and Australia. anti-avoidance law, under certain stapled the “Top 1,000 reversed the tax namely whether structures. This will Accordingly, portfolio Tax Performance offset in 2018. This they have artificially reduce previously companies (including Program.” focus will continue avoided an Australian calculated after-tax their subsidiaries) into 2019 as the The compliance permanent rates of return. incorporated government commits approaches will establishment; offshore may need more resources Thin capitalisation seek to ensure to reorganise their b) need to be wary to the ATO and these taxpayers Foreign investors will existing corporate of a 40% “diverted Department of are reporting the also be prevented governance profits tax,” on profits Industry, Innovation right amount of from using double- framework to avoid diverted offshore in and Science. income across four gearing structures, triggering unintended the form of higher Portfolio companies selected income through multiple Australian tax expenses to related will be well-advised years based on a layers of flow- consequences. For parties, which would to review existing number of criteria through entities, example: otherwise have arrangements to including overall tax to convert trading increased Australian ensure compliance as ▪▪ dividends paid by performance, type income into tax payable; the ATO has taken a such companies and size of business favourably taxed narrow approach to may no longer activities, tax risk c) be subject to interest income. granting the R&D tax be exempt from management and higher penalties for offset. Foreign pension fund Australian income governance, and false or misleading investors tax; co-operation with statements, late The R&D tax offset the ATO during the lodgement or tax has also been The withholding ▪▪ capital gains from review. The taxpayer schemes; and reduced. For tax exemption for the sale of such foreign pension companies may will be given a short d) be required to companies with fund investors in no longer be window to make any prepare general annual turnover <$20 respect of interest reduced; voluntary disclosures purpose financial million, the offset and dividends will be ▪▪ such companies before the review is statements. rate will be 13.5% commenced. plus the company’s limited to portfolio will be subject to tax rate. For all other investments (subject CGT on all CGT At the initial stage, companies, the offset to transitional rules). events; and the ATO will ask rate will be between Accordingly, these questions which ▪▪ such companies 4% and 12.5% plus investors will need relate to the may be brought the company’s tax to reconsider the alignment between into the Australian rate, depending on exit timeline for their accounting and tax consolidation the R&D intensity. investments. tax results, tax regime. governance and risk management, significant and new transactions, and tax risks flagged to the market. hwlebsworth.com.au Page 10 Private Equity Outlook 2019 Contacts

Mergers & Acquisitions

MATTHEW NELSON JAMIE RESTAS BRENDAN EARLE PARTNER | SYDNEY PARTNER | PARTNER | P +61 2 9334 8769 P +61 8 8205 0581 P +61 3 8644 3469 E [email protected] E [email protected] E [email protected]

CAMERON JORSS DAVID CLARKE JEREMY MCCARTHY PARTNER | PARTNER | SYDNEY PARTNER | MELBOURNE P +61 7 3169 4704 P +61 2 9334 8644 P +61 3 8644 3481 E [email protected] E [email protected] E [email protected]

ROBERT GIBSON ROWAN MCDONALD SAM DWYER PARTNER | SYDNEY PARTNER | SYDNEY PARTNER | MELBOURNE P +61 2 9334 8744 P +61 2 9334 8948 P +61 3 8644 3558 E [email protected] E [email protected] E [email protected]

Tax

NIMA SEDAGHAT SHAUN CARTOON YAN LI WANG PARTNER | SYDNEY PARTNER | MELBOURNE PARTNER | MELBOURNE P +61 2 9334 8921 P +61 3 8644 3615 P +61 3 8644 3618 E [email protected] E [email protected] E [email protected]

Funds

JAMES LONIE KATE MCKEOUGH PAUL BROWN PARTNER | SYDNEY PARTNER | ADELAIDE PARTNER | SYDNEY P +61 2 9334 8762 P +61 8 8205 0534 P +61 2 9334 8943 E [email protected] E [email protected] E [email protected]

Equity Capital Markets

DAVID WOODFORD GRANT HUMMEL THOMAS KIM PARTNER | MELBOURNE PARTNER | SYDNEY PARTNER | MELBOURNE P +61 3 8644 3683 P +61 2 9334 8681 P +61 3 8644 3532 E [email protected] E [email protected] E [email protected]

Finance

MATTHEW WILSON PETER KAY SARAH CARROLL PARTNER | SYDNEY PARTNER | MELBOURNE PARTNER | MELBOURNE P +61 2 9334 8523 P +61 3 8644 3728 P +61 3 8644 3474 E [email protected] E [email protected] E [email protected]

hwlebsworth.com.au Page 11 ADELAIDE BRISBANE Level 21 Level 19 Level 5 Westpac House 480 Queen Street HWL Ebsworth Building 91 King William Street Brisbane QLD 4000 6 National Circuit Adelaide SA 5000 P +61 7 3169 4700 Barton ACT 2600 P +61 8 8205 0800 F 1300 368 717 P +61 2 6151 2100 F 1300 464 135 F 1300 769 828

DARWIN MELBOURNE Level 9 Level 9 Level 26 Mitchell Centre 85 Macquarie Street 530 Collins St 59 Mitchell Street Hobart TAS 7000 Melbourne VIC 3000 Darwin NT 0800 P +61 3 6210 6200 P +61 3 8644 3500 P +61 8 8943 0400 F 1300 377 441 F 1300 365 323 F 1300 307 879

NORWEST SYDNEY Level 3 Level 11 Level 14 21 Solent Circuit Westralia Plaza Australia Square Norwest Business Park 167 St Georges Terrace 264-278 George St Baulkham Hills NSW 2153 Perth WA 6000 Sydney NSW 2000 P +61 2 9334 8555 P +61 8 9420 1500 P +61 2 9334 8555 F 1300 369 656 F 1300 704 211 F 1300 369 656

Disclaimer

This report contains general information and is not intended to be comprehensive nor to provide legal, tax or other advice or services. This report is not a substitute for such advice or services. If you require or seek advice, you should obtain such advice from your own professional adviser. Whilst reasonable effort has been made to ensure the accuracy of the information contained in this report, this cannot be guaranteed and HWL Ebsworth shall not have any liability to any person or entity which relies on the information contained in this report.