How Relevant is the ASX in View of Large Takeovers?

A client recently asked some questions about the affect on the ASX of the takeover of companies by private equity funds and large industry superannuation funds. Craig Shepherd, our CIO, responds.

Q1: Is there a sustainable and material reduction in assets available for investors such as First Samuel in public and private markets?

A1: No.

Public markets

The market capitalisation of the ASX200, ignoring share price changes, has increased every year bar one for the past 17 years. That is, the stream of new companies listing on the ASX (Initial Public Offerings – IPOs) and capital raisings by existing companies boosted the overall capital of the market.

So, for instance, in 2012, the market capitalisation (excluding price increases) rose 2%. This can only be the case if the net amount of equity raised (new funds sought from outside) was at least 2% of the previous year’s market cap after all possible sales of large companies to external parties are netted off.

Looking at the chart below, in 2023 the market size was forecast to retreat. I say forecast, as the final affect of the various takeovers is yet to be finalised. It is almost certain the market size fell with the loss of Allkem, Invocare and 50% of Newcrest. The proposed Origin delisting did not eventuate, but the dearth of new IPOs did. The market shrinkage was probably between 0% and 1%.

The Australian Equity Market is shrinking? ASX 200 equitisation (excl. price change)

Source: ASX

So, while structural concerns about the motivation of private equity funds and large industry funds have merit, the actual impact to date has been muted.

Private markets

The impact of the reduced IPO pipeline also warrants attention. When the IPO pipeline slows, it is generally not because there are no companies that would like to list, but rather due to market conditions not being conducive to a successful IPO for both sellers and new owners.

In such circumstances, these businesses remain in their existing structures and will often use other sources of funding until a listing can be pursued. In former times, this market for capital in unlisted and pre-IPO companies may have been closed. However, this is not true for superannuation funds nor First Samuel. This fact is critical in assessing the impact of the trends discussed.

Both we and larger (but not the largest) superannuation funds will dedicate funds to:

venture capital or private equity firms that may lead such companies from private hands, such as founders and friends and family investors, through to trade-sale or IPO;
private credit funds that are likely to provide financing solutions that are similar to those they would attain if they did IPO; and
pre-IPO funds that specialise in funding companies that are positioned at this point of the lifecycle.

We employ a range of investments in our portfolios to capture this. They are included in both the Income Securities sub-portfolios and parts of Alternative Securities sub-portfolios and are recommended in most client portfolios.

It could be argued that, in some cases, in a closed IPO market, we are likely to have higher investment returns by waiting and letting these assets continue to develop before listing.

Hence, as you suspect, part of our action in response to these trends is to increase the amount invested in the pre-IPO and private equity space.

As far as the market is concerned, when these companies eventually list (i.e. when the listing conditions become more favourable) their capital needs will generally have already been met.

Q2: What would the impact of a continued stream of assets being removed from access be upon the price of remaining assets?

A2: Most likely increase.

Price impacts are likely to consist of at least three factors:

the impact of higher demand for some assets;
the premiums likely paid should de-equitisation occur; and
the change in behaviours of the companies in response to the changed motivations.

For instance, imagine a scenario in which a range of significant industry funds (Australian Super, Aware, UniSuper, CBUS and Hesta) continue to compete for directly listed assets.

We would argue that identifying assets of interest to them would be so transparent that listed share prices for such companies would rise to a point where either:

the premium that would be required to be paid for such assets to remove them from public markets would make the investment uneconomic; or
the price would have risen to a level that should make an active manager sell its position regardless.

In this scenario, existing owners would get paid excess returns as this trend played out – a positive development for a considerable period.

We consider that the market for infrastructure assets over the past 15 years has worked in a similar manner: limited supply, inflated prices and the transfer of such assets into private hands almost entirely.

This occurred simultaneously with artificially low global interest rates. The impact on fund returns from these investments, as interest rates normalise, is yet to play out fully. It would not surprise us to see some discounted infrastructure assets return to public markets.

Were de-equitisation more widespread and less forecastable, we would need to look no further than activity in the takeover space in 2021-2023 to see the impact.

While we were disappointed by the premium finally paid for our stake in Costa Group, the transactions (both proposed and consummated) that occurred in PushPay, PointsBet, Newcrest, Patties Foods, United Malt, and Origin Energy were all at substantial premiums.

These recent premiums are similar to those evident from 2012 to 2019 – as seen in the table below.

Generally, the premiums paid to remove stocks from the public markets are reasonable and represent a good balance between the underlying value of the business and the future options likely to emerge under private ownership.

Takeover premiums of ASX businesses

Source: UBS, AFR

Our point regarding the premium paid is that should there be a continued exodus of firms, our clients should expect:

Higher returns for a number of years as companies are removed from the ASX, and large premiums are paid for their purchase; and
That First Samuel would continue to actively invest in firms whose characteristics are consistent with the types of firms, types of franchises, nature of cash flows, and domestic economic significance that these buyers would appreciate in order to seek takeover targets.

Q3: What would the impact of a continued stream of assets being removed from access be upon the supply of new assets?

A3: Probably a little.

These are two separate albeit linked matters. The supply of new assets more likely depends upon factors other than those related to the exit of old ones.

Clearly, there are push and pull factors that are relevant in the assessment of future supply. On the one hand, a listed-market that proves an attractive place from which larger funds will seek great assets increases the likelihood that strong companies will want to be listed to generate the highest value.

On the other hand, should the regulatory burden and operational complexity of the listed exchanges prove high, it is possible that the role of the ASX is disintermediated.

We have previously discussed the cyclical nature of the IPO market and how we find adjacent markets. In the case of disintermediation of larger assets, I suspect there are a couple of ways to address this issue.

Suppose otherwise, companies that would have appeal to public-market investors may pass straight from private hands to large superannuation funds.

This is already the case with property assets. An office building will be built for or with CBUS, for instance. Or an infrastructure asset is bid before construction by a consortium of players. However, property is ubiquitous; one CBD office building is similar (in investment terms) to another. A well-constructed portfolio needs access to CBD property in general, not a CBD property in particular.

In the case of operating businesses, it is critical to gain exposure to those that make money from otherwise private transactions. For instance, part of the investment thesis for Macquarie Group, and to a much lesser degree, Lend Lease, is due to their capacity to continue to earn fees from facilitating these types of transactions. We may miss the assets, but we still capture part of the economic value.

As an aside, we can see from some private markets that due to the rapidity of internal change in some of the superannuation funds, it is likely the levels of trading of these assets (despite protestations of being long held) means that a large part of the value created will be captured by the facilitators, not the members themselves.

We suspect it is more likely, for the benefits of governance, transparency, and oversight, that industry superannuation funds will build external structures or use external management to aggregate such assets. Gaining access to these vehicles is already important and will grow.

For this reason, we continue to foster relationships with these aggregators and would look to continue to increase our Alternatives sub-portfolios diversity.

The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.