By Gleb Kuznetsov, Corey Sullivan, and Purav Bhandare (University of Queensland)
Report Head: Timur Kurbanov (New York University Shanghai)
1.1 – Restructuring within Banks
In ANZ, the conclusion of the Financial Services Royal Commission, combined with the changing dynamics in things such as ‘open banking’, will serve to drive significant change within banking and the financial sector at large. We have already seen a divestment trend as financial institutions have sought to off-load their foreign divisions over the past years and sell off life insurance divisions to foreign buyers who can exploit their lower cost of capital and scale synergies. Banks have also to re-assess their Wealth Management arms, with a number of sell-offs (such as CBA’s sale of Colonial First State to KKR for A$3.3 bn in May) already occurring, and it is expected that others may find the future compliance costs greater than any derived revenue. In general, financial institutions in ANZ are looking to identify and carve out any potential areas where there may be issues with compliance and regulation.
Further, the status-quo of a ‘portfolio approach’ by large financial institutions is being forced to change as smaller entrants to the market are specializing in niches and forcing the entrenched players to deliver market leading services and products. This could further add to M&A divestment activity as financial institutions seek to make their operations simpler.
Similarly, to the majority of the APAC region, Chinese commercial banks are seeing lower interest rates drag on earnings, whilst there is expected to be lower revenues from credit cards and personal lending. Smaller and mid-sized institutions are naturally facing the brunt of this, but the government has continued its policy of containing financial-sector risk by providing recapitalization to struggling banks and more opportunity for lending to state-owned corporations. This further increase opaqueness in the Chinese commercial banking system and should slow any domestic consolidation within the industry, given the government appears to be willing to prop up struggling firms.
Another prominent M&A trend in the near future for Chinese banks is the acquisition targets that virtual banks present. COVID-19 has drastically accelerated the pace and importance of digital banking transformation. Traditional banks will be tempted to look at acquiring companies that have developed new technology that can be applied to their current product offerings, or at companies that have developed customer their own ‘virtual’ customer bases across different areas and present an opportunity to cross-sell services such as insurance.
In July 2019 it was announced that China will open up its financial sector to foreign investment through a number of measures, which included the removal of foreign ownership restrictions for securities firms, funds, life insurance and futures firms in 2020.
1.2 – 2020 at a Glance
The start of 2020 has seen numerous banks indicate interest and initiate taking managing control of their mainland financial ventures. Earlier in the year, JPMorgan Chase took control of China International Fund Management Co. for an undisclosed price. Some of the largest global financial institutions such as Goldman Sachs and BlackRock are now following suit in attempting to reach the US$13 trillion worth of assets held by Chinese households. The entrance of global players into the recently opened Chinese financial sector should be a major driver of M&A activity. It is expected that despite political tensions, foreign demand for Chinese assets will remain strong - especially given the potential addressable market in mainland China.
Whilst there is expected robustness in inbound M&A activity, Chinese outbound investment is likely to be directed towards countries with greater deal certainty for Chinese investors. 2019 saw India record its slowest annual economic growth of 4.9%, a major reason for this was the country’s credit slowdown that hampered domestic demand. Banks had a high-level of bad debt on their balance sheet, with 9% of total bank lending in 2019 being non-performing loans. This has been accentuated by the economic shutdown from COVID-19. Former Reserve Bank of India governor Raghuram Rajan, the former Reserve Bank of India Governor, commented that the pandemic would lead to unprecedented levels of bad debt in 6 months’ time. Accordingly, there has been little activity in the banking sector and financial sector at large in India- a trend that is likely to continue in the coming months as banks present risky investments and firms in the industry are conserving capital to brace for loan defaults.
Within the financial sector, it seems that fintech presents the best opportunity for a resumption of M&A activity. Due to local regulations, it is difficult for foreign players to develop their own operations from scratch. This makes local companies tempting takeovers for foreign firms looking to enter India. Recent legislation and tensions with China would however dissuade investment from India’s largest neighbor, another headwind for financial sector M&A activity in India.
1.3 – Negative Outlook in Japan
The banking industry in Japan has a negative outlook. This is driven by incredibly low interest rates, as well as an ageing and shrinking population. Japanese financial institutions have typically looked abroad to generate growth in such an environment, with South East Asia typically being one of the preferred geographic locations for investment, given the economic growth in the area and large proportion of the population currently without bank accounts. Japanese M&A in general has been dominated by outbound M&A transactions, with outbound M&A reaching US$ 205 billion in 2019, a lower value than 2018 but still a very high level historically.
This environment, coupled with COVID-19, has put additional pressure on small and medium sized institutions and even the larger, better-capitalized banks, such as Sumitomo Mitsui Financial Group Inc. and Mitsubishi UFJ Financial Group Inc. are likely to conserve capital as a buffer against any further economic downturn. As a result, this will curtail outbound Japanese activity in the coming months, though there should still be a trickle of high-conviction acquisitions.
The Japanese insurance sector, arguably in a better position than the banks, is also likely to continue to see a slow-down in M&A activity in the short to medium term. The Japanese insurance market is one of the largest in the world. By total annual premium, Japanese Life Insurance is the second largest in the world, after the US, whilst its Property and Casualty insurance market is the fourth largest in the world. The sector is predicted to see a double-digit decrease in new business in the coming months and a single digit decrease in annual premiums following that. This, in combination with insurers having to rethink their business models to adapt to the new state of the industry, should again slow outbound Japanese insurance M&A. Nonetheless, there should still be activity as firms may be drawn by lower valuations in markets with gradually ageing demographics, such as Asia and Western Europe to expand their operations on relatively ‘safe’ investments. Japanese insurance firms will be looking to tap into their expertise with an ageing population in these markets.
2.1 – Market Volatility in the Natural Resource Sector
Activity in the resources industry has dominated the ANZ public M&A market for at least the last decade, representing ~25% by deal volume, on average. This is mainly due to the fact that around 60% of Australia’s exports compose resources, namely iron ore, coal briquettes, petroleum gas, gold, and many others. Further, mining in particular has consistently constituted 10% of Australia’s output over the last few years. Of Australia’s total exports, just under 40% are destined for China, with a further 25% being split between Japan, South Korea, and India. Therefore, volatility for M&A in this particular industry is unsurprisingly due to ongoing global uncertainty regarding economic development post-COVID. Further, trade and geopolitical tensions between Australia, the U.S., and China, also threaten the robustness of the ANZ M&A space within resources in particular.
Indeed, the recent mega-mergers of Barrick and Randgold and Newmont and GoldCorp have composed a bulk of the industry deal volume, but the highest value deal in the resources sector recently was Wesfarmers’ acquisition of Kidman Resources in the battery metals sector, which was completed in September of 2019. Even outside of public M&A, the Australian market saw Santos’ A$2.15bn acquisition of Brookfield-controlled Quadrant Energy and Abermale’s A$1.3bn acquisition of a majority stake in Mineral Resource’s lithium-producing Wodgina project. Nonetheless, despite the resources sector historically dominating the ANZ M&A landscape, there has been a decline in total deal volume over the last year, as healthcare and financials have increased their share of deal volume on the back of increased activity by financial sponsors, namely KKR and BGH Capital. Indeed, this is partly due to the persistence of low commodity prices globally, and in particular, many companies with core efforts in oil and gas are struggling to adapt to these new market conditions. This difficult environment, coupled with restricted access to financing, has dampened deal making. This common theme of volatile and low commodity prices is likely to persist given COVID and overall geopolitical uncertainty, as seen in Figure 3.1. Rising iron-ore prices have cushioned the negative impact to this sector, but the M&A outlook for the resources sector is still uncertain in the short run.
Figure 3.1: Natural Resources 5-Year Price Comparison
Commensurate with the struggling sector, less capital is flowing throughout natural resources. Outside of Saudi Aramco in late 2019, IPOs in this space have been close to zero, and both fixed-income and follow-on equity offerings have also decreased largely due to the limited access to capital markets, as well as high barriers to entry and considerable required capital expenditures. Smaller players have and will continue to find it difficult to acquire competitors to consolidate fragmented markets. As stated briefly earlier, private equity has presented itself as a recent driver of public M&A in Australia, but the amount of new money flowing in has targeted investments that look to be priceresilient and backed by real assets, and thus both investments and exits by financial sponsors have proved challenging in the current commodity markets. In all, we expect aggregate distressed acquisitions to increase in this space throughout ANZ, but this is also largely dependent on the state of future commodity prices and the geopolitical tensions that have such a large impact on said prices. As China, Australia’s biggest export destination of natural resources, begins to resume its industrial expansion, we expect greater deal volume more broadly, could be paused for the rest of 2020 if Coronavirus cases globally don’t begin to slow or a vaccine isn’t introduced commercially by Q1 2021.
2.2 – China Remaining Strong
Consistent with China’s strong growth, aggregate M&A across all sectors has been strong over the past few years. In particular, Chinese outbound M&A has largely been concentrated on energy and natural resources, followed by the establishment of China as a net importer of many raw materials amidst their housing and infrastructure booms. Chinese companies have been the largest buyers of overseas mining assets throughout 2018 and 2019, increasingly targeting minerals needed for electric car batteries and clean energy technologies. Although broader M&A volumes have declined, some of China’s mining companies have been acquiring domestic gold mines and strategic mineral producers on the back of depressed asset prices. In particular, Shandong Gold Mining Company in May of 2020 offered US$165m to buy Canada’s TMAC Resources, and also offered US$221m for Ghana-focused miner Cardinal Resources in June. In the same month (June), Zijin Mining Group agreed to buy Toronto-listed Guyana Goldfields for US$238m, which is subject to approval. Hence, it is clear that the resources sector remains active in outbound mergers and acquisitions.
In aggregate, resource M&A in China has and will continue to be impacted by the introduction of the PRC Foreign Investment Law, which came into effect on the 1st of January 2020. The law will mean that foreign-invested enterprises will be subject to new corporate governance and capital systems, and so cross-border M&A with foreign capital providers will prove marginally more difficult from a regulatory point of view. In particular, as mineral-rich countries Australia and Canada tighten restrictions on foreign investment, players in the natural resources industry have seemed to enact a buying spree, as illustrated previously by the acquisitions undertaken or planned by Shandong Gold and Zijin Mining Group. Hence, geopolitics will likely play an important role in the activity of cross-border M&A in the natural resources sector, given that many Western countries are considering or have already implemented capital controls both to and from China.
With China a net importer of natural resources, it is evident that broader companies benefit from globally low commodity prices. As such, it is likely that short-term sentiment regarding commodity prices will increase volume in domestic M&A within the natural resources sector, particularly those with primary activities in thermal coal and petroleum, both of which have experienced a sharp drop in bulk prices as per Figure 3.1. However, it is also likely that the only companies with the capacity to engage in cross-border or domestic M&A will be strong domestically or state-backed with sufficient capital, expected that particularly in the natural resources space, we will see large deals, but fewer transactions in terms of aggregate quantity and volume.
2.3 – Rise of Indian Natural Resource Sector
Similar to the situation described in China, India has emerged as a net importer of natural resources, with over 30% of its imports coming from natural resources (~20% Crude, ~5.5% Coal Briquettes, ~6.6% Gold, etc). Their biggest export remains refined petroleum (~13%) to China and the UAE, however, with exports and imports representing ~20% and ~24% of India’s GDP respectively in 2019, it is abundantly clear of the importance of natural resources to India’s economy. In particular, India is one of the largest developing economies, alongside China, and so we expect the importance natural resources have on India to grow even stronger as it undergoes housing and infrastructure improvements.
M&A in the natural resources space has increased in recent times, consistent with the rapid growth in M&A activity throughout India more broadly in distressed deals, enabled through the aforementioned corporate insolvency resolution process under the Insolvency and Bankruptcy Code. In particular, 2019 saw BP’s USD900m investment on a retail venture with Reliance, and an acquired stake in Adani Gas for USD870m. In addition, Saudi Aramco acquired a 20% stake in Reliance’s oil-to-chemicals division for USD15bn in August. Hence, it is clear that there remains strong demand growth for refined products and an interest in privatizing assets, and so we expect downstream deal activity throughout India to remain active throughout the next few years.
With global commodity prices at major lows, it is clear that net exporters of these commodities are and will continue to suffer, and so given the improved and modern legislation surrounding distressed acquisitions, we expect that both domestic and crossborder M&A in distressed oil & gas assets in particular to increase as commodity prices continue to suffer from geopolitical volatility. This is supported through the fact that an overall economic downturn and an amplified oversupply have all the bearings of ushering in the next phase of consolidation.
3.1 – Race for the Cure
Healthcare is the industry most largely impacted by the COVID-19 pandemic, which is facing disruptions across Australia. The increased demand for healthcare during the period has caused the Government to partner with private healthcare providers such as Ramsay Health Care to ease the burden on the public health system. This has created a challenging environment for M&A activity to take place, especially in the first quarter of 2020 during the initial coronavirus shock. Despite this, there are a number of ASX-listed healthcare companies that are currently under the spotlight for being critical players in the fight against coronavirus. Resmed, a California-based medical equipment company that has manufacturing facilities in Australia, is a global top-5 manufacturer of ventilators which are required to treat coronavirus patients. Ansell, a medical and industrial glove manufacturer is also facing high demand for surgical gloves. Fisher and Paykel Healthcare is also facing a demand spike for respiratory humidifiers, again important in the treatment of COVID-19.
3.2 – Healthcare Spending in Australia
Historically, Australian healthcare spending has grown at a much faster pace (~50% growth from FY07 to FY16) than population growth (~17% growth in the same period). Healthcare spending in 2019 was at $6,661, 9.2% of GDP, which was higher than the OECD median of $5,107 which made up 8.2% of GDP on average. Hospital expenditure was at 39% of the total, followed by primary health care being 35%. During the initial stages on the coronavirus pandemic (Q1CY20), healthcare M&A deal value declined by 70% to $918m compared to Q1CY19; at a median Q1CY20 EV/EBITDA multiple of 10.8x, lower than the 11.8x multiple in Q1CY19. 90% of the acquisitions in Q1 were from trade buyers, but PE activity increased in Q2 and is expected to continue increasing given the developing PE interest in Australian healthcare (Brookfield acquiring Healthscope and Aveo in 2019).
The lockdowns have reduced demand for pathology and general healthcare. People are delaying routine visits to the hospital, fearing that they might catch the virus. This is likely to have disastrous consequences in the future, with an expected increase in the number of people dying by preventable diseases or a delay in cancer detection. In this space, M&A activity has particularly increased during Q2. BGH Capital (Australian PE firm) is acquiring Healius’ 70+ medical practices for ~$500m (10x EBITDA), after which it will become one of the largest operators of medical centers. GenesisCare (cancer care and heart disease specialist) acquired 21st Century Oncology for $1.6b (7x EBITDA), increasing GenesisCare’s EV to $5b and increasing EBITDA to $450m. Crescent Capital Partners is planning to sell Australian Clinical Labs (Australia’s 3rd largest pathology player) for ~$600m, expecting to attract interest from top-2 players Sonic Healthcare and Healius (or BGH Capital).
With long-term drivers of increasing population, ageing population, elective-surgery demand growth, and MedTech innovation, healthcare M&A is likely to increase postpandemic. Moving into Q3, it is expected that the number of deals and deal size should increase. This may include distressed M&A for sectors facing incredibly low demand at the moment (such as pathology, ironically, given pathology is critical in preventing illnesses).
3.3 – What Happened in China During the Outbreak?
In China, the outbreak of COVID-19 brought the healthcare industry under spotlight, with vaccines, antiviral drugs, medical protection, IVD, etc. likely to affect M&A going forward. 2019 was an active year for China’s healthcare M&A markets, with M&A deals in the pharmaceuticals sector totaling U$22.1b, highest in 4 years. The medical device sector was also active, with 12 companies listing and total M&A transactional value at U$2.7b. However, given the economic shock of coronavirus, total deals in China (incl. Hong Kong) totaled only U$8.4b, down 54% compared to the same period last year. Chinese outbound investment plummeted, with total deal value falling 93% to U$1.4b from Jan to May in EU and falling 89% to U$700m in North America. For the first time in a decade, inbound investment was higher than outbound, with inbound investment in the first five months of the year totaling U$9b.
The drop in outbound investment was due to governments around the world adopting stricter FDI policies to avoid predatory acquisitions during the health crisis. For example, the European Union released guidance for FDI urging states to protect companies and critical assets in health-related industries from foreign buyout. Similarly, Australia announced measures to drop investment review thresholds to 0 for all economic sectors, with a focus on preventing Chinese investment. This has made M&A in 2020 difficult for Chinese firms as compared to their activity in 2019, especially in the medical consumables space (one-time-use devices for medical purposes). Zhende Medical, one of China’s largest low-value medical consumables providers, acquired a 55% equity stake in Rocialle Healthcare for U$6m in 2019 to create synergies in surgical sense control by integrating technology, production and sales channels. Similarly, Blue Sail Medical, a lowand high-value medical consumables provider, acquired NVT AG for U$193m to obtain market-leading heart-valve tech to expand their product line.
There are some key themes prevalent in China’s healthcare market. China’s pharmaceutical market is currently at the edge of shifting to innovative products and more efficient solutions through industry integration. Additionally, Investments in life sciences and healthcare are being driven by innovation and through use of technology. Online medical consultation, 5G, AI and big data are the current technology focus. Similarly, consolidation of providers to execute buy-and-build strategies and rising digital platforms and innovation investment are major investment themes which are likely to continue in the future.
3.4 – Healthcare in India
Healthcare is one of India’s largest sectors (in terms of revenue and employment), growing quickly due to strengthening coverages, rising income levels, improved access to insurance and increasing public and private expenditure, with the sector reaching ~U$280b at the start of 2020. However, given India’s high-density population, the country has had a difficult time dealing with the rising number of COVID-19 cases, entering a strict lockdown regime in early March, with more than 587,000 cases and 17,400 deaths confirmed by July.
M&A deals jumped a record 155% in the hospitals sector to U$1.1b in FY19, but M&A deals during COVID-19 faced many disruptions. Transactions in the structuring stages will likely to be deferred, and seller-driven processes will likely see bidders drop out. We are also seeing an increase in M&A in essential sectors within healthcare, with Maddison Dearborn Partners’ proposed 55% acquisition of Quadrant PE-backed Advanced Personnel Management (injury management, allied health intervention) for U$825m being the largest transaction in Q1. Additionally, in May, Carlyle Group acquired a 74% stake in SeQuent Scientific (animal health-focused pharmaceutical company) for U$224m.
In the future, M&A activity in the healthcare sector is expected to increase as a proportion of total activity. In FY20, government spending on healthcare grew to being 1.6% of GDP, and government aims to increase spending to 3% of GDP by 2022. Health insurance will be a key driver of activity in the sector, given that currently, a large proportion of the Indian population is without any insurance. A crisis such as COVID-19 highlights the importance and need for insurance and should result in a significant uptick in the insurance sector and increased M&A activity.