Interview – Nicholas Assef with LCC Asia Pacific
About Your Firm…
LCC Asia Pacific is an independent investment banking firm operating out of Sydney and Brisbane in Australia. LCC was founded in 2004. The Firm provides both strategic consulting and investment banking services to both public & private corporate clients in the mid- to upper mid-market ($50 million and $1 billion in enterprise value), principally in the following sectors:
- Engineering, Contracting & Complex Services
- Oil Field, Energy & Infrastructure Services
- Renewables, Water, Environmental & Waste Services
- Industrials including Industrial Technology & “Smart Manufacturing”
- Mining & Resources
- ICT & Logistics
Describe the corporate market in Australia and Asia
While the U.S and Europe tend to have a broader number of companies in the mid-market, Australia and Asia markets typically look like an “hour-glass”. A market map would illustrate many smaller companies at the bottom, a number of larger companies at the top and lower concentration in the middle. Mid-market companies in Australia and Asia tend to get acquired when they demonstrate a number of key positive factors – hence the lower number of constituents.
Across Australasia pension funds tend to invest in mid-caps as they become “Stock Index Relevant”. You can then see valuations of many mid-caps become “full” in time from such index related investment inflows, and as a strategy, identifying those that are likely to be on this trajectory and acquiring them before they hit high valuations can be highly effective.
Differences in M&A between Asia and Australia
Australian companies are different from the rest of Asia – and each of the Asian nations have their own unique characteristics.
As a western nation, corporate governance standards in Australia are high – and basic corporate matters such as board packs, data production and financial reporting are all transparent. It is easy for international parties to gain comfort on operational and financial matters reasonably quickly.
Asia is a different matter. It is a rich tapestry of many different cultures and many different business protocols – and large economies which provide significant opportunity. One of the issues we often strike with North American companies wanting to go into Asia is helping them understand that Asia is not a single block. Some cultures are more Westernized than others – and the risk profiles for deals is generally a lot higher (hence why returns need to be also higher). Often you will need a local partner – and locating and doing a deal with that partner can also take considerable investment of resource.
Diligence can be a challenge, and often a much more practical approach needs to be taken. With higher risk, a focus also needs to be on deal structures – and with private companies ensuring that business alignment can be maintained after a transaction closes. The last thing you want to do, for example, is not retain a strong Founder or Leader in some form or capacity.
Strategically, some Asian countries have very different business decision processes compared to Northern Hemisphere companies. In particular, understanding and appreciating time tables to decision making and the way that decision making works is critically important.
Board of Director operations, in particular, is an area where Western and Eastern approaches can be very different. For example, the Board for one of our large Chinese clients only meets quarterly. This is a Board of 25 or 30 people. There’s a real ceremony around that Board coming together. They meet for two days. But to get any decision on a strategic initiative if you miss that meeting window, you just have to wait. They don’t do Circular Resolutions or Dial-Ins – it just does not work that way.
We also spend a lot of time making sure we are talking to the right decision makers and figuring out who are the influencers – the confidants of CEOs and the Chairman. Often these are ex-politicians, ex-business leaders – that sit “at the edges” of many Asian companies.
The good news is that Asian companies are becoming very ambitious. Whilst they will do outbound deals, you have to start them up a lot earlier in any strategic transaction process compared to a Western company to ensure that they hit the overall timetable. In addition to patience, you also should make any process as convenient as possible – including translating key transaction documents in order to remove time roadblocks.
Differences in M&A between Asia and North America
A critical difference can be observed at the early stages of a deal. North American clients are strongly strategy driven and very pragmatic, whereas regionally (Asia) there can almost be a singular focus on financial performance initially and less into the deep strategic discussions.
Almost all deals LCC Asia Pacific does are cross border – be it with European, Asian or North American counterparts. Our Firm’s deal style is based around both strategy and quant. We often find spending too much time early, on the financial performance, is not as fruitful as a focus on operational and strategic issues. Once those two pre-requisites can be satisfied, then the real deal making tends to start.
So, if you are dealing with an Asian company, make sure they have their house in order around more than their statutory accounts before you start doing any heavy lifting.
M&A in Australia vs. Northern Hemisphere
Australian deals can tend to see comprehensive but still general information provided upfront, but not “deep dive” data into any particular area. The thinking often is – we’ll let them ask those questions and we will respond – driven by lawyers in the diligence process trying to minimize risk. Our Firm does not really advocate such an approach. We understand the requirements of Northern Hemisphere and typically will work with the client to prepare bespoke “strategic fit” documents early in any cross-border divestment process (as an example) – and we see this as critical to keeping momentum building in deals.
Australian deals are often geared towards domestic and regional private equity – hence the early focus on sustainable earnings, health of balance sheet (so it can be geared), etc. So, for any North American acquirer, it is important to signal upfront areas of specific diligence they will require in order to progress – and as I have mentioned, often the financial information is not the highest priority.
Australia has also seen a spate of M&A deals fall over due to offshore parties pulling out – often unexpectedly, and usually due to some financial data that they don’t like (and claim it effects value fundamentally). The approach of focusing on operations from our perspective reduces the risk of deal failure – if it makes sense strategically, then there is a higher percentage of a final deal being arrived at. This different initial approach style (bias on operational analysis vs. financial analysis) is subtle but very important.
Industry Trends In Industrial Sectors
Inside what we call “smart industrials”, there has been a noticeable trend in the last few years to automation, efficiency, technology and optimization – and this is driving a lot of the discussion on deal making. We expect it to only increase over the near term.
For example, imagine the scaffolding you see around a building, piece of infrastructure or construction site. I was talking to the CEO of one of the larger scaffolding companies about the introduction of drone technology for inspection and non-destructive testing (NDT) – which is a huge business in Australia & Asia given the often challenging climate conditions. They were moving into drone technology, including with highly customized software, to assist in specific instances. Although he was not certain how this new tech would affect overall business, there was, from a customer perspective, considerable benefit in adopting such approaches in low risk applications.
A data analytics example…
A client of ours is a leader in the mining technology sector, training individuals on complex machinery. That training & simulation business is morphing because the vast amounts of data they have captured over many years is allowing analysis of additional critical operational indicators to be made. For example, driver fatigue, fuel consumption patterns, tire wear and other key data points can be observed – leading to greater efficiencies, productivity and increasing safety standards. Sensor development (that allows all of this data to be collected) is also an interesting area of development.
An industrial technology product example…
We executed a deal at the end of 2017 (WEARX, bought by Metso out of Finland). WEARX makes wear products that are crucial in “hard ore” environments. Iron ore is often moved many kilometers around a mine site via conveyor belts, transfer chutes and associated infrastructure. WearX produces a number of IP rich products that extend the time period between servicing of infrastructure – particularly around both chutes and conveyor belts. Delaying the period between plate changes in chutes and conveyors at a mine site results in higher productivity (more ore processed) and so higher profit.
So, in the last 5-10 years, there’s been a move toward what internally we refer to as “Smart Industrials”. These are traditional industrial businesses that are becoming more IT rich to figure out how to use automation and efficiency to drive profitability.
A last example that gives a glimpse off the future…
An engineering firm here has hired robotics engineers without a specific job mandate. That is, they have no real fixed job description. They are taking almost a “skunkworks” approach of trying to figure out where change might take place in the Energy Services (onshore and offshore) and to figure out opportunities to automate. So, the robotics engineers are touring sites and contemplating the future – which is seen to be all about a continual process of efficiency improvement.
These smart industrial applications are having a noticeable impact on valuations. Companies with technology & IP edges definitely trade at higher values. One crucial attraction for offshore players is to acquire smart industrial targets and distribute what are often localized products on the international stage – in addition to (and this is true reverse synergy) moving the local human resource expertise into a wider corporate footprint.
Thoughts on Current Valuations
I think it is difficult not to have the view that valuations are high. In the sectors we track, the EV/EBITDA multiples through the cycles over 20 years are all pushing in the top quartile. Cheap debt will do that every time.
There is also a fragility in the markets in my view. For example, the volatility in the Dow Jones returned on the back of tariffs on imports of steel and aluminum to the USA. Many economists have predicted the impact of a potential fear of a “trade war” – and I think that it is certainly one of those key issues that could drive a correction in time. But as a Firm we are more focused on the impact of interest rate moves.
There are many financial sponsors across Australasia with new funds creating a lot of competition in the private deal markets. They are using less leverage compared to historical deals, but there’s a lot of capital to deploy. In competitive auctions, as the valuations are going up, we are seeing the corporates stepping back from the process, given their appetite for risk is often lower.
For corporates to compete buy-side, we stress the importance of pursuing the right deal and not being swept up in FOMO (fear of missing out).
Higher valuation expectations can of course be countered on the buy-side with more detailed diligence, deal structuring and approaches to valuation that protect the bidder.
As an example, we have a client that will take 30-40% of equity to determine if the product or service works throughout their company and then follow-on with a secondary deal – if needed on a pre-determined formula. That’s certainly a strategy we support to mitigate the risk of overpaying, because… Buy-side at the top of the valuation cycle generally end up in a great deal or a poor one – but rarely to the pre-deal plan.
To support valuations & deal structures, a commonly used approach is to wrap the deal in Reps and Warranty Insurance to protect both buy-side and sell-side. It does put pressure on time tables. We’ve seen it used both tactically and strategically. North Americans are very used to Reps and Warranty insurance. European companies know about it, but it’s not as prevalently used. In Asia, it’s not used at all because you just can’t get that level of comfort around some of the information. In Asia in particular, most of the deals you see in a private setting are “structured deals” because you want to observe performance for 2-3 years before you hand over all the consideration.
Western Companies Acquiring in Asia
There are many “jewels” in Australian & Asian companies that can accelerate or complement Northern Hemisphere organizations with growth ambitions. Large populations and / or highly competitive markets mean that products and services developed within this region are often world class.
For North American bidders, the approach of putting the strategic and operational interface team first and then doing the financial due diligence later is a real strategic advantage. The advantage in deal making can be as simple as the bidder casting the vision and convincing the target of its place in the ecosystem moving forward. That certainty early in a process can make all the difference.