How an IPO drought and consolidation are hitting retail investors

The candle seems to be burning from both ends for retail investors who are facing a drought in initial public offerings and a prospective pick-up in mergers and acquisitions this year.

Last year, M&A activity continued to exceed historical norms after a record high in 2021. Nearly 1700 local deals were announced and the value of the deals – at least those that were publicly disclosed – reached $US78 billion ($116 billion).

Some of Australia’s biggest companies have had merger and takeover offers that would take them off the ASX.Credit: Michael O'Sullivan

Despite economic uncertainty, that momentum is set to continue this year. Almost two thirds of Australian chief executives surveyed by PwC at the end of 2022 said delaying deals was not something their company was considering in the face of economic challenges in the next 12 months.

Already this year, a number of the country’s largest companies have come under enticing offers that would take them off the ASX. Origin Energy, a supplier of electricity and gas to 4.5 million customers, is in the final phases of a takeover bid from offshore firms Brookfield and EIG Partners, which have offered to pay a 50 per cent premium on the company’s share price.

Lithium miner Liontown Resources was also in demand, with one of the world’s largest lithium producers, New York-listed Albemarle, lobbing a $5.5 billion takeover bid at the West Australian company in March.

Most recently this month, gold miner Newcrest received a sweetened takeover bid from American miner Newmont, which could take Australia’s biggest gold player out of the equation for retail investors.

‘The sharemarket is a bit volatile, and we’ve had the banking crisis offshore so that’s creating uncertainty for investors and making it harder for IPOs to come through.’

Jun Bei Liu, Tribeca Investment Partners

While M&A activity has slowed in the first three months this year compared with the same time last year, HLB Mann Judd partner Simon James said the average transaction size had increased from $97.4 million to $110.9 million and that private equity firms have been swooping in.

“Private equity firms have been very, very active,” James said. “Some of the deals we’re working on at the moment are not going as quickly as they can because it’s a private equity-backed firm that’s acquiring the asset that we’re working with. PE funds are cashed up, and they’re actively spending the money.”

Over the past five years, private equity has increased its share of total deal value from about one third to nearly half, according to PwC’s 2023 M&A Outlook report. “Improved buying conditions mean we’re seeing private equity funds being increasingly active,” the report read.

James said demographic factors were also likely to drive deals involving small to medium-sized businesses in the year ahead.

“A lot of SMEs were founded by the very entrepreneurial Baby Boomer generation that is at, or past, retirement age now, but haven’t retired because of COVID. They need to either pass their business down to the next generation, which is happening less and less, or they need to sell it. There’s going to be a raft in the SME market coming through as a result of that.”

As private equity funds claim larger portions of the market, James said retail investors could have a harder time directly participating in the equity market.

“It’s potentially harder for retail investors to have cash within private equity funds themselves, so if there’s less initial public offerings, retail investors have less opportunity to participate in transactions,” James said.

The number of initial public offerings dropped substantially last year, and the pipeline looks thinner yet for the year ahead.

In 2022, there were 87 new listings on the ASX which raised a total of $1.1 billion compared with 191 new listings in 2021 which raised a record $12.3 billion.

So far this year, only eight new companies have listed on the local bourse, of which six have been in the materials sector. There are also only eight more companies lined up to go public in 2023, according to the ASX’s page of coming floats and listings.

Montgomery Investment Management founder Roger Montgomery said that IPOs had dried up in the past few months because markets weren’t particularly strong and because the discount rate – or the interest rate used to discount future cash flows from an investment – had risen.

“Because the discount rate has increased, in order to generate higher returns, people have to invest at lower prices,” Montgomery said. “Vendors would have to meet those lower prices to get their IPOs away, so they’re not willing to sell at the moment. They’ll hold off and wait until the next boom.”

Tribeca Investment Partners portfolio manager Jun Bei Liu said uncertainty in the sharemarket and overseas events have also dampened the number of IPOs this year.

“The sharemarket is a bit volatile, and we’ve had the banking crisis offshore so that’s creating uncertainty for investors and making it harder for IPOs to come through,” she said.

Meanwhile, M&A is likely to pick up in the next 12 months according to Liu, particularly in the mining space. “We should see a lot more M&A activity among resources companies because of the cost escalation for new mines and exploration,” she said. “Most of the miners, who are very cashed up, would much rather buy a mine that’s already in production.”

But Liu said there were likely to be substantial opportunities for retail investors to engage in IPOs this year.

Virgin Australia is preparing to float on the ASX. Credit: James Alcock

“In terms of the outlook for IPOs, the big one that’s coming is Virgin Australia,” she said. “That’s going to be quite a large one and is expected to go quite well.”

The airline went into voluntary administration in 2020 and was bought by private equity giant Bain Capital. In February, Bain signed on Goldman Sachs, UBS and Barrenjoey to provide advice on the potential float of the country’s second-biggest carrier.

And despite the likely increase in M&A and the small number of planned IPOs, Liu said conditions for retail investors were generally favourable.

“Given the choppy market conditions now, it means there may be more opportunity for retail investors to get bigger cuts of some of the more attractive deals,” Liu said.

“Retail investors who are already shareholders of a mining company will always be given first priority to buy the cheapest stock when they do issue new stock to do M&A. I think this environment might actually conversely be good for savvy retail investors to make a lot of return.”

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