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13 July 20227 minute read

State of the Australian M&A Market

State of the market

The Australian M&A market in 2021 was a wild ride. As Covid-19 restrictions (imposed both domestically and internationally) lifted, returning investor confidence, coupled with low inflation, low interest rates, and many businesses sitting on dry powder, meant that investors returned to transactions previously shelved during 2020, as well as new strategic opportunities, as valuations soared across all asset classes.  This generated significant levels of Australian M&A activity and solid returns for investors. The Foreign Investment Review Board (FIRB) Annual Report for the year ended 30 June 2021 supports this. Although the number of approvals for this period were down, as against the previous reporting period (the result of a $nil screening threshold applied to all foreign investors between March and December 2020 to protect Australia’s assets in the wake of the Covid-19 pandemic - lowering the level of foreign investment), the value of approved investments over this period increased by AU$37.5billion as against the previous period. 

At the end of 2021, Australia revelled in the reopening of its domestic borders and, a short time later, its international borders.  It seemed that the only way was up after the previous 18 months of lockdown and stagnant levels of investment.  Welcome 2022, the year that heralded:

  • War in Europe – The Ukraine Russia conflict resulted in significant Western trade sanctions and in turn commodity shortages, in particular, gas and wheat.  The cost of substitutes and commodities from non-sanctioned countries quickly rose – the price of Australian coal has skyrocketed and remains at historically high levels.
  • Inflation – A sharp increase in rates of inflation, with the Australian inflation rate sitting at 5.1% as at March 2022 (and expected to reach 7% by December 2022) and the US inflation rate sitting at 8.5% as at May 2022 (a 40 year high), and the potential for a recession in the US, Australia, and globally. Whilst the Reserve Bank of Australia maintains that there is no certainty of a recession in Australia, it is predicting that Australia’s inflation rate will not return to the targeted 2-3% range for “some years”.
  • Interest Rates – As a result of rising inflation, central banks (other than the Bank of Japan, focused on increasing the rate of inflation) have been quick to raise interest rates. In April 2022, the Reserve Bank of Australia increased interest rates for the first time in 12 years, after 10 years of reductions and sustained historically low rates. Since then, interest rates have been raised again in May and June 2022, with the expectation that further rates rises are on the horizon to rein in inflation.
  • Australian Electricity Network – A domestic energy ‘crisis’ for Australia in June 2022 as the national electricity market began to buckle under the pressure of soaring input costs for gas and coal, and planned and unplanned generator outages. 

In six months, global market dynamics have changed in ways that were not foreseeable in 2021. Whilst the events of 2022 raise concerns, at present, Australian M&A activity remains steady and strong, but it is reasonable to expect that investors will be taking a cautious approach going forward, as interest rates and inflation bite, and value gaps begin to widen. 

However, against the backdrop of the above events, investment opportunities continue to exist. Where do these opportunities exist for foreign investors?  

War in Europe

As a consequence of the war in Europe, commodity prices, in particular for coal, gas and wheat, remain at record high levels as Western sanctions bite and substitutes are required to be obtained.  Accordingly, these asset classes are currently commanding significant premiums as investors look to take on or increase exposure to them. Even though some investors have long term exposure to these asset classes in Australia, the current market may present an ideal opportunity for foreign investors to realise a significant premium for certain assets which are no longer core or are inconsistent with ESG positions adopted by head office in their home countries.

Security ties

As the market softens with rising inflation and interest rates, it is expected that investors will move away from assets and sectors focused on consumer spending or which provide the potential for growth. Instead, investors will focus on defensive assets or those that consistently generate strong cash flows, such as large public utility infrastructure that are not directly impacted by changes in consumer discretionary spending.  These types of assets are typically subject to foreign investment review for national security risks. 

In the Indo-Pacific region we have seen a commitment to regional security through The Quadrilateral Security Dialogue, or the “Quad” - a strategic security dialogue between Japan, Australia, the United States and India. It represents a significant commitment to regional security in the Indo-Pacific region. 

Investors can reasonably expect that the deepening security ties between the Australian and other Quad Governments, coupled with the long history of successful and mutually beneficial investment in Australia, will leave foreign investors from those countries positioned as preferred investors in Australian assets. This expectation particularly relates to assets which carry national security risks, such as ports, rail, energy generation and transmission, health, data storage and defence assets (including jointly developed defence exports), being those which are increasingly likely to become an investment focus as investors look at alternate assets to maintain returns in a softening market. 

The increased focus on the Indo-Pacific region sees an increased investment in the Pacific Islands, which serves not only a strategic purpose but an economic one, with the region possessing significant fish stocks and oil reserves, and a growing consumer base. We see the Pacific Islands continuing to be a significant focus of the new Labor Government, which represents an opportunity for foreign investors to jointly develop with Australia. 

Renewable energy opportunities 

Sectors tipped for growth during the current market conditions include those exposed to energy transition. Australia’s June 2022 ‘energy crisis’ identified a noticeable domestic energy deficit, which will only expand, as more coal-fired power stations are decommissioned and economical substitutes for the baseload power generation they provide remaining to be identified and commissioned. 

Australia’s Energy Security Board has stated that with the planned closures of coal powered generators by 2030, coupled with those that may become uneconomic during that period, Australia requires the equivalent of another Snowy 2.0 to be connected every year until 2030 to replace that lost capacity. The Australian Energy Market Operator’s expectation is that Australia will require (in addition to existing hydro and gas fired generation):

  • 122GW of new solar generation assets; and
  • 45GW of new storage capacity

by 2050, to compensate for the planned exit of all coal generators by 2043.

“The new capacity required over the next 28 years is more than seven times that built over a similar time frame since the [national energy market] commenced 24 years ago and around 50 times the amount built by the Snowy Hydroelectric Scheme”.1

This is a tremendous amount of generation infrastructure needing to be built in a short period of time, in addition to the development and upgrade of transmission networks required to support these new generation assets. Significant investment is required. 

However, investment in this sector for the last decade has been stifled under a lack of clear policy initiative.  In May 2022, Prime Minister Albanese committed to reducing Australia’s carbon emissions by 43% by 2043 and being net-zero by 2050, signaling to the market that there would be policy support for investments in renewable assets.  In June 2022, the Australian Energy Security Board announced the proposed design of an energy capacity mechanism, under which energy providers would be paid to have their capacity available during specific periods in order to reduce the risk of a disorderly transition from fossil fuels to renewable energy, as opposed to the current mechanism under which providers bid for contracts on the wholesale energy market.

While hydrogen continues to be pursued as a potential alternative energy source, the Australian Energy Security Board is not predicting that hydrogen will be a material part of Australia’s energy mix in the period to 2050.  Accordingly, the development of a hydrogen industry in Australia, at least presently, remains export focused, with a number of foreign investors already taking significant exposure to various hydrogen projects. 

In spite of an increasingly uncertain economic and security landscape, we see foreign investors continuing to benefit from their activity in the Australian market.


1https://www.energy.gov.au/sites/default/files/2022-06/Capacity%20mechanism%20high-level%20design%20consultation%20paper.pdf

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