Liam Murphy Director E: [email protected] T: 07 3839 9733
Shaun Lindemann Director E: [email protected] T: 07 3839 9733
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ON CORPORATE FINANCE
www.pkf.com.au
ISSUE 20
QUARTERLY INSIGHTS INTO KEY FINANCE
MATTERS AFFECTING YOUR BUSINESS
IN THIS ISSUE• PRE-SALE
PLANNING & PREPARATION
• HAS YOUR BUSINESS CONSIDERED LEVERAGE?
ASX:
TECH IPO SURGE STABILISES MARKET
focus | on corporate finance
INCREASED IPO ACTIVITY ON ASX, BUOYED BY IMPROVED INVESTOR SENTIMENTBy Nick Navarra – Principal Sydney
Australia’s initial public offerings (IPO) market displayed strong growth in 2017 compared with the previous year. A total of 110 IPOs were completed on the Australian Securities Exchange (ASX) in 2017, compared to the previous five-year average of 83 listings. Heavily driven by small-cap IPOs, total funds raised in 2017 did, however, decline from $7.5 billion in 2016 to $4.1 bn in 2017.
Figure 1: Overall activity on ASX
7.5
4.1
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2016 2017 Amount raised ($ bn) (LHS) # of IPOs (RHS)
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2016 2017 Amount raised ($ mn) (LHS) # of IPOs (RHS)
Figure 1: Overall activity on ASX
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2016 2017 Amount raised ($ bn) (LHS) # of IPOs (RHS)
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2016 2017 Amount raised ($ mn) (LHS) # of IPOs (RHS)
After a surge in IPOs over the last few years, technology companies are now the third largest sector on the ASX by number with 207 listings. While 2016 saw the highest number of technology listings since the dotcom boom of 1999-2000, 2017 continued to be a strong year for tech IPOs with 18 new listings raising over $235 million and with a combined market capitalisation of over $1.08 billion.
Small-cap stocks dominate IPO market on ASXOver the past two years there has been a notable increase in small-cap companies listings on the ASX, indicating a reversal of the trend of large-cap companies dominating the IPO market in 2014 and 2015. In 2017, 80% of all new listings consisted of companies with market capitalisations of less than $100 million at the time of listing.
Since 2016, the technology sector has seen a total of 48 IPOs, of which 83% were companies with market capitalisations of less than $100 million. In 2017, 16 of the 18 technology companies listed had market capitalisations of less than $100 million. The market cap brackets of $10–25 million and $25–50 million were the two most active segments. In 2017 and 2016, the largest IPOs in the small-cap segment were of Audinate Group and Dreamscape Networks, the former raised $21.0 million in 2017 and the latter $25 million in 2016.
“Since 2016, the technology
sector has seen a total of 48 IPOs, of which 83%
were companies with market
capitalisations of less than
$100 million.”
Figure 1: Overall IPO activity on ASX
Figure 2: Tech IPO Activity on ASX
Source: CapIQ
Source: CapIQ
2017 2016
10.2x
5.8x
: Small-cap Tech IPOs on ASX
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2016 # of IPOs (LHS) 2017 # of IPOs (LHS) Average amount raised 2016 (RHS) Average amount raised 2017 (RHS)
Market Capitalization on Listing ($ mn)
2017 2016
10.2x
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: Small-cap Tech IPOs on ASX
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2016 # of IPOs (LHS) 2017 # of IPOs (LHS) Average amount raised 2016 (RHS) Average amount raised 2017 (RHS)
Market Capitalization on Listing ($ mn)
Tech companies’ valuations on listing The valuations of tech companies appear to have decreased on average over the last two years. In 2016, companies achieved a median revenue multiple of 10.2x. This was almost halved to a median revenue multiple of 5.8x in 2017. Whilst it is difficult to pinpoint the exact cause of this decrease, it would appear that an increased focus on sustainability and operational performance has played a key role.
The average percentage of shares offered to public by technology companies in their IPOs also reduced to 28% in 2017, against 31% dilution witnessed in the previous year.
2018 OutlookOf the 18 technology IPOs on the ASX in 2017, three were foreign firms (Mobilicom and Elsight from Israel and Credible Labs from the US).
ASX Code Company Name Market Capitalisation As on April 2018 (AU$ mn)
Country of Incorporation
ASX:XRO XERO Ltd 4949.7 New Zealand
ASX:TME Trade Me Group Ltd 1645.7 New Zealand
ASX:PPH PushPay Holdings 1031.6 New Zealand
ASX:UPD Updater Inc 540.2 USA
ASX:GTK Gentrack Group Ltd 519.9 New Zealand
Figure 3: Number of Small-cap Tech IPOs on ASX
Figure 4 : Median EV/Revenue on Listing
Source: CapIQ
Source: CapIQ
The ASX is expected to witness a surge in demand from foreign tech companies for listing on the bourse through 2018 as it aims to be the world’s top junior tech exchange for companies that are too small for the NASDAQ and New York Stock Exchange. A higher number of tech firms from the US, Israel, New Zealand, Singapore, Malaysia, Germany and Ireland are expected to appear on the ASX in the coming years.
The ASX is an appealing choice for tech companies looking to list outside of the major US exchanges as it offers:• access to local and global institutional investors;
• earlier entry to a globally recognised index, with a minimum market cap requirement of around $300 million for the S&P/ASX 300 index; and
• flexible and efficient capital-raising opportunities with the main board listing.
on corporate finance | focus
HAS YOUR BUSINESS CONSIDERED LEVERAGE?
Gearing or leverage in the financial world refers to funding a portion of the capital in your business using debt. Large corporates usually understand the benefits of leveraging their capital structure with an optimal level of debt which is known to be cheaper than equity as returns expected by equity holders are normally greater than the prevailing interest rates. However, many privately held businesses consider debt to be the funding of last resort instead of being an integral part of their capital structure strategy.
The numbersThe chart below illustrates how a private company can decrease its weighted average cost of capital (“WACC”) and increase return for equity investors by including debt in the capital structure.
• strengthen accounting processes;
• streamline budgeting and forecasting process;
• monitor covenants and review business performance frequently;
• manage cashflows with more discipline; and
• report to external stakeholders including banks or other lenders.
While some of these may seem to be an unnecessary compliance burden, these are traits that make a business attractive to potential investors. As such, the process helps prepare a business for external investors and their due diligence when they come calling. A substantial portion of risk for privately held businesses comes from unreliable historical reporting and absence of checks and balances. Taking on external debt forces businesses to focus a lot more on these issues than they usually would.
Even if an exit is not on the cards, creating a debt strategy can help businesses to:
• free up a portion of invested capital and increase ability to pay dividends;
• free up seasonal working capital locked in the business; and
• provide access to immediate funding to ride through unforeseen cashflow events such as delay in payments from major customers.
The right structureThere are a range of funding alternatives available for companies looking to raise debt. The available alternatives typically differ based on security, charge on assets, features and source of funds as noted in the table below.
Security Charged on assets Features
Secured Senior Term Debt
Unsecured Subordinated Revolving credit
Asset finance Mezzanine Interest only
Factoring / invoice discounting Convertible
0%
5%
10%
15%
20%
25%
30%
0% 5% 10% 15% 20% 25%
Cos
t of C
apita
l %
Debt as % of Capital Structure
Weighted Average Cost of Capital
By Vikas Nahar – Senior Manager Sydney
The analysis above assumes:
• Cost of equity of 20% based on returns expected by investors in mid-sized private businesses in Australia;
• Return on assets of 20% in line with cost of equity;
• Cost of debt of 6.0% based on a premium of ~2.5% over yields on BBB rated corporate bonds in Australia;
• Tax rate of 30%; and
• Debt at 0% to 35% of the total value of business.
WACC in the above analysis goes down from 20% to about 15% by including debt in the capital structure. Leverage also helps increase the returns for the equity holder as suggested by a higher implied return for the equity holder with greater leverage.
An important thing to note here is that leverage magnifies the risk to equityholders when a business is loss making as the interest is an additional obligation. Sustained losses with high levels of debt can increase solvency risk. As such, it is important to assess the optimal level of debt for the business based on its capacity to service debt under different scenarios.
Beyond the numbersMathematics aside, there are other reasons to consider including debt in the capital structure. This is especially true for business owners that may be looking to exit in the near future. Here is a list of things that a business may be “forced” to do as it takes on external debt:
The nature of business and its funding requirements typically determine the appropriate debt funding structure.
Happy to helpWe have helped many businesses in creating an optimal capital structure and securing debt funding from banks, non-bank financial institutions and private investors. Our team can provide an end-to-end debt advisory service to secure funding or help in specific areas such as building financial forecast models and business plans.
Feel free to contact your trusted advisors at PKF for a discussion on your capital structure strategy and funding needs.
focus | on corporate finance
The sale of your business can be one of the most significant decisions you can make. The business is often a family’s most valuable asset, and often has also been a huge part of a family’s life over many years. It is therefore important that the sale process runs as smoothly as possible and also generates the largest return.
In order to achieve this, we strongly recommend starting to plan and prepare for the sale well before the intended sale date. Below we discuss some of the key components which you should consider as part of this planning process.
Stage 1 – Assessment of your business It is vital that your business is assessed to identify areas of weakness or where there can be improvements made. It may be possible to perform this assessment in-house, but unless your team has the necessary skills and time to perform it, we recommend engaging an independent third party which specialises in pre-sale planning and due diligence.
The assessment should cover the following areas:
Financial records
• At least three years of financial records for the period before the date of sale should be prepared and kept up to date;
• Prepare budgets which are reasonable but not overly optimistic – often a buyer will assess budgeting accuracy;
• Maintain detailed schedules to support year end balances (for larger businesses this should be monthly);
• Monthly management accounts should be kept up to date, trying to minimise adjustments in subsequent months due to errors or corrections;
• Identify non business related items (expenses, income, assets and liabilities) and move these out of the business;
• If there are multiple businesses being operated from the one company, consider separating them and putting each into its own legal entity; and
• Identify related party transactions, in order to ensure they are on an arm’s length bases going forward.
Valuation
• Identify the value drivers of the business, this will allow management to focus on these drivers and thus improve the value of the business; and
• Determine an indicative valuation range as well as
PRE-SALE PLANNING & PREPARATION
the valuation metrics which are used in determining the range, thus giving shareholders an idea of what their business may be worth if the valuation drivers can be improved.
Taxation
• The assessment should consider the appropriateness and compliance with tax matters over at least the three years prior to the planned date of sale. The assessment should cover, Company Tax, GST, FBT, WorkCover, as well as Payroll Tax. It should also assess whether appropriate records have been maintained to support and substantiate each of the above, as well as ensure all necessary compliance requirements have been met.
Operational
• Key staff should be identified. Often key staff will need to be informed of the sale process as a purchaser may wish to interview them and may also include their employment and incentivisation as part of the terms of purchase;
• Depth of management should also be considered, as a purchaser will wish to know how many of the key tasks are distributed amongst the management team or whether they are concentrated within one or two individuals; and
• Systems and processes are to be considered as part of the assessment. The stronger the processes and systems in place, the greater the reliance can be placed on the financial reporting system and the increased chance of management picking up any errors early.
Commercial
• Relationships with suppliers and customers should be assessed, including whether appropriate contracts are in place, and the key terms within these. Exclusive rights in contracts may also be of benefit or even a selling point.
• Concentration of suppliers and customers should be considered. Often a diverse customer base will be preferred, as well as multiple suppliers providing the same inputs, thus reducing any reliance on one or a few customers or suppliers. Where this is not possible, appropriate contracts should be put in place; and
• A pipeline of customers showing gradual conversion to actual customers will also be beneficial.
Compliance
• A full compliance and regulatory review should be performed. This would address regulations for the states and countries of operation, as well as industry specific regulations.
By Alastair Richards – Associate Director Melbourne
PKF International Limited administers a network of legally independent firms and does not accept any responsibility or liability for the actions or inactions of any individual member or correspondent firm or firms.
Our Corporate Finance Team
If you would prefer to receive your newsletter via email, please contact your local Corporate Finance representative.To download a soft copy of this newsletter please visit: www.pkf.com.au/Our-Services/Corporate-Finance
Our Corporate Finance Team
Andrew Jones Director E: [email protected] T: 02 8346 6000
Andrew Beattie DirectorE: [email protected] T: 02 4962 2688
Nick Navarra PrincipalE: [email protected] T: 02 8346 6000
Steven Perri DirectorE: [email protected] T: 03 9679 2222
Paul Lom Director E: [email protected] T: 03 9679 2222
Alastair Richards Associate DirectorE: [email protected] T: 03 9679 2222
Stefan Galbo ManagerE: [email protected] T: 03 9679 2222
Liam Murphy Director E: [email protected] T: 07 3839 9733
Shaun Lindemann Director E: [email protected] T: 07 3839 9733
John Bell Director E: [email protected] T: 08 9426 0666
Rick Hopkins Director E: [email protected] T: 08 9426 0666
Vikas Nahar Senior ManagerE: [email protected] T: 02 8346 6000
Simon Rutherford DirectorE: [email protected] T: 02 4962 2688
PRE-SALE PLANNING & PREPARATION CONTINUED
By Alastair Richards – Associate Director Melbourne
Stage 2 – Action planNow that the matters have been identified, it is key that each is addressed. Some matters may be more important than others, therefore these should be focussed on first; with the less important matters being resolved subsequently. It is also vital that processes are put in place to ensure that once a matter is resolved, that it remains resolved.
Conclusion
A selection of the key matters to consider when planning to sell your business have been included above. This is not an exhaustive list but provides a good base to start. We recommend seeking professional advice and assistance where you and your team don’t have the necessary skills or don’t have time to perform it as thoroughly as it should be.
We also wish to reiterate, that it is much better to inform a potential investor or purchaser that there was an issue, but it has been rectified and thus should not have any impact on the sale price; rather than the purchaser finding out about it during their due diligence process and either walking away from the deal or requesting a discount to the price. It should also be noted that many professional investors consider the planning and preparation for sale to be so important, that they start this phase even before they make the initial acquisition or investment. So please keep in mind, how important this planning and preparation phase is.
If you would like to discuss this further, please contact me or one of my colleagues as listed on the back of this newsletter.
“It may be possible to perform this assessment in-house, but unless your
team has the necessary skills and time to perform it, we recommend engaging an
independent third party which specialises in pre-sale planning and due diligence.”
