Merger and Acquisition Rates have Fallen to Pre-Pandemic Levels – is this a Result of Surging Bankruptcy Rates?

The Australian Securities and Investments Commission (ASIC) has recently released alarming statistics regarding the number of Australian companies who have collapsed. From 1 July 2023 to 31 March 2024, 7,742 companies entered external administration, which is a 36.2% increase on the previous corresponding nine month period. Companies within the construction, accommodation and food services industries account for approximately 43 percent of that total.

ASIC expected the number of companies entering external administration to exceed 10,000 by the end of the 2023/24 financial year, a level not seen since the 2012/13 financial year. That said, it is important to note there has be overall growth in company registrations during the last financial year. The failure rate as a proportion of registered businesses is actually lower than the 2012-2013 peak, however, what factors other than increased company registrations have led to the increase in businesses becoming insolvent?

Corresponding with an increased business failure rate is a 31 percent decrease in merger and acquisition deal volume (M&A). The overall value of M&A deals dropped from 1022 in 2022 (worth $118.2 billion) to 708 in 2023 (worth $68.2 billion), which is the lowest number of transactions recorded in the last decade.[1]

Are the high levels of failing companies having a detrimental impact on M&A transactions? If not, what other factors are influencing the M&A market post Covid? Does the current market present a good opportunity for investors and business owners?

One theory is that higher business failure rates are in fact boosting M&A activity, potentially due to a number of factors such as generational change and compliance requirements in addition to the current cost of living financial pressures.

What is an M&A?

An M&A is a transaction involving one or more companies which allow businesses to increase performance by increasing or decreasing scale or scope, and diversifying risks across a range of activities. M&A’s are important for the efficient functioning of the economy and can range in value. For example, the largest deal conducted in Australia in 2023 was the acquisition of Newcrest Mining Limited by Newmont Mining Corporation for a staggering $26.1 billion, while 38 percent of total M&As are valued at up to $10 million.

When analysed separately, a merger and an acquisition are functionally similar, however, have some differences. Essentially, a merger involves two companies combining into a single new company, while an acquisition will see a larger company take over the interests of a smaller company, with no new entity being created.

Regulatory Factors Influencing M&A Levels

The Competition and Consumer Act 2010 (Cth) (Act) plays a role in many M&A transactions, as section 50 of the Act prohibits any merger that would have the effect, or be likely to have the effect, of substantially lessening competition in a market. Even though legislation governs mergers, 3 out of 4 mergers go unchecked by the regulator of the Act, the Australian Competition and Consumer Commission (ACCC). This is in contrast to countries such as the US, Japan, Canada and all EU members who have systems that require the compulsory notification to watchdogs of mergers.

On 23 August 2023, the Australian Treasurer announced a Competition Review which will last for 2 years and focus on the government’s priorities for modernising the Australian economy. The Competition Review was headed by a Competition Taskforce led by seven experts in business, government, law and economics to advise on competition policy.

Of note are the substantial reforms in relation to Australia’s merger clearance regime proposed by the Competition Taskforce that will come into effect on 1 January 2026.  The reforms have the potential to result in considerable changes to the assessment of mergers by the ACCC in the future, including the potential for a formal mandatory merger clearance regime (in contrast to the current informal clearance regime) as well as changes to the substantive test for when mergers will be cleared.

Essentially, the reforms mean that notification to the ACCC of transactions above certain thresholds will no longer be voluntary but mandatory, and these transactions will not be able to proceed without ACCC approval. The thresholds will be monetary and market share based. Did impending regulatory reform effect the M&A transaction market?

Current Trends

Rising inflation is one of the leading factors that puts strain on companies willing to enter into M&A transactions. Most of us would be aware of the hike to the cash interest rate, which in turn creates market uncertainty and volatility, and leads to more meticulous due diligence processes. Further considerations include environmental, social and governance factors, along with heightened regulatory scrutiny. These factors combine to create reluctant investors not willing to execute M&A deals.

The 38% of transactions which are up to the $10 million amount is a decrease from the 10 year average of 51%, highlighting how the small to medium business sector is most at risk of financial influences affecting a successful M&A transaction.

The RBA is projecting the CPI to decrease throughout 2024 and into 2025, with the CPI sitting at 4.1 in December 2023 and forecast to sit at 2.8 by December 2025.[2] Lower interest rates typically support better valuations for businesses and lower recessionary pressures. This leads to increased levels of M&A activity, with a distinct correlation between the number of M&A transactions and the RBA cash rate.

Due Diligence is the Key to a Successful M&A

Due diligence is the process of investigating a company or business before a purchaser enters into a contract with the target company. Legal due diligence is important to mitigate the duties placed on company directors in order for them to make informed investment decisions prior to any company merger or acquisition. Provided that an appropriate due diligence process has been conducted and the purchasing company’s directors believe the purchase of the target company is in the best interests of the company, the directors will have a defense to any claim that entering into the transaction constituted a breach of their director’s duties.

No matter what factors are affecting M&A transactions, due diligence must be conducted to investigate a potential target. Any potential target must be consistent with the purchaser’s business plan and overall strategy, as well as identifying issues that may prevent the transaction from proceeding or be useful in the negotiation. Three key matters that should be addressed throughout due diligence are:

• Risk factors
• Value factors
• Deal structure.

Any commercial transaction comes with risk, as noted above by the number of failed businesses. Due diligence identifies underlying risks, such as the performance of the target company, and identifies critical information such as contracts.

Legal Trends

Schemes of arrangement and takeover bids are both legal structures used to effect an MA and both are legislated in the Act. Schemes of arrangement are the most favoured deal structure for M&As in Australia, but there are substantial differences in why the different legal structures would be used.

Schemes of arrangement

A scheme of arrangement is a formal process that allows a company to restructure its operations with the approval of its shareholders and a court. This process under the guidelines of the Act, enables companies to modify their share capital, assets, or liabilities and it can also be used to reach a compromise with creditors.

Schemes of arrangement are often preferred to takeover bids due to their “all-or-nothing” nature and potentially lower shareholder approval requirements. Unlike takeover bids, schemes require target company involvement and court oversight, however, its successful completion results in the acquiring company owning all shares of the target company.

Takeover bids

A takeover bid is an offer by a company (the bidder) to purchase shares from shareholders of another company (the target). If the bidder acquires a sufficient number of shares, it can gain control of the target company.

There are two primary types of takeover bids: off-market and on-market. Off-market bids involve direct offers to shareholders, while on-market bids are made through the stock exchange.

Off-market bids are more common as they allow for more flexibility, including conditional offers but in both types, detailed documents (bidder’s statement and target’s statement) must be prepared and distributed to shareholders.

Takeover bids can be friendly or hostile with friendly bids often involving a bid implementation agreement outlining the terms of the deal and including provisions to protect the bidder’s interests.

The Future of M&A

Although the construction industry contributes highly to the failed business statistics, industrial companies contribute strongly to M&A transactions, along with the technology, consumer and media and communication industries. There is a generational emphasis on technological innovation, particularly in generative AI, biotech and sustainability. The industrials and materials sectors will be critical in advancing green energy for renewable technology such as batteries and electric vehicles.

The focus is likely to be on these industries in 2024 and beyond. Strong and effective merger law is crucial at all times, but its importance is magnified by the current economic climate. Australians are facing significant challenges due to rising costs, the shift to a green economy, and rapid digital transformation. Fostering competitive, innovative, and dynamic markets is essential to address these issues. A robust merger regime is widely acknowledged as the cornerstone for safeguarding competition.

Author Christopher Horn

[1] https://williambuck.com/tools/dealmaking-insights-2023/

[2] https://www.rba.gov.au/publications/smp/2024/feb/overview.html