Outlook: 1H 2025

Anna Ellis: Hi everyone, thanks for joining. I'm Anna Ellis. I'm with Michael Lukin here this morning and we are going to talk about what we've seen in 2024, and what we think is in store for 2025 from a private market’s perspective.

Last time I chatted to Frewen Lam and he reflected on some of the sticky inflation that had persisted globally as well as geopolitical challenges that were weighing on transaction activity towards the end of last year. However, he did talk about how the liquidity issues had created opportunities for secondaries in private markets. But now, Mike, I'm keen to see what you thought because we didn't chat last time, to see what your thoughts were on 2024 and what you think 2025 has in store.

Michael Lukin: Thank you, Anna. I think if I summarise 2024 in a few words, it's probably another lost year in private markets with transactions, I think at least at the larger, more high-profile end. So, thinking back to this time last year, I think everyone was hopeful that interest rates would start beyond the decline, the economy would start improving around the world. And so, on the back of that, we'd see a lot more transaction activity.

But I think probably a couple things got in the way last year. Not least of which is we had elections all around the world and I think more than half the population of the world went to the ballot box last year, not least of which the US election, which obviously is the key bellwether for markets around the world is what happens in the US.

So, I think, what we saw in ‘24 was probably, a hope that uncertainty would dissipate, but then a reality that uncertainty lingered over the course of the year.

So even just reflecting on it, yeah, obviously election in the US in November, but before that talks about interest rates may be going up rather than down earlier in the year. Questions about sticky inflation... and so, as I roll into 2025, if I look at the global context, I think we're starting to lift the fog around what the outlook looks like and that should be better for transaction activity this year.

Once we fully understand what the Trump administration means for the US I think, the high-level view is probably that it will be conducive for transaction activity in the US with less regulation, less red tape, but it will take time for that uncertainty to dissipate around what does Trump mean for the US economy.

And then locally we also have an election here. So probably, 50/50 line ball call now an election by May this year, which I think will also have implications for some of the government related sectors that that we operate in and businesses in those sectors looking to exit. And so, as I think about 2025, some of those economic conditions are clearly on the improve. We're seeing interest rates coming down around the world, that should take pressure off the consumer cost of living coming down should also improve. And then the uncertainty of regulation and governments around the world starting to dissipate.

Maybe a little bit of a slower start, but as we move into the second half of the year, definitely more activity as we as we roll forward.

And I think, even while we've been talking about this limited activity, there's still been pockets of activity around the place and things like technology and smaller end and we'll touch on this today.

There has been a little bit of activity. It's just not the high-profile, blockbuster deals that we usually see. And I think on the back of that, uncertainty and that limited transaction activity, we have seen, as Frewen mentioned last time we spoke to him, the prevalence of secondaries. And I think that asset specific secondary model or what we call the ‘continuation vehicles’ in the private equity market that really took off during 2024 on the back of this inability to get transactions done for a whole bunch of reasons. So, I think we'll continue to see continuation vehicles through 2025. I think we'll continue to see deal activity continue to bubble along in the market and as we go forward, further into the year, I think we'll see more and more deals done across the spectrum of the market.

The one thing you should never discount is self-interest, private equity individuals, professionals, are pretty self-interested individuals. And so, in a world where no deals have been done for a while, that means, no realisations, which means no carry, no new deals means the inability to raise future funds and the management fee stream that comes along with that. So don't be surprised to see those 2020-2021 vintage funds starting to think about how do I deploy the rest of my capital before I have to give it back? And some of the more mature assets, private equity managers accepting the valuation they can get and moving on as those assets become six, seven, eight years old. So, I do think we'll see more activity. Obviously, it's been probably call it now three years since we really saw the top of the market. So, we're really coming into a point where, the impediments to deal doing are definitely reducing.

Anna Ellis: So perhaps it's more of a the new normal because I think, the 21 and 22 were off particular highs. And what I've also heard you talk about there is private equity managers being creative around exit. So, I don't think that's necessarily a negative thing, but it just creates other opportunities for private market investors to become involved. Like it might be a sector that was not the right time to exit even though say it was three year hold. Like what are some of the other sort of circumstances that you've typically seen drive, one of these more creative type exits?

Michael Lukin: Yeah, so look, I think there's a whole bunch of different reasons and part of what we do, I guess is trying to understand why a private equity manager is going down these bespoke exit options. What we don't want to see is a manager run a process and not find any buyers and try to do a continuation vehicle to give them some liquidity. But yeah, you're right, it might be that the sector's out of favour at the moment. If you've got a great consumer business, you probably don't want to be selling it when the consumer around the world is pretty depressed with a high cost of living. A lot of funds run out of money at some point in their fund life, but they might have a great asset wants to continue to grow. There's one deal we're looking at today locally that is a great tourism asset. They're looking to bolt on another business into that tourism business. They need further capital, no further capital left in the fund. How are we going to do that? We're going to have to do a continuation vehicle to step into that new asset.

So, a clear reason for undertaking a continuation vehicle and I think that's really important is you don't want to just be caught with an asset because it's there and it's the last one in the fund.  You want to understand. Well, okay, if we go and fund that asset, what does that mean for the end value of that business? Are we actually making it a more attractive asset to sell down the track?

Anna Ellis: Yeah. And what about if we just put aside continuation vehicles. We know that exits have been much slower than they were during 21 and 22, and 23 and 24, pretty much similar. I think there's been pockets, but perhaps, more international trade coming in and they might have a different agenda. What do you think about the exit market in 2025? Like IPO market, trade or even just secondary exits?

Michael Lukin: Yeah, And I think you probably need to separate Australia, say, from the rest of the world in that context. So, I think the IPO market in Australia will continue to be challenged. We're not seeing a lot of new IPO candidates coming to market. I think a combination of the ease of doing business in private markets just continuing to substitute for the IPO market as an exit option.

But then also I think the IPO, the listed equity managers obviously are very particular about the types of assets that they want to own and not necessarily all private equity assets are going into that model.

So, I think the private the IPO market in Australia will continue to remain relatively challenged. I think if you find a good asset that probably could be IPO’d, there is definitely demand there, but it's got to be a particular fit, to fit into a particular box. Whereas I think globally particularly around areas like technology was continuing to see more and more IPO activity starting to build as the market remains relatively resilient.

I think we will see a lot of activity in exits will be what we call secondary buyout style activity. So, private equity selling to other private equity where the market in Australia has become really stratified by small cap or growth, small cap, midcap, large cap, global PE.

And so, the businesses as they grow, moving from one hand, one set of hands to the other, we'll continue to see that. And I think in particular, the wave of capital coming in from, call it, ‘Pan Asian’ funds. Whether that's Pan Asian fund-to-funds looking to deploy capital into Australia or the likes of the KKR’s, the BlackStone’s, the TPG’s who have big Pan Asian funds. Looking for assets, they've raised a lot of money for Asia, they're still a little bit hesitant on China as a market to deploy capital. India looks expensive, Japan looks expensive. There's not too many other markets where you can deploy 50, 500 to a billion dollars in equity into a transaction.

And so Australia, I think will continue to see global buyout interest and that'll create a lot of exit activity for the small cap, midcap, private equity managers here in this market. So, that's the horse I'm betting on as the driver of exits in the market.

I think also as we see corporates get more confidence around the outlook, we have a change in government or at least an election cycle. Corporates getting more confident on what the outlook looks like both from a regulatory perspective and also from an economic perspective. I think we should be able to see corporate start to play the role of trade buyer in some of these assets. So, there's nothing, the markets, assets are well valued. There's nothing really slowing corporates apart from that uncertainty in doing transactions.

Anna Ellis: And without digging too deep into the ramifications of an election, given it's likely to be in the first half, obviously, do you think that just means that it might be a slightly slower start again to the calendar year in terms of transaction action?

Michael Lukin: Yeah, I think that's right, Anna. And I think it'll be industry by industry specific. So, clearly there's some sectors where government policy doesn't really play a big part.  I think areas like technology, like consumer-focused assets, probably less relevant in those businesses. And so, I expect to see those businesses potentially coming to market over the first…

Anna Ellis: Business as normal?

Michael Lukin: Yeah, business as normal. Where I think you'll see potentially, a bit of a hold back on assets will be areas that are influenced heavily by government policy. So, I think areas like healthcare, obviously government services and areas like childcare as well where government policy does play a role in what the future looks like for those assets.

Anna Ellis: Yep. And if we think about like… you've touched on sectors there. So, if we just transition and talk specifically perhaps more on the domestic market, some of the sectors where we've been quite active in, have you seen any particular trends around investments, transactions in some of those spaces? Like perhaps we start with healthcare for example.

Michael Lukin: Healthcare is a great example Anna because I think if I recall, my 20-years in private equity, 20-years plus now unfortunately that old, healthcare has almost been the no brainer. If you find a good healthcare asset, regardless of where it plays in healthcare, it's generally been a good private equity asset. And so that's really been the playbook for a lot of private equity managers for the last 20 - 25 years. Everything from private hospitals to clinical roll ups to professional services in the space. They've all generally worked out pretty well. I think what we're seeing now in healthcare driven by the cost of doing business going up, whether it's rent costs going up, labour costs going up, consumables going up, you've got to really differentiate or determine which part of healthcare you want to play in. So, if you are a large business with a lot of tenancy that you see your rental costs going up and your labour costs going up, it's going to be really challenged where government funding is kind of flat to slowly growing. So, you get this impact of the jaws of death where your margin compression really hurts your earnings.

But I think what you need to do is just pick through the various areas of healthcare and find those areas where you're less susceptible to that. Either it's because you can grow your revenue stream either by ancillary services or price improvement or technology, new technology coming into the market. Or alternatively, you have a good control around your cost base. So, again, technology can play a role there around how you manage your cost base in your business.

Anna Ellis: So, what I'm hearing is just being in the right sector now isn't enough?

Michael Lukin: No, I think that's right, right.

Anna Ellis: You can’t just ride the growth of the market, its more competitive, you've got costs increasing faster than say what you can increase your revenue because of the funding...

Michael Lukin: Exactly right. And I think, we're seeing that more and more in different sectors, government services, business services. I think we're seeing a similar thematic where, generally providing services to the government. I think, if we think back five years ago, NDIS, it was almost like if you could find any asset in NDIS, it was clearly growing really quickly and as long as you got off the train before it stopped, you would do quite well. I think we're seeing a change in that market. Probably the one area where people are still relatively, riding the sector is technology. And I think that we will see a bit of differentiation there amongst technology assets, what are actually globally, best practice, what are domestic champions, what has got really strong growth with versus what just happens to be a business technology space. We'll start to see that separating out.

But maybe Anna, given your operating in that sub $100 million enterprise value on a day-to-day basis, talking to businesses, talking to advisors in the space, I'm up here in the clouds. What are you seeing actually on the ground in terms of sectors and assets and what's happening in M&A?

Anna Ellis: And it's interesting because I think we've got to take it back. I'm not talking about global, definitely domestic and probably as you talked about at the start, that sort of lower mid-market space. So that's what I'm reflecting on. And when you think back on the last few years, there's no doubt 2023, we had those multiple interest rate rises and in the lower mid-market, we're talking about real people. They've got cool businesses, you find them in the strangest places. They might be boring B2B businesses or exciting consumer discretionary businesses, but they really feel that. And so that uncertainty meant; why would they do something then? So, I think 2023 was really uncertain.

I think last year when we spoke about this and when I spoke to Frewen, I talked about this concept of less uncertainty because we didn't have any interest rate rises. Everyone was wanting to be a little bit more positive. And really, we're seeing what do people see in their businesses? They see the inflation in costs and that hurts and say if consumers are hurting, that's impacting most businesses trading on a day-to-day basis. But, for one reason or another, I think that less uncertainty meant that we did see transactions happening in the lower mid-market. Whereas valuations were very high in 21 - 22, I think by then, the other thing is that a lot of founders, they've become comfortable that they weren't going to get those high valuations. So that friction had come around, come off around the valuation discussion.

And then when I think about now into 2025, I think the conversation is that interest rates are more likely to go down. So, I think now, although we talk about all of the geopolitical uncertainty, elections and so on, again, there's businesses and sectors where there's no doubt that the election will impact what they decide to do. But I think a number of transactions are just going to press ahead. And we've heard, you know already a lot of activity in the market and in the market around that.

Michael Lukin: Yeah, and I'm presuming your part of the market as well. It's not necessarily corporate owned or private equity owned businesses that may be a little less sensitive to, what I call death, disability and divorce, right? The personal issues around the founder, either because they need to buy out a partner or they need capital to grow or they looking to retire.

Anna Ellis: That's right.

Michael Lukin: And those personal aspects they don't wait for economic cycles, right? So, if you need to do a deal, you you've got to do it when it’s there.

Anna Ellis: And what we are seeing with those types of, perhaps you'd say, less sophisticated financially, perhaps during 21 and 22, they just sort of come to market, find an advisor. I think now they're a little bit more deliberate about it. So, we're seeing a lot more prepared founders. And so, transactions, there's no doubt they're still taking longer because investors are cautious. So, they're doing their due diligence well, but they're becoming to market prepared.

And what that means is more vendor due diligence and more sort of, let's have a look at this business which investors matches this business. And I think therefore what we're seeing is transactions happening a lot more smoothly, valuation being a less of an issue. So, terms valuation agreed and then held throughout to a final transaction. And I think overall that's good for transaction activity. And I think it's just better for a partnership deal as well because you're not having that friction around valuation and renegotiation and that kind of thing.

Michael Lukin: Yeah, exactly right.

Anna Ellis: So, Mike, let's switch to a different part of the market. Let's talk about private credit. A lot of talk about private credit. We spent a lot of time talking about uncertainty, sticky inflation, interest rates, how do you see all of this impacting private credit going forward?

Michael Lukin: Yeah, look, it's been an amazing run in private credit over the last probably five years. We've seen the real growth in the sector is base rates started to lift and so private credit returns look more and more attractive. Not completely unexpected given the US market has been there for a long time. And if you think about, adoption of new asset classes, new types of securities, US generally leads the market and the rest of the world follows. So, when we kicked off our private credit business, it was still relatively early days in private credit here locally. And what we've seen since is really a proliferation of managers hit the market. What I would say is what we've seen up until now is really, partially it's the media and the press around private credit, partially it's probably investors getting up the curve on what private credit really is. But really a treatment of all private credit managers is the same.

So, you know, in some cases I'll sit in a meeting with a potential investor in a private credit meeting and try to explain the nuances of what private credit is and the different sectors and different risk profiles. But they tend to still gravitate back to how you think about equity managers, which is if this managers delivering 20% and this manager is delivering 15%, the 20% manager must be doing a better job. And really private credit doesn't operate like that. It's very much a nuance of what is the risk you're taking. So, it's all about risk adjusted returns.

And I think what we're seeing is as the market here matures, it's very rare that a deal goes bad in the first three months, six months. But as you get more maturity in the private credit business in Australia, I think we will start to see differentiation amongst the managers. You'll see investors getting more sophisticated once they dig into why a manager is underperformed or a manager is outperformed. And so, I think on that basis, we will see probably a shift in allocation, potentially a slowdown in allocation to private credit over the course of 2025 as investors start to get their heads around what this all means. But as we see some underperformance in some parts of the market that will affect flows and how those flows operate in private credit.

But having said all that, private credit is definitely here to stay. The benefit of private credit to the local private equity community that brought up credit markets here in Australia, there is no doubt that it is adding to transaction capability and adding to liquidity in the market. And so, over the course of the next year and next five years continue to see really strong growth in private credit. And really, those managers that show the ability to ride out the cycle and generate good returns, we'll continue to see more and more flows coming to them. So very supportive of the private credit market here in Australia. I think if I think about, the private equity industry in Australia, it is turning to private credit more and more regularly now for capital. Even five years ago you may see a private credit player in a syndicate on a private equity deal. Now you're seeing deals done where it's completely private credit funded debt in a private equity deal.

Anna Ellis: And Mike, why is that? Like what has really been driving that? Is it an understanding of intimately of the needs of what a private equity wants? Is it that the big four banks here are just no longer as active in that space?

Michael Lukin: Yeah. So, I think it's a combination of all of the above. I think the certainty you get from private credit. Private credits the game of putting capital out into those types of transactions. The banks, they will move in and out of sectors depending on what's attractive to them from a risk perspective where they're over allocated, regulatory requirements, and capital adequacy requirements. And so you will see different banks, I always say of the big four, there's always two that are active, one that's floating around and one that said we're not doing much in syndicated loans or private equity backed loans at the moment. They're all always different. The two that are active are always different. One that's out is always different, but you see that they all tend to float in and out of the sector a little bit in terms of their appetite for the space.

Whereas if you think about the big private credit firms around the world, they are in the business of supporting private equity through transactions. So, they want to deploy capital. And I think what that means is you get certainty, you get speed of execution, particularly as the private credit market becomes more competitive and you see more options in the market. And so, I think all up, that actually means that, doing a deal, if you can do a deal with private credit, even if it's maybe a little bit more expensive, there are generally some benefits to that. I'd also add the other piece of that is what I would call, ‘special situations’ type lending. So, there's parts of the market that it would just take too long for the banks to get their head around lending to that part of the market…

Anna Ellis: processes along…

Michael Lukin: …processes along, they don't have a track record. So, things like NAV lines are a great example. So, this is where a lender will allocate capital or provide debt capital to a private equity fund to help either create liquidity for their investors or to help fund further growth in the portfolio. That is very much a private credit backed industry. Very difficult to say, the big four banks here say get their head around security being equity in a private equity portfolio. So, I think we're seeing these more special situations tending to gravitate... the great thing about those special situations types lens is they're actually very, very attractive if you can do the diligence, you understand the lend that you're undertaking, you can actually make outsides returns. So very supportive of that.

Anna Ellis: And you mentioned earlier, sometimes you sit in meetings with investors and you talk about the differences between different credit, well, different types of credit funds, for example. What are some of the points of difference typically you see around private credit?

Michael Lukin: Yeah. So look, I think there's obviously the more traditional structuring of credit. So, senior debt, subordinated loans, stretch senior, mezzanine loans. I think investors generally get the head around that, that if someone's senior in the capital structure, I compare them to someone that's senior. The example I give is there's businesses that were borrowing money at 15% when base rates were zero. You know, I'd argue if a business needs to borrow money at 15%, even if it is senior when base rates are zero, it's probably equity, right? And it probably should be equity. And so I think that's the nuance that we'll see as we play through the cycle that a business that's really strong cash flow in a good sector that's not heavily levered, you won't get the same yield on that as something that's a bit more spicy and potentially equity like in nature. And I think that's really where investors will start to unpick different kind of styles of approach to private credit as to as to what it is it that I actually owe.

Anna Ellis: Yeah. So that sort of may be education piece that not all private credit is the same.

Michael Lukin: Correct. Exactly.

Anna Ellis: Great. Thank you, Mike. Thank you, everyone, for joining us this morning. If you want to know anything else about what we've spoken about today, please jump on our website or feel free to contact any of our team. Thank you.