When the federal government first flagged changes to Australia’s foreign investment framework, to start from January 1, 2021, it seemed like just one more hurdle in a difficult year for inbound investors, unable to travel to inspect targets or focused on challenges on their home turf.
But now the law has passed and the start date looms, the changes have made the local tech sector very nervous.
Extra scrutiny on a wide range of potential deals and sectors has been put forward as a tactical option for companies trying to fend off takeovers, and the banks have warned it could make funding harder. Meanwhile, advisors are also concerned the change could force some local sellers to take a lower price to avoid risking delays.
So what should we expect for mergers and acquisitions (M&A) once the new foreign investment framework begins?
The first thing to note is the scope of business activity that would require the review of the Foreign Investment Review Board (FIRB) has been greatly expanded.
Traditionally, FIRB approval for non-government investors has been limited to investments above certain thresholds (normally in excess of $275 million or $1.12 billion for free trade partners), as well as certain high-value agribusiness investments, or property or land purchases.
Some acquisitions that could affect the national interest, including media and mining tenements, required greater scrutiny, but over the past decade, fewer than 100 of more than 15,000 FIRB approvals have been rejected.
That set of rules changed in March, when the federal government introduced a zero threshold for any foreign investments under the Act, and will change again in January when the new framework begins.
The new reforms introduce a ‘national security’ test that in practical terms is likely to be broader than ‘national interest’, and all foreign investors will need to seek approval to start or acquire a direct interest in a business that meets that test.
Potentially sensitive businesses include those in media, utilities or transport, those supplying the Australian Defence Force, those manufacturing or supplying technology or goods that could have a military purpose, or those developing or supplying encryption and security technologies or communication services.
In other words, everyone from a regional bus company, to an NBN installation business, to the contracting service that provides after-hours maintenance for government offices could be caught in the net.
Under the change, the Treasurer could either block or divest an investment deemed to put the country’s national security at risk, or intervene for up to 10 years after the fact to do things such as require the investor to sell, or cancel business contracts.
In the government’s own example, a foreign investor in a data company that hosts public websites could come under scrutiny years down the track if it later takes out a contract hosting customer content for a bank.
The second thing to note is the chilling effect of the changes is real — and is already being felt.
Earlier this year, we surveyed dealmakers in Australia and found confidence in completing mid-market deals in the defence sector had vanished completely, and dramatic falls were being seen in the prospect for deals in government services, and in the energy, mining and utilities sectors.
When we looked more broadly, we found the same concerns by dealmakers offshore.
A new report from our international network Baker Tilly shows a widespread belief that national security concerns could scuttle deals across the Asia Pacific.
National security concerned just 10% of APAC dealmakers in 2019, but is now a pressing issue for nearly half in 2020, while 60% also see tighter regulatory changes as a growing concern.
When considered against downturn already associated with COVID-19 and border restrictions, it paints a grim picture for inbound M&A.
The third effect of the changes will be seen in values.
The complexity of foreign buyers achieving an M&A in Australia in any sector that could potentially be considered sensitive will now be priced into the offer.
It’s already more difficult to attract foreign interest given the difficulty of travel, and the challenge of doing due diligence when you can’t cross borders, but the possibility of having your investment questioned up to 10 years down the track will be a bridge too far for many dealmakers.
So we can expect lower offers from offshore buyers, while the temptation will also be for local sellers to take the easier, and often cheaper, offer from a domestic buyer.
If offshore sales do progress, we can expect longer timeframes, with tougher requirements for early FIRB involvement to reduce uncertainty.
It will change initial discussions from whether a buyer should make the investment, to whether the buyer can make the investment, which alters the calculus for many negotiations.
Finally, the changes will put the onus on businesses wanting to sell to rethink their contracts and consider the impact even a small exposure to sensitive sectors could have on their M&A prospects.
It’s still too early to know how wide the net of national interest will be cast, but for businesses that have defence or government contracts or sensitive technology as a small part of their commercial mix, it will be important to understand that could be enough to push you into the Treasurer’s sights.
So should businesses be worried?
The federal government argues the changes will lead to no more than 100 additional applications and 1,800 additional registrations being made by investors each year. The chair of the FIRB has called for calm.
But until foreign buyers and dealmakers become confident that deals won’t be derailed or walked back under the new framework, we can expect to see confidence — and offshore M&A activity — remain low.
With the additional uncertainty, the gap between well and ill-advised will only widen.