SYDNEY -- A tussle for ownership of a vast electricity network in Australia is shaping up as a test of the country's attitude toward foreign investment in critical infrastructure, months after Canberra tightened approval rules for overseas owners.
AusNet Services, which owns and operates the electricity transmission network and gas and power distribution assets in the country's second-most-populous state of Victoria, is at the center of a bidding battle between Canadian investment company Brookfield and Australia's biggest gas pipeline operator, APA Group.
Brookfield is already seen as the favored bidder after initially securing the exclusive right to do due diligence, after making an all-cash offer of 9.6 billion Australian dollars ($7.3 billion).
This is the first time since new rules were put in place at the start of the year that a majority stake in a perceived "sensitive" asset is on sale, and the participation of the Canadian company means global investors are paying close attention.
Given that the rules reflect Australia's sensitivity in particular to investment by Chinese state-owned companies, an added twist with AusNet is that one of the sellers would be the State Grid Corporation of China, which currently owns 19.9% of the company. Approval of a deal would remove State Grid from the picture.
"It's a big case, it's quite high-profile," said Tin-Lok Shea, special counsel at H&H Lawyers in Sydney. "If approved, it will be the first time (since January) that a 100% stake will be changing hands. So it will be a very important transaction."
"I think there will be concern if this one got rejected," he said, "because it would then send out a message as to Australia's appetite for investment."
A final decision hinges on the country's Foreign Investment Review Board (FIRB), which has in recent years blocked a number of deals on national security grounds.
AusNet's top shareholder is also a foreign company: Singapore Power, which owns 32.3%. State Grid is the second-largest shareholder, while the balance of about 48% is publicly traded. Since the new foreign investment rules only apply to fresh transactions, the existing foreign owners have not been affected so far.
Neither of them has shown their hand publicly yet, but both now face a range of options for their holdings. They could either accept Brookfield's cash offer and completely exit the investment at a hefty profit, or they could negotiate retaining a partial stake. Alternatively, they could accept APA's cash-and-stock offer, which would give them a minority stake in the gas pipeline company.
Each of these options present a test of the FIRB's sensitivities around critical energy infrastructure, but some analysts think Canberra could be inclined to support a sale to see the back of State Grid.
A resolution could come as early as next month, when AusNet's board will face shareholders at the company's annual general meeting. The winning bidder will then knock on the regulator's door for an approval.
UBS analyst Tom Allen said he expected the FIRB to apply a high bar because electricity transmission is considered one of the most critical types of infrastructure from a national security perspective.
Changes put in place from Jan. 1 have introduced a national security test for all foreign investment bids on sensitive assets, which now include transactions in a broader list of sectors including defense, telecommunications, gas, power, water, ports and more.
The new laws have also widened the powers of the federal government, allowing the treasurer to review or impose conditions on a deal or even force divestment after a deal is approved, if he considers national security is at risk.
Treasurer Josh Frydenberg last year flagged that all foreign investors would face greater scrutiny when bidding for sensitive assets regardless of the size of the deal and whether the buyer is private or state-owned, citing the need to balance economic and national security.
"Technology has been evolving, and our geopolitical climate has become more complex. In fact, the world over, governments are seeing foreign investment being used for strategic objectives, not purely commercial ones," he said at the time.
Australian Treasurer Josh Frydenberg, shown speaking to the media at Parliament House in October 2020, indicated last year that all foreign investors would face greater scrutiny when bidding for sensitive assets, citing a need for balancing economic and national security. © EPA/Jiji Even before the stringent rules were put in place, Canberra had begun battening down the hatches, as recent geopolitical tensions with top trading partner China have spilled into the trade and investment spheres.
The nation was ranked the fifth-most-restrictive among OECD countries in 2018 because of its onerous screening and approval regime for foreign direct investments.
Last year, it blocked the AU$600 million sale of Lion Dairy and Drinks to China's Mengniu Dairy on national security grounds, in what was seen as a tit-for-tat response to Beijing hitting several Australian exporters with trade sanctions.
The government also forced the withdrawal of a AU$300 million bid by China State Construction Engineering Corp. to buy the Australian construction company Probuild on similar grounds.
"The tightening of these rules have meant that Australia has become, on paper, one of the most restrictive places to invest," said Shiro Armstrong, an associate professor at the Australian National University.
The AusNet deal comes at a time when demand for Australian infrastructure is high as global investors scout for low-risk, stable-earning assets amid rising volatility and low interest rates.
Spark Infrastructure struck a $3.7 billion deal in August to be taken over by a consortium that included U.S. private equity group KKR and two Canadian pension funds. The transaction is pending FIRB approval, though it is likely to get a green light, as Spark only owns minority stakes in power networks in Australian states.
Sydney Airport Holdings, which operates Australia's biggest airport, is also in discussions with a group of pension funds and U.S.-based Global Infrastructure Partners for a buyout worth $17.3 billion.
AusNet itself presents an attractive opportunity for investment in a regulated monopoly -- it is the operator of the only electricity transmission network in Victoria -- and several electricity and gas distributors, with an asset base worth over AU$11 billion.
It reported a net profit of AU$302.1 million for the 12 months to June 2021, on revenue of AU$1.92 billion, and a dividend yield of 5.2%. Analysts expect growth to mainly come from a planned investment in Victoria's electricity transmission network that will connect the Snowy 2.0 hydropower project to the state grid.
AusNet reported a net profit of 302.1 million Australian dollars ($225 million) for the 12 months to June 2021. (File photo by Getty Images) Still, investors are gripped with uncertainty following the new foreign investment laws and are looking for an indication of which transactions are welcome and which aren't.
"We will get some insight based on what conditions, if any, the FIRB imposes on the investment. The more sensitive it is, the more likely we're going to see a range of conditions imposed," said Jason Van Grieken, a Melbourne-based partner at the M&A law firm Arnold Bloch Leibler.
"More broadly, it may provide some insight around the scope of how they're going to interpret this national interest policy."
The issue has already come to the forefront of the fractious takeover battle for AusNet, with APA Group trying to curry favor for its own slightly higher offer of AU$2.58 per share from regulators over its ability to keep vital infrastructure in Australian hands.
It has claimed that rival Brookfield would treat the target company as a portfolio asset with its operations limited to the state of Victoria.
Brookfield's Asia-Pacific headquarters in Sydney. The Canadian investment company is expect to emerge victorious in the high-profile and politically sensitive battle to buy AusNet Services. © Getty Images APA, which has been scouting for diversification opportunities from its existing gas business due to rising environmental, social and governance (ESG) concerns, says it would instead expand AusNet's electricity business nationally and accelerate a push into renewable energy.
However, analysts believe an APA takeover of AusNet could face a significant regulatory hurdle from Australia's competition regulator, given its dominance in the gas infrastructure business.
Meanwhile, AusNet shares have continued to trade slightly above Brookfield's AU$2.50 bid price, indicating a likely improved offer from the Canadian company. Brookfield no longer has exclusive due diligence rights. Last week, the Australian Takeovers Panel evened the playing field by directing that all the rival bidders get equal access to the target company's books.
"It's pretty close to a bull price already, so I don't think there would be a huge jump from these levels," said Julia Lee, chief investment officer at Sydney-based fund Burman Invest.
She expects Brookfield to emerge victorious, with shareholders preferring its all-cash offer to the rival combination of cash and APA shares, though "We might see them sweeten the offer a little bit," she said.