Why did the government block the China-led Probuild sale? What does this mean for mergers and acquisitions?

In any other era, the sale of Probuild might have been a simple arrangement. 

A Chinese bidder looking to expand its exposure in Australia offers $300 million for an Australian building company — and all parties assumed it would proceed, given Probuild’s parent is listed in South Africa and the target is already in foreign hands.

The deal would not have been dissimilar to the sale of John Holland a few years ago to the China Communications Construction Company for three times the price, and that secured Foreign Investment Review Board (FIRB) approval, despite John Holland’s significant defence contracts at the time. 

But the federal government’s decision to block the sale of Probuild to China State Construction Engineering Corporation has illustrated just how complex national security has become — and it foreshadows problems for companies looking to sell offshore. 

The offer to buy Probuild was withdrawn once it became clear that FIRB would declare the transaction a risk to national security and contrary to Australia’s interest.

But since the federal government is not in the practice of explaining exactly why a particular sale is rejected, it is left to the business community to draw its own conclusions. 

An objective look at Probuild’s contract book doesn’t immediately scream national security risk.

Unlike John Holland, which sold holding contacts including the provision of defence bases, airfields, medical facilities and armouries, Probuild’s defence exposure is comparatively minor. 

But reports suggest its construction of the Victorian Police headquarters, as well as CSL’s Melbourne home, are both considered ‘sensitive’ buildings and were part of the decision making.

If this is correct, it underscores the challenges for sellers ahead. 

It makes sense that a company currently holding a defence contract, or with plans to build a government data facility, will face extra scrutiny under Australia’s tougher foreign investment laws, which started on January 1.

But it’s still not clear how far the shadow of these laws will extend. 

Under the changes, the Treasurer has a host of powers, including being able to block, put conditions on, or force a company to divest from a deal judged not to be in Australia’s ‘national interest’, for companies deemed to be national security businesses. 

That national security definition includes those associated with critical infrastructure (such as ports and utilities), but separate legislation could broaden the proposed range of assets this covers to include public transport, university, health and food or grocery assets.

For many Australian companies, it is therefore possible that assets and contracts not considered particularly sensitive in the past will now be held to the highest security standards.

So what are the prospects for companies looking to sell offshore or get substantial foreign investment under the new framework? 

Well, it’s impossible to know just how the government will jump — and you can’t simply do a self-assessment to see if a deal might get the all-clear.  

All you can do is draw conclusions from what’s happened in the past, and make some assumptions about whether it was the buyer, the target, the assets, or the client book that caused a particular deal to fail. 

For a company looking to sell, it now becomes a test to think like the government thinks, to figure out if you have exposure to something that will rule you out of foreign investment. 

If you have a pipeline of work in the hundreds of millions and a small portion relates to building a jail or work on defence-owned land, for example, you need to weigh up whether having that contract is worth the risk of a deal falling over. 

If you have an asset that could potentially be considered sensitive, you need to decide if it is easier to divest. 

The second thing sellers must factor in will be the increased risk of deals collapsing, with the reputation risk and opportunity cost that comes with that outcome, then assess potential buyers accordingly. 

If you are looking at an international investor as part of your buyer pool, consider the red flags — are they government-related? Have they a history that could rule them out? Have they sensitive assets somewhere else? What are the politics that could impact on this decision?

The level of due diligence you need to do on would-be buyers — not just the other way around — now becomes far more significant when they are international and from a sensitive market. 

The third issue will be price. If you want to accept an international offer, and there is an assessed risk, the bid will need to be much more compelling for companies in sensitive sectors to agree.

In Probuild’s case, the failed deal price is now out in the market, and it is hard to see it being matched by a second-chance local buyer. That’s the risk of having an international bid overturned. In many cases, the easy, local sale will seem preferable. 

Where will these changes take Australian M&A in 2021? It’s not clear — although many buyers and sellers will have been chilled by the Probuild decision. Uncertainty erodes confidence and that’s unhelpful for all parties to a deal. 

The international demand for Australian targets is high and getting higher, but we’d expect some sellers will now sit on the sidelines to get a sense of what deals are likely to be ruled in and out before they act. 

As the Treasurer continues to stress, foreign investment delivers significant benefits for Australia, but it is going to face a difficult time until the reach of the new rules becomes clear.