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Morningstar | Link Administration Remains Undervalued Despite Brexit and Superannuation Uncertainty

At Link Administration’s investor day last May, the CEO of its U.K. business explained its Brexit position as follows "…no deal, hard Brexit, soft Brexit…what you will see is more regulation and compliance…and regulation and compliance is our friend because it's complex, we build it once, we sell it multiple times…." This concept can equally be applied to Link’s other businesses which also provide low-cost but important and complex administrative services to regulated industries, underpinning customer switching costs and a narrow economic moat. However, the share price appears to be ignoring these attributes, instead focusing on uncertainty which primarily impacts Link’s clients. We maintain our fair value estimate at AUD 8.50, and at AUD 7.21, the shares are materially undervalued.

In Australia, for example, the short-term outlook for superannuation is increasingly uncertain. The 2018-19 Federal budget included changes to superannuation rules which are still progressing through parliament, the most important being the transfer of inactive superannuation accounts to the Australian Taxation Office. The Productivity Commission’s report into the superannuation sector, released earlier this month, also recommended changes and the Royal Commission into Misconduct in the Banking, Superannuation, and Financial Services Industry will likely recommend changes when it is released on Feb. 1, 2019.

However, Link is well placed to manage industry change as it is a large and important service provider to the superannuation industry with a cost advantage over other third-party providers and in-house administration. Superannuation proposals are mainly calling for lower fees and better investment performance, which is likely to be achieved by lowering fees. We expect this to ultimately impact the profits of intermediaries, such as active investment fund managers, financial advisors, and superannuation fund providers, and that Link’s competitive position will remain strong.

The political complexities of the superannuation industry, including relationships between the unions and the industry superannuation funds, will ensure the debate between the main political parties and uncertain outlook continues. But what’s reasonably certain is that Link will benefit from long-term trends such as population and account value growth. Link is already the largest administrator of industry superannuation funds and proposals such as the "best-in-show" concept, whereby 10 high-performing superannuation funds would receive preferential fund flows, are likely to strengthen its position. Similarly, the proposal for a pseudo-nationalisation of superannuation, by using the Future Fund to provide superannuation services, would also likely benefit Link.

In the U.K., the uncertain outlook for Brexit creates uncertainty for Link, following its AUD 1.5 billion acquisition of U.K.-based Link Asset Services, or LAS, in November 2017. To recap, the U.K. voted to leave the European Union in 2016 but British politicians are yet to agree an implementation plan. The rejection of Prime Minister May’s plan by Parliament earlier this month, and subsequent failure by the Labour party to trigger a general election, will only prolong uncertainty. At this stage, we consider the most likely medium-term outcome to be a second referendum. However, whatever the Brexit outcome, Link will remain in a strong competitive position and it’s worth remembering that LAS only comprises around a third of group EBITDA, with around one fourth of that sourced from Ireland. In addition, LAS has operations in Luxemburg meaning it is well positioned for any Brexit outcome.