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Morningstar | Link Remains Significantly Undervalued As Investor Day Reiterates Business Strengths

Narrow-moat Link Administration’s annual investor day largely recapped known information, albeit with an update about the United Kingdom business. The most notable news was that the AustralianSuper contract has been renewed for another four years. AustralianSuper is the largest superannuation fund in Australia and Link’s largest client, which we estimate comprises about 10% of group revenue. Link still faces the risk that other large superannuation fund clients will not renew contracts, with negotiations currently ongoing with REST in particular. However, our forecasts assume all contracts will be renewed because of Link’s low-cost position in the industry.

We maintain our earnings forecasts and AUD 8.90 fair value estimate and, at the current market price of AUD 5.53, continue to believe the shares are materially undervalued. We expect the market is concerned about the short-term effect of new Australian superannuation legislation, the risk of contract losses, and Brexit-induced weakness in the U.K. However, the group remains a reasonably defensive collection of asset-light businesses, which generate strong cash flows. This means Link is likely to appeal to the many cash-rich private equity funds and a takeover bid could be the catalyst to close the share price discount to our fair value.

At the current price, Link’s fiscal 2020 price/earnings, or P/E, ratio is just 14, but this includes a 44% stake in PEXA, which generates no earnings yet. PEXA was revalued at AUD 706 million when Link increased its stake in November 2018. Considering Link’s current market capitalisation of AUD 2.9 billion, excluding the PEXA stake, implies a market value of just AUD 2.2 billion for the underlying earnings or a P/E ratio of about 10. This is very low considering the size and quality of the group and the rapidly falling 10-year Australian government bond yield.

Link reiterated earnings guidance provided just three weeks ago, which had caused the share price to fall sharply at the time. However, additional earnings information was provided for the CPCS business in the U.K., which has been sold but which will contribute AUD 35 million or 10% of group EBITDA in fiscal 2019. We were surprised by the strength of the CPCS guidance because management previously said the division was a key cause of earnings weakness, resulting from Brexit. However, it’s not sufficiently material to change our earnings forecasts, although further information will be made available at the full-year results in August. Management also reiterated its expectations of GBP 15 million annual cost savings from the U.K. business, which will partially offset the lost CPCS earnings.

Link will retain about three quarters of it’s U.K. businesses, including its fund solutions, market services, and banking divisions. The market services division, which undertakes share registry and associated services, appears to be the most affected by Brexit-related uncertainty, including the postponement of IPOs and a drop in client-share trading activity. However, we expect this effect to be cyclical and the division, which comprises about 10% of group EBITDA, is likely to recover. Market Services also appears to have experienced an increase in price-based competition, but this is, to some degree, the nature of the industry.

We were encouraged by the U.K. Fund Solutions presentation, which comprises about 10% of group EBITDA, and boasts insulation from Brexit and attractive growth opportunities in Europe. Similarly, the U.K. banking division, which comprises about 10% of group EBITDA, is mainly exposed to the Irish market and has attractive long-term European growth opportunities.

We continue to view Link’s 44% shareholding in PEXA as the jewel in its business portfolio crown. Unlike Link’s other more mature and relatively low-growth divisions, PEXA is growing extremely quickly and already claims a market share of 60%. We also think the business has a mild network effect because all real estate market participants, from a settlement perspective, need to be on the platform. This could be strengthened if Link successfully involves real estate owners in its platform, as it hopes to do.

Link’s Australian superannuation business, which comprises about 35% of the group, continues to be affected by the massive volumes of calls being received by its call centre because of new superannuation legislation. The consolidation of dormant superannuation accounts will affect Link in the short term, but is expected to benefit the company in the long term as Industry funds win market share. The Royal Commission into the financial services sector has helped in this regard and funds continue to flow from retail funds into low-cost industry funds such as AustralianSuper, as envisaged in our recent special report "Link a Likely Winner From Superannuation Reform".