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Morningstar | Link Remains Undervalued Following Shrewd Pexa Acquisition

We have maintained our fair value estimate for narrow-moat-rated Link Administration at AUD 8.50 per share following its agreement to increase its shareholding in Australian electronic conveyancing exchange, Pexa. At this stage, little detail has been provided other than that Link is likely to increase its shareholding from 19.8% to between 27% and 44% and that the transaction values Pexa at between AUD 1.5 and 1.6 billion on a 100% basis. This implies Link will need around AUD 250 million for its new shares which we believe it can fund without issuing new equity or debt. Generally speaking, we think the transaction is likely to be positive for Link in the long run, but we await further details before adjusting our financial model and fair value estimate. At the current market price of AUD 7.49, we continue to believe Link shares are undervalued.

The process to sell Pexa has been a rollercoaster ride and complicated somewhat by its broad shareholder base which includes the New South Wales, Victorian, Queensland, and Western Australian state governments, Link, Macquarie Capital, and the four major Australian banks. Although Link’s existing owners undertook a "dual-track" initial public offering and trade sale process, it was complicated by the fact existing shareholders also made a bid for the company. Link’s consortium, which includes Commonwealth Bank and Morgan Stanley Infrastructure, were reportedly the only bidders remaining at the end of the trade sale process. However, unsatisfied with this offer, Pexa’s shareholders pursued an AUD 2 billion IPO which failed due to weak Australian equity and real estate markets and which pushed Pexa’s owners back to the negotiating table with the Link consortium.

We think there’s a strong chance the Link consortium may be acquiring Pexa for less than its intrinsic value for a number of reasons. First, we expect the consortium was able to accurately value Pexa thanks to its long-standing shareholding and understanding of the company. We suspect this was also the reason why Pexa’s shareholders attempted to IPO the company for a higher price. Link’s decision to offer half of its shareholding into the IPO was a shrewd move which potentially undermined the IPO by signalling to the market the company was overvalued and also overburdened the lead managers with too much stock to sell. This forced Pexa’s owners back to the negotiating table and strengthened Link’s bargaining position. External trade-sale bidders may also have been deterred by the prospect of bidding against existing shareholders or by only being able to acquire part of the company. We suspect fund managers and trade buyers were also deterred by short-term equity and real estate market weakness which we don’t expect to materially impact Pexa’s long-term prospects.

Pexa has reportedly spent around AUD 300 million to create its platform meaning its latest valuation appears to include a significant amount of goodwill. The Australian Financial Review reproduced revenue and gross profit charts for Pexa on Nov. 7, 2018 which include a fiscal 2019 revenue forecast of AUD 100 million, a gross profit forecast of around AUD 78 million, a history of EBITDA losses, and a forecast EBITDA loss of around AUD 5 million. We expect these figures are Pexa management estimates which came from the pathfinder prospectus. Based on these figures, Link seems to be paying an enterprise value/revenue multiple of around 15 for a revenue growth rate of around 100%. To put this into perspective, other similar-size technology stocks such as Wisetech Global, Xero, Afterpay, and Altium, trade on revenue multiples of around 12 currently, although we expect Pexa is growing more quickly and likely has a stronger competitive position.

Pexa could well be an extremely strong business and may develop into a monopoly despite the attempts of regulators to increase competition. Although Pexa only cost around AUD 300 million to build, its real value resides in the network of conveyancers, solicitors, financial institutions, state land registry offices, stamp duty offices, and regulators who are connected to its platform. Electronic conveyancing will eventually be mandated nationally and will reduce conveyancing costs from thousands to a couple of hundred dollars and significantly improve transaction times and accuracy in the process. Although the ASX claims to be planning a rival exchange, it’s likely to struggle to overcome Pexa’s first mover advantage and network effect.