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Morningstar | Woodford Issues Unlikely to Have Material Impact on Link

We don’t expect narrow-moat-rated Link Administration to be materially affected by the Woodford Investment Management affair in the United Kingdom, and we maintain our earnings forecasts and fair value estimate at AUD 8.90 per share. At its current price of AUD 5.35, we continue to believe Link is materially undervalued. WIM is a client of Link Fund Solutions, a U.K. business that was acquired by Link in mid-2017 and contributes around 8% of group revenue and profits.

The media have reported that the Woodford issue could undermine confidence in the U.K. financial system, but we think this is extremely unlikely due to the insignificant magnitude of the issues. We also think it’s highly unlikely that Link's Australian superannuation business will be affected by the Woodford issues, considering the differences in jurisdiction, regulators, and business attributes.

At this stage, we think the main risks are that Link could lose LFS clients due to the impact on its reputation, be prevented from operating in the U.K. by the financial regulator, or be fined by the regulator. However, even in the extremely unlikely event that LFS lost all its revenue, the impact on the Link group wouldn’t be huge. The potential impact of a fine is more difficult to quantify, but we don’t think the affair reflects sufficiently badly on Link to warrant a large fine if the company were to be found guilty of any wrongdoings.

Before it was acquired by Link, LFS was involved in two issues with similarities to the Woodford issue, including problems with the Arch Cru investment funds in 2012 and the Connaught fund in 2017, which cost LFS GBP 22 million and GBP 66 million, respectively, in compensation and fines. These situations appear to have been more serious than the Woodford issue, and a similar financial impact from Woodford would be small relative to Link’s market capitalisation of around AUD 3 billion. They also indicate that LFS is most risks a fine with little impact otherwise on its business.

Our analysis of previous Financial Conduct Authority fines indicates that a fine of over GBP 100 million is rare and typically requires an extremely serious issue. For example, in 2014, a range of international banks were fined around GBP 200 million each by the FCA for manipulation of foreign-exchange rates. Deutsche Bank was fined GBP 163 million for inadequate controls leading to money laundering in 2017, and Standard Chartered Bank was fined GBP 102 million in 2019 for shortcomings in anti-money-laundering controls. However, we don’t think the Woodford issue would warrant a similar fine for LFS.

WIM is an investment management company founded by Neil Woodford in 2014 following a long and successful investment career, including 25 years at Invesco. He expanded WIM into a multi-billion-pound fund manager with three main funds: Patient Capital Trust, with around GBP 1 billion in funds under management; Woodford Equity Income Fund, with around GBP 4 billion in FUM; and Income Focus Fund, with around GBP 500 million in FUM.

WIM’s issues relate to the largest fund of the three, WEIF, which experienced poor investment performance over the past couple of years and growing investor redemptions. In early June 2019, WEIF was suspended, meaning it stopped accepting new money into or redemptions from the fund. This action was taken to prevent a rush of redemptions and a fire sale of assets at low prices. However, Income Focus Fund and Patient Capital Trust continue to operate normally.

LFS is the authorised corporate director of WEIF which effectively means it administrates the fund, with WIM responsible for managing the investments. Aside from the poor performance of the fund, the key issue appears to be that the proportion of illiquid assets in the fund may have breached the fund’s mandate and regulations. As authorised corporate director, Link may be held responsible for the fund’s issues.

WEIF’s issues were identified by the U.K. financial regulator, FCA, as far back as February 2018, and Link has been in regular contact with the regulator since, including regarding the decision to suspend the fund. The recently launched formal investigation into the affair by the FCA is therefore unlikely to uncover anything particularly surprising to the FCA but may result in blame being apportioned. The FCA itself may also ultimately come into criticism for its performance.

We consider the issues to be potentially due to incompetence rather than fraud. We also consider WIM to be a legitimate and credible fund management company that has intended to act in the interest of its investors. The investment performance of WIM’s funds doesn’t appear to have been catastrophic by any means, which limits the consequences of the fund’s suspension. It’s quite possible that the suspensions will have its intended consequence of enabling illiquid assets to be sold at reasonable prices and the resumption of normal trading in the fund.