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Morningstar | Woodford Issues Unlikely to Materially Affect Link

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

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

Currently, we think the main risks are that Link could lose LFS clients because of the effect on its reputation, that it is prevented from operating in the U.K. by the financial regulator, or that it is 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 effect 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 the business was acquired by Link, LFS was involved in two issues with similarities to the Woodford affair, 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. However, these situations appear to have been more serious than the Woodford issues, although a similar financial effect from the Woodford issues would be small relative to Link’s market capitalisation of about AUD 3 billion. They also indicate LFS is most at risk from a fine with little other effects on its business.

Our analysis of previous FCA 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 about GBP 200 million each by the FCA for manipulating foreign exchange rates. Similarly, 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 situation affair 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. Woodford built WIM into a multibillion-pound fund manager with three main funds including the Patient Capital Trust, with about GBP 1 billion in funds under management, or FUM; the Woodford Equity-income fund, or WEIF, with about GBP 4 billion in FUM; and the Income Focus Fund, with about 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 few 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, the Woodford Income Focus Fund and Patient Capital Trust continue to operate normally.

LFS is the authorised corporate director, or ACD, of WEIF, which effectively means it is the administrator of the fund, with WIM responsible for managing the investments. Besides 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 ACD, Link may be held responsible for the fund’s issues.

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

Importantly we consider the issues to potentially be the result of incompetence rather than fraud. We also consider Neil Woodford and WIM to be a legitimate and credible fund management company, which has intended to act in the interest of its investors. In addition, 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 possible the suspensions will have the intended consequence of enabling illiquid assets to be sold at reasonable prices and the resumption of normal trading in the fund.