Acquisitions Improve Magellan Prospects

Magellan Financial ((MFG)) has announced two strategic acquisitions along with its first half results, expecting these to be modestly accretive in the first full year. The acquisitions make strategic sense to brokers as they help to diversify the business and protect growth prospects.

Airlie Funds Management and Frontier Partners have been acquired for around $130m, consisting of both cash and scrip.

Buoyant markets helped the business reach pre-tax profit growth of 25% in the first half and UBS notes net flows, at $3.5bn, represent the best half since the first half of FY15. This run rate is not expected to persist because flows benefited from retail incentives and the pending closure of core global funds to new institutional clients as of last December.

Yet, UBS believes a de-rating that has occurred since the FY17 result is overdone and the new marketing-related acquisitions should boost the company’s earnings and expand domestic retail opportunities.

The stock continues to deliver superior earnings growth relative to peers and Macquarie expects latest additions will continue the company’s recent trend of growing via acquisitions.

While this does raise a question for the broker regarding the ability of Magellan to outperform its peers, the relative premium is now around 1% to ASX listed funds managers and this begins to offer some value.

Countering this, the recent market performance presents a near-term risk to valuations as well as earnings. Macquarie envisages risks to both management and performance fee expectations should the broader market sell-off continue.

Retail flows continued to languish and this is not so good in Morgan Stanley’s opinion. A lift from the acquisition of Airlie is required to reach the broker’s current flow targets as these fall short of the $150m monthly average forecast. Extra flows and diversity should offset some short-term de-rating pressure.

Credit Suisse suspects the acquisitions will be 2-3% accretive and, despite higher costs which are weighing on forecasts, upgrades FY19-20 estimates for earnings per share by 1%.

The broker now envisages upside to institutional flows and valuation support, despite the emerging risk in market activity.

Morgans acknowledges current market volatility poses a short-term risk to the share price but on a longer view upgrades to Add from Hold. The broker finds the FUM base resilient and the industry backdrop supportive in the long term. The strong capital position also provides longer-term options regarding acquisitions.

Airlie Funds Management

Airlie diversifies the business and provides an Australian equities product that Macquarie observes is managed by highly reputable fund managers. However, limited information was provided regarding staff retention and lock-in arrangements, and this could present medium-term downside risks if key personnel depart. The company will acquire Airlie through the issue of shares, with completion expected on February 28.

Airlie is an Australian equities specialist with over $6bn in FUM. While moving to a mature market segment may surprise some, Morgan Stanley finds growth avenues exist. The portfolio is more than 90% institutions and a minimum $500,000 investment level represents a high hurdle for retail flows. A new channel in industrials will be launched shortly and generate growth for the first movers.

Longer term, the broker suspects the company may develop products such as those that target offshore investors, leveraging its distribution reach. Credit Suisse agrees there is an opportunity to leverage the expertise in retail distribution if the company can attract additional FUM.

Frontier Partners

Frontier Partners will expand the company’s North American distribution capability. Magellan currently has $12.8bn with Frontier, or most of its North American sourced FUM. Morgan Stanley envisages the opportunity lies with accelerated mutual fund growth and developing the next generation of products for the US market.

Also, the company’s distribution costs will decrease by around -$10m per annum. This is an important point, Credit Suisse asserts, as it will prevent distribution expenses from surging as its US presence grows. The broker notes there was minimal disclosure around lock-in arrangements, and personnel remains a risk. The acquisition will be funded using cash and shares.

There are four Buy ratings and to Hold on FNArena’s database. The consensus target is $28.94, which signals 11.6% upside to the last share price. Targets range from $27 (Morgan Stanley) to $30.35 (Ord Minnett, yet to comment on the report).

Greg Peel

About Greg Peel

Greg Peel joined Macquarie Bank in 1986 and acquired trading experience in equities, currency, fixed income and commodities derivatives, ultimately being appointed director of equity derivatives trading. He later published In With The Smart Money (a plain English guide to the mysterious world of financial markets and derivatives) and acted as a consultant to boutique investment funds. In 2004 Greg joined FNArena as a contributing writer. He is now a director and principal of the company. Greg compliments the journalistic background of the FNArena team with lengthy experience as a financial markets proprietary trader.

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