What Perpetual takeover will mean for Pendal shares
The fortunes of listed fund managers tend to rise and fall in line with the markets. Consequently the past 12 months have seen the share prices of the largest listed fund managers on the ASX decline by between 30% to 70% from their 12 month highs. Pendal Group (ASX: PDL) has fallen by about 36% over the past year.
In late August Pendal received a takeover offer from rival firm Perpetual Limited (ASX: PPT) which has been endorsed by the board. This followed an earlier, and lower offer, received in April which the board rejected. The takeover is structured as a scheme of arrangement, and Pendal shareholders will vote on it towards the end of this year or early next year.
For existing Pendal shareholders they will need to decide if they think the company's prospects will be better as part of a combined business. Others considering a purchase of Pendal shares would need to consider both the stand-alone and combined prospects of the business, as well as the potential for an arbitrage opportunity.
Pendal is the fourth largest funds management business listed on the ASX by market cap, second largest by funds under management and third largest by revenue.
Perpetual is not strictly a pure play funds management business as it only derives 51% of its revenue from funds management. The rest comes from the financial advice and corporate trust businesses.
Pendal was previously known as BT Investment Management and at one stage was owned by Westpac. Their approach is to operate a house of boutique fund managers, operating four distinct brands.
This allows the fund managers in each business to operate independently in terms of pursing their investment philosophies, but gives access to the combined scale for distribution and administration. Should the takeover go ahead, this approach will be maintained with Perpetual's three brands added into the mix.
Funds management businesses earn revenue based on the amount of funds under management. They normally charge a fee that is a percentage of funds under management. For Pendal, the average fee is 48 basis points, or $48 for every $10,000 managed. In addition, some of the investment products they offer may include a performance fee.
This usually means that if the returns of the fund exceed a specified hurdle, then the manager is rewarded with an additional fee.
Therefore improving returns to investors leads to increased funds under management and higher revenue, and potentially additional revenue via performance fees. The other way to increase funds under management is by attracting additional investments into the funds, known as inflows. A significant factor in that attraction will be the performance track record of the funds.
Up until 2018 Pendal's funds under management had been growing strongly. They then plateaued for a few years before jumping higher in 2021, but that was primarily driven by the acquisition of a US-based fund manager. Like most fund managers they have experienced significant declines since then, due to negative investment returns and net outflows from clients.
When considering an investment in a fund manager, it is useful to consider the market capitalisation compared with funds under management. The higher the ratio, the more expensive the stock, all else being equal. Both Pendal and Perpetual have a ratio of 1.6%. This compares with 1.1% for the largest ASX listed fund manager Janus Henderson, 4% for Magellan and over 5% for Platinum and GQG Partners.
Of course, this is only a starting point. Different fund managers charge different fees, based on the types of products they offer as well as reputations. For example Magellan's average fee is 62 basis points. They also have different cost structures leading to different levels of profitability.
Pendal is now trading at about a 14% discount to the takeover offer value. As the consideration for the offer is both Perpetual scrip and cash, with the scrip forming the majority, the value of the offer fluctuates with Perpetual's share price. Since the time the offer was announced, Perpetual's share price has declined by 17%. Any attempt to arbitrage the discount runs the risk of the profits being wiped out by a further decline in Perpetual's share price.
The deal is also not guaranteed. Perpetual have come under some criticism for pursuing it and of course, it may be rejected by Pendal's shareholders. Therefore a decision to invest in Pendal should stand up on its own merits. On that basis it is quite cheap. Pendal is trading on a PE ratio for 2022 of 9.3. Note this is based on forecast earnings as their financial year ends September 30 and they haven't yet released their results. The forecast dividend yield is 9.3%.
However they will need to stem the outflow of funds quickly to avoid becoming a value trap. If the deal does go ahead, the same issues apply, but on a larger scale.
People investing in funds management firms at the moment need to steel themselves for a rough ride, however it is often the investments that are made at the worst of times that end up providing the best results over the long term.
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