|Summary: The federal government’s announcement of proposed changes to the Fringe Benefits Tax in July sent McMillan Shakespeare shares into free fall. The company’s share price future hinges on what happens in the election, which will dictate changes to the tax treatment of novated leases.|
|Key take-out: McMillan Shakespeare is a buy stock for those punting on a Coalition victory, but a sell for those putting their money on a Labor return.|
|Key beneficiaries: General investors. Category: Shares.|
On the weekend of the 13th and 14th July, newspaper articles appeared suggesting that the Labor Party would abolish the Fringe Benefits Tax (FBT) if re-elected to power in the upcoming elections.
By the following Monday, it became apparent to the investment community that this was in fact Labor policy on FBT, and that a large part of McMillan Shakespeare Ltd’s (MMS) novated lease business was potentially under threat.
This news proved to be very unexpected for MMS shareholders, as the share price initially dropped 15% before going into a trading halt and ultimately being suspended for three days. In the intervening period, the Liberal Party expressed disagreement with Labor’s FBT policy and this chain of events set up a classic ‘Monte Carlo’ style probability outcome for the MMS share price.
As always in these situations no-one has perfect information, and investment managers often attempt to make decisions with imperfect information.
However, it was useful at the time to quickly put together some valuations around a ‘best-case’ and ‘worse-case’ scenario. Roughly speaking, I estimated a best-case scenario for MMS would be if the Coalition gets elected next month, in which case the stock may be worth around $14.
The worse-case scenario for MMS would be that the ALP gets re-elected, in which case I estimate MMS shares may be worth around $6 per share.
The betting agencies in Australia place the probability of the Coalition getting into power at around 75%, and the ALP getting into power at around 25%.
So, running the Monte Caro analysis I get the probable value of MMS shares to be:
(75% x $14) (25% x $6) = $12 per MMS probable share value
Of course, as we now know, when MMS shares started trading again on July 25 they dropped as low as $6.75 before closing at $8.80 for the day, and since that time they have recovered to around $12.
In fact, MMS shares closed on Tuesday at $12.14 per share. The combination of lack of information, fear and panic created by uncertainty caused an overreaction in the MMS share price on the downside, and MMS is arguably trading at around 75% probability of the Coalition getting into power.
A number of newspapers and trade journals have been referring to MMS as the ‘election stock’, and in many ways this is true.
If you had a strong view that the Coalition would get elected you would buy MMS stock, and if you had a strong view that the ALP would get elected you would sell MMS or even short-sell MMS stock based on Monte Carlo analysis.
An interesting side note for MMS is that the Singaporean owner of Smart Salary (an unlisted but smaller competitor to MMS) is for sale and being advised by Macquarie Group.
We can assume that the valuation of Smart Salary would have fallen since the ALP’s FBT announcement, and that ironically the current set of circumstances may create an opportunity for MMS management to acquire Smart Salary at a much better valuation than may have been possible a few months ago.
Note: Cadence Asset Management has owned MMS shares since they listed at $0.50 per share but has reduced its exposure since Labor announced a potential revision to FBT policy.
Karl Siegling is portfolio manager at Cadence Capital Limited.