Link: Result 2019

Link Administration Holdings has had a challenging 18 months. The outsourced financial administration services group has downgraded earnings expectations twice and its role as an authorised director to a UK fund that halted customer redemptions, run by former funds management star Neil Woodford, is being investigated.

Last October, the share price briefly pierced $8. As a result of these stumbles, it fell over 40%, a situation we took advantage of when we upgraded the company to a Buy in June (the original upgrade also provides more background on each division whose performance we discuss below).

Link is a collection of high-quality businesses with reasonable long-term prospects. Customers tend to be sticky and there are opportunities to cross-sell and reduce costs. Combining employee share plans with share registry services for clients is one example. Link is also gaining a foothold in new markets so, amidst the turmoil, there's cause for optimism.

But this stock, like so many of our buy ideas, isn't a recommendation for the impatient. Earnings will fall next year as better performance in some businesses is offset by weaker results in others. It's the period beyond that, however, upon which you should focus.

Well-positioned

Let's deal with the short term first. Retirement and superannuation solutions reported a weaker result with the division's earnings before interest, tax, depreciation, and amortisation (EBITDA) falling 15% to $108m in the 2019 financial year. Next year, with revenue expected to decline by more than 10% to $480-500m, it could fall even further, due to client losses and regulatory changes that will sweep low-balance accounts into the purview of the ATO.

That said, Link remains the low-cost provider in the market for superannuation administration and is well-positioned for member growth and fund consolidation. Pleasingly, Link has recently resigned AustralianSuper and REST, the second and third largest Australian superannuation funds measured by members.

Growth in the UK is possible, too, as the pensions market develops into one more like Australia's that's focussed on defined contribution plans rather than defined benefit plans.

The company's other division responsible for the recent downgrade is Asset Services, which includes the share registry services business that's recently disappointed. Asset Services reported EBITDA unchanged from the prior year of £53m, despite 4% revenue growth. That growth came entirely from Banking and Credit Management and Link Fund Solutions (LFS), with combined revenue up 7% to £166m. Both should continue to grow next year.

Gains and losses

LFS continues to sign up fund managers despite the regulator probing Link's role in halting redemptions at Woodford Investment Management's Equity Income Fund. Management indicates that the likely response from regulators is a change in the regulations as they relate to funds and their corporate directors, although large fines and sanctions remain a possibility, albeit a low one.

The largest business in the division - Link Market Services (LMS) - didn't fare as well. The UK share registry provider lost customers and was hampered by Brexit uncertainty, capping corporate market activity like capital raisings. Revenue fell 4% to £90m but profit fell by more (management didn't flesh out the details). LMS will be combined with Link's other share registry businesses to form a new division, helping with the bundling of new products to improve customer retention and earnings.

Now to the star. PEXA is a fast-growing online property settlements platform. Link owns a 44.2% stake and management must be pleased with its progress. Revenue surged to $109m from $39m in the prior year. With profitability immaterial at this stage, PEXA continues to invest in new offerings. Earnings have the potential to grow quickly in the coming years.

Sensible approach

As for cost cuts, Link expects to save $50m per annum by 2022, around 5% of current total costs, although this may be offset by investments across the company to update technology in the UK, for example.

A more immediate benefit for shareholders is the move to buy back up to 10% of outstanding shares. With a strong balance sheet and what we believe is an attractive valuation, this is a sensible move.

In the meantime, Link will pay out a 20.5 cent fully-franked final dividend, unchanged from last year. Future dividends are unlikely to be fully-franked owing to greater offshore earnings. 

Let's summarise. What was once considered a predictable and growing business has turned out to be more volatile than expected, partly due to the UK acquisition but mainly due to regulatory changes outside Link's control. The company has fallen out of favour with the market as a result, delivering us this opportunity.

Assuming PEXA is worth the $700m paid for it - and we see no reason why it shouldn't be - the rest of Link is currently valued at about $2.2bn - about 11 times 2019 earnings. Proposed buybacks should increase the stock's value, making this an attractively priced collection of decent businesses with reasonable long-term prospects that should benefit from tuck-in acquisitions.

Still, members that pursue this recommendation are going to have to live with the Brexit and Woodford mess although, as ever, this is why the stock looks attractively priced. BUY.

Disclosure: The author owns shares in Link Administration.

Note: Our Model Growth and Model Income portfolios own shares in Link, as do the Intelligent Investor Equity Growth Fund, Intelligent Investor Ethical Fund, and the Intelligent Investor Equity Income Fund.