Link's UK Expansion Adds Accretion And Risk
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Link Administration ((LNK)) will acquire Capita Asset Services in the UK, an administrative/financial platform which generated around $87m in earnings last year. A large equity raising is involved but brokers suggest the accretion to earnings justifies the risk. Link believes it is acquiring a business that has been neglected, which leaves scope to generate efficiencies.
UBS revisits the outlook for Link in the wake of the acquisition, taking into account a softer revenue base in FY17 and double-digit accretion from the deal. The broker lifts outer year forecasts for earnings per share by 10%, but this is largely reliant on low-cost debt funding and a realisation of synergy benefits.
Strategically, UBS believes the deal provides the appropriate platform to grow offshore, but there is limited visibility around divisional revenue and margin drivers, which means the broker's conviction is reduced in terms of taking a more upbeat view on medium-term growth prospects.
Citi suspects the sizeable equity raising will create near-term risks, while the acquisition will take the company into uncharted waters and provide a significant challenge for management. The broker suggests the acquisition changes the investment profile of Link from a very stable Australian annuity-style earnings stream that is driven mainly by superannuation funds administration.
While it still expects 90% of revenue to be recurring, 45% of revenue will be earned outside Australasia and that introduces material currency risk especially, in the broker's opinion, if the UK pound displays further volatility as the Brexit process is worked through. Citi believes the price of the acquisition is full but acknowledges accretion will eventually be significant and this is hard to ignore. The broker upgrades to Buy from Neutral.
Link will pay GBP888m for Capita Asset Services and undertake an equity raising of $883m. The equity raising will be via a fully underwritten 4-for-11 pro rata, accelerated, renounceable entitlement offer and the balance of the price funded by $664m in debt from existing and new facilities.
Macquarie considers the capital raising large relative to the company's current market capitalisation but expects it should be supported, underpinned by the promise of around 30% accretion to earnings per share. The size of the acquired assets and associated integration risks, as well as diminished financial flexibility, suggest to the broker there will be some compression in the stock's multiple, which will partly offset some of the upside.
Macquarie also recognises this as an opportunity, given the recent devaluation of the pound. The broker suggests the market was already pricing in financial flexibility and scope for acquisitions that were accretive, but some of the upside will be offset by exposure to an arguably lower-growth EU market.
Capita Asset Services
Morgans has a positive view on the deal, believing it is a reasonably strategic fit and highly accretive, although acknowledges risks exist. Around 50% of revenue comes from funds solution and shareholder registry and Link has material operations experience in similar areas, albeit centred on Australia. The other 50% of revenue comes from what Morgans believes are rational extensions for Link, such as UK debt servicing.
The various businesses exhibit defensive characteristics but the broker points out this is a lower quality business versus Link's existing funds administration operations and deal integration remains a risk. The acquisition appears to be accretive in double-digits when factoring in expected efficiency benefits, and around 5% accretive excluding efficiency benefits.
The broker understands around $25m in benefits accrue over the medium term and is confident that these can be achieved from the opportunity for property optimisation, as the business has 15 separate UK properties, and removal of duplicate shared service functions. Morgans believes the price paid is fair versus current peer multiples. The acquisition is not included forecasts as completion of the capital raising and transaction is required.
Citi observes the Capita Asset business needs a technological overhaul and should benefit from being a business in its own right rather than a division within a large conglomerate. Capita plc is selling the business as it needs the proceeds, rather than because of problems per se.
Nevertheless, a significant part of the banking and debt solutions are in run-off and the registry is likely to be difficult to grow substantially, in Citi's view, while the funds solution business has arguably hit saturation point in the UK. Still, the acquisition will broaden Link's geographic footprint and offering in both the UK and Europe.
On FNArena's database there are three Buy ratings and two Hold. The consensus target is $8.85, suggesting 13.0% upside to the last share price. Targets range from $8.29 (Morgans) to $9.50 (Macquarie).
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