Online conveyancing service to boost Link
Buying a big stake in Pexa will drive up the valuation for the unloved—and undervalued—superannuation services provider.
Mentioned: Link Administration Holdings Ltd (LNK)
Investors in Link Group could be forgiven for losing faith, says Morningstar equity analyst Gareth James. Shares in the superannuation administration service provider have cratered 55 per cent since highs of $9 in early-2018 following a series of disappointing announcements.
Link’s retirement and super business, which comprises 26 per cent of group EBITDA, has struggled in recent years as accounts fell to its main competitor or to in-housing of administration services. Membership numbers have also shrunk under legislative reforms including Protecting Your Super.
James says there's hope yet. He believes the firm's investment in e-conveyancing firm Property Exchange Australia—better known as Pexa—is the "silver lining" for this unloved stock.
"Link's 44 per cent investment in Pexa is a key valuation driver of the group and this appears to be underappreciated by the market," he wrote in an October special report on Link Administration Holdings' (ASX: LNK) recovery story.
James has placed a $7.70 per share fair value estimate on Link. The stock is currently trading around $3.90, representing a near 50 per cent discount to fair value.
"We still believe the market is too focused on several disappointing recent events, rather than the long-term potential of the group, and that the stock is materially undervalued," he says.
Read Gareth James' special report.
Link acquired a stake Pexa in late-2018 for $500 million. Pexa is an electronic conveyancing platform for settling Australian property deals. The online system removes the cumbersome and error prone task of in-person settlements by moving transactions online, including processing paperwork, bank cheques and registering titles.
Today, conveyancing transactions are required to occur electronically in NSW. Over 8,000 lawyers and conveyancers registered on the platform. Note, this was pre-covid.
Link has had a string of bad news in recent years
Source: Morningstar, S&P CapIQ
James says Pexa benefits from its first-mover advantage, resulting in a "near-monopoly in electronic conveyancing". However, he says regulators and state governments have passed laws to increase competition from 2022 via "interoperability". This will require platforms to interact with rival platforms.
James acknowledges that this could disrupt Pexa's opening gambit but believes the company has done enough to develop deep relationships with customers.
"Although interoperability could destroy Pexa's network effect, obstacles still need to be overcome to achieve this goal, and in the interim, Pexa will continue to entrench its dominant position, reputation, and customer switching costs," he says.
"Therefore, we expect competitors will still struggle to win material market share from Pexa by purely competing on price."
Pexa's fees are marginally higher than its key competitor, Sympli, a joint venture between the ASX and InfoTrack and Lextech. But James believes the incentives for real estate to switch to a lower cost platform is low. He also believes Sympli's platform lags from an operational and network size perspective.
Pexa generates a fee when transactions occur. For example, in the sale of a property, fees stem from the sales transfer and the registration of mortgage. This means revenue generated is determined by the number of billable real estate transactions.
James also expects earnings from Link's retirement and super division to recover, emerging victorious from the disruption of Australia's $3 trillion superannuation industry.
James is yet to assign an economic moat to Pexa on a standalone basis as it is not publicly listed. However, he says the company enjoys "sustainable competitive advantages based on network effects and switching costs".
Weaknesses are apparent, however. James notes that Pexa's software intellectual property "lacks significant value" and that the capital and technological barriers to entry are low. He says the firm's network effect also shows signs of frailty.
"A large global platform such as Facebook, for example, which has billions of users who interact regularly via the platform, has an extremely strong network effect," he says.
"Although Pexa claims to have over 8,000 organisations using its platform, it would be relatively easy for a rival platform to contact all of these users and pitch the alternative platform to them."
‘A little concerning’
Link has had its fair share of controversy, most recently the announcement of Vivek Bhatia as the incoming managing director. Bhatia's former employer, NSW insurance agency icare, is currently engulfed in a corruption scandal following a July 2020 joint Nine/ABC investigation. According to reports in the Australian Financial Review, he was appointed to run icare's forerunner by then company chair Michael Carapiet, who is also the chair of Link Group. This was followed by allegations of CV embellishment.
James describes the affair as "a little concerning" but says it doesn't fundamentally impact his outlook for Link.
"Although this issue is a little concerning, it doesn't change the attributes or economics of Link's businesses and investors may be overlooking the benefits from replacing long-standing chief executive John McMurtrie," he says.
"Bhatia may be a catalyst to release the latent intrinsic value within the group, such as via an initial public offering or trade sale of Pexa."
James believes Link's investment in Pexa is now worth $1 billion.
Read Gareth James' special report: Pexa Is the Silver Lining Inside Link's Cloud