The monopoly asset that could boost Link
A bigger stake in the online conveyancer PEXA could be the key to increasing Link Administration's revenue, says Morningstar's Gareth James.
Mentioned: Link Administration Holdings Ltd (LNK)
Emma Rapaport: Hello and welcome to Morningstar. My name is Emma. I'm here today with Morningstar equity analyst Gareth James to talk about Link (ASX: LNK).
Gareth, thanks for joining us.
Gareth James: Thanks Emma.
Rapaport: So, there's a lot being going on with Link at the moment. We're going to take the takeover offer that they've just received and put that to the side for one second and we're just going to focus on your special report for now. As you know, and any investor in Link knows, it's been quite a tough time for Link investors over the last couple of years, but in your special report you talked about the fact that you actually think Link can turn it all around with their investment in PEXA. Can you explain quickly who PEXA is, and why you think they'll be able to grow their revenue?
James: Yeah, sure, so PEXA is a provider of electronic conveyancing services. So historically conveyancing in Australia was a manual process. Conveyancing is obviously the exchange of ownership of real estate. And people used to get together in a room and exchange documents, checks for real estate and and that kind of thing. It is very labor intensive process historically. So the state governments decided a few years ago that they would make this whole process digital and that was the the beginnings of PEXA. So PEXA has a monopoly over electronic conveyancing now and it's mandated in most areas of Australia.
Rapaport: And so, Link bought into the company a couple of years ago.
James: Yeah, Link's had a shareholding in the company for a number of years, but in 2018 quite a few of the shareholders we're looking to sell out of PEXA. So, for example the big four banks were shareholders, state governments were shareholders, and they'd really taken the business as far as they needed to take it. So PEXA was looking at doing an IPO. The IPO wasn't successful, partly due to what was happening in global markets at the time. And instead the business was sold to a consortium including Link, Morgan Stanley and Commonwealth Bank. So, they are the current owners of PEXA. So, Link has got a 44 per cent shareholding in PEXA currently.
Rapaport: And in your report you describe PEXA as I guess, a silver lining for Link. Can you explain what you mean by a silver lining?
James: Yeah look. I mean, Link owns a number of businesses. It's got quite a diverse portfolio of businesses. And you know it's had challenges in those businesses over last couple of years. If you look at PEXA, PEXA is particularly special business, because it does have a monopoly in Australia and it's in a sector that's not going to go away. It's only going to grow, and so it's pretty much got guaranteed profits and no real competition at the moment. So, it's a really incredible asset. Now there are some competitive threats on the horizon, but it's still what we consider to be a really great asset. We haven't given it an economic moat rating because it's not an independent entity, but we think that it would probably have at least a narrow economic moat, if it were listed in its own right.
Rapaport: In your report you talked about Link not having that many competitors, but there are a couple of people that are sniffing around in this area, but you still think that PEXA will be able to continue to grow and really continue to maintain an almost monopoly in the area.
James: Yeah, that's right. At the moment PEXA does have a monopoly. There is one other or a couple of other competitors who are kind of on the brink of being able to provide services, but there isn't really, any reason why users of PEXA would switch to another service. You know the fees that are paid to PEXA, by people who need to undertake real estate conveyancing are relatively low. So, there's a very low incentive to switch providers. And the other thing is that the the organizations which determine which electronic conveyancing platform to use aren't the people who pay the fees. So, the fees are paid by homeowners, but the service is chosen by organizations like the banks and the conveyancing firms. So, we see it as being very highly unlikely that people will switch away from PEXA. Now there is state governments trying to push to enforce competition in the sector. But we think that it's, always going to be very challenging for competitors to compete with PEXA.
Rapaport: And it's sort of impossible to talk about conveyancing without talking about the outlook for Australian property. I mean, I assume that PEXA makes money on the amount of transactions that they do. You know how many settlements they do, how many loans they do, those sorts of things. So, do you believe that they'll be able to keep growing the number of transactions that they do over the next year or the next five years?
James: Yeah, look in the long term, real estate transactions in Australia should grow pretty much in line with population. Obviously in the short term, things are more volatile, so you know, during a pandemic, you know things can be challenging, obviously. So, we expect there's going to be ups and downs in the volumes of property transactions. But over the long term, the number of transactions should grow pretty steadily.
Rapaport: In your report you've talked about one of the reasons that Link hasn't done so well over the last couple of years has been in their retirement in superannuation business which I think would be quite surprising to people because they see the big growth in superannuation and all the money flowing in. But unfortunately, Link doesn't look like they've I guess had a lot of success in that area, but you still think that division will come back?
James: Yeah, that's right. So, in the superannuation sector Link provides administration services to superannuation funds and its client base are mainly industry superannuation funds, which is the largest funds in Australia. So generally speaking we think the firm's got a cost advantage over other providers, we expect the industry to consolidate, the superannuation industry which is going to put increasing cost pressures on superannuation funds. And we think they're going to be forced to move towards using Link as their service provider.
Rapaport: So I guess bringing all this together is, the share price has been doing poorly the last couple of years and had issues with their incoming CEO and the press, and that's all led to this takeover offer they've received during the week, and anyone that was invested in Link saw their shares jump up 24 per cent, 25 per cent in a day, but the the takeover offer of $5.20 is way below your fair value of $7.70. So, you have a recommendation for Link shareholders on this issue.
James: As long as the share price is below our fair value, we wouldn't recommend, selling Link shares. So, at the moment the offer is just indicative, so it's not like—there isn't a firm offer on the table. So, the the bidders are saying, they've given an indication of what they will eventually offer for the company. I think it's very much the beginning of the process. The bidders, which includes PEP and Carlyle Group, still need to do due diligence. We need to wait and see how the company responds to this bid. You know, we've seen the second largest shareholder has come out already and said that the bid is too low. So, it's going to be kind of a bumpy few months. I wouldn't be surprised to see other bidders come in. I think the the current bid of $5.20 is relatively low and you know private equity firms don't look to overpay for companies, so I'm not surprised that they're offering $5.20. I think that's the price that they think is a great price. I think that would be a great price to buy Link also. So, still early days I wouldn't be rushing out to accept the offer at that price. Obviously, shareholders can't do that at the moment. But, yeah, I think it's, a wait and see how things will develop, but I think, either way I think it will be good for the Link share price because even if this bid falls over, I think it will wake the market up to, the intrinsic value that sits within Link that the markets been overlooking.