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Cheaper ways to take a bite out of the Pexa IPO

Lewis Jackson  |  30 Jun 2021Text size  Decrease  Increase  |  
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Pexa will become only the fourteenth company on the ASX 200 to merit a Morningstar wide moat when it lists tomorrow, but investors should think twice about piling into an expensive IPO.

Its wide moat rating, which implies a 20-year competitive advantage, stems from the firm’s hold on the real estate conveyancing market. 

The firm is Australia’s only operating electronic conveyancing platform and has around 80 per cent of the market. It's platform removes the cumbersome and error prone task of in-person property settlements by moving transactions online.

Morningstar senior equity strategist Gareth James expects market share to reach 90 per cent longer term, in a special report out Wednesday.

“We don't expect competitors to develop a superior platform, nor do we expect price-based competition to result in significant market share losses for Pexa,” he says.

Morningstar initiates coverage on Pexa (ASX: PXA) at a fair value estimate of $13.20 a share, for an equity value of $2.2 billion.

The fair value estimate is 23 per cent short of Thursday’s IPO price of $17.13. The offer price would give Pexa an indicative market capitalization just north of $3 billion.

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IPO backers point to Pexa’s defensive earnings, overseas growth potential and a roaring real estate market.

Pexa’s revenues depends on the number and price of transactions, which in fiscal 2021 soared by 18 per cent as investors swarmed into property.

But James cautions against hasty extrapolation. With interest rates near zero there is little juice left for further cuts and interest rate hikes could reduce activity instead.

He forecasts transactions to stabilise around 3 per cent annually longer term. Prices are regulated and forecast to grow at around 2 per cent, in line with inflation.

Cheaper exposure to the wide-moated business is available via Link Administration (ASX: LNK), which owns a 43 per cent stake in Pexa, says James. Link plans to increase it’s holding up to 47 per cent post-IPO.

Link is trading at a 27 per cent discount to James’ fair value estimate of $6.90.

Of the ASX 200 stocks under Morningstar coverage only 9 per cent have a wide moat. The list includes firms such as the big four banks, Wesfarmers (ASX: WES) and now Pexa.

Pexa was formed in 2010 by the QLD, NSW and Victorian state governments in a bid to digitise conveyancing.

The big four banks joined in 2011. The firm was eventually acquired by a consortium of investors including Link and Morgan Stanley in 2018.

Before the IPO was announced, Pexa was the subject of two bids by private equity groups KKR and Carlyle in October 2020.

Strong prospects

Pexa’s future is buttressed by a capital light business, strong margins and the prospect of international expansion.

Reliance on a digital platform means fewer expensive capital investments in exchange for its high margins.

Pexa’s margins sit around 25 per cent today and James’ base case sees them rising to 30 per cent by fiscal 2026.

Pexa is set to take its capital light business abroad, with plans to expand to the UK, Canada and New Zealand.

James expects some difficulties building relationships with the necessary government agencies—Pexa has relationships with 11 separate offices in Australia—and dealing with undigitized records, but he believes Pexa is “well positioned” to successfully expand.

Stable pole position

Economic theory would argue monopoly profits attract hungry competitors and Pexa’s market share could get challenged from 2023 when interoperability is launched. This would allow competitors to connect to Pexa’s platform and offer cheaper services.

But James thinks the miniscule cost of conveyancing, $70 on a $1 million transaction, means most people won’t notice or care if competitors enter and cut costs.

Pexa’s platform also has a technical and operational leg up from the close relationships with government and the major banks during its incubation.

Australia’s largest mortgage lender, Commonwealth Bank (ASX: CBA), remains a large shareholder and has an incentive to use the platform.

There are regulatory risks in this still evolving space, especially if Pexa’s dominance attracts unwanted attention from regulators concerned about the political sensitive housing market.

The firm has yet to commit to a formal dividend policy but James forecasts dividend payouts to commence in fiscal 2023, at a payout ratio of 90 per cent.

“The economic moat should enable relatively high investment returns and profit margins and the asset-light business model should enable strong cash generation and ultimately sustainable franked dividend,” says James.

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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