This week, we’ll analyse Macquarie Group and Perpetual’s FY-24 results and outlook.
But before that, the usual company ‘confession season’ revealed weakness businesses exposed to the consumer. For example, these stocks, such as JB Hi-Fi, Baby Bunting, and Super Cheap Retail, have been sold off.
We have little exposure to consumer stocks besides consumer staples such as Woolworths, and the currently reorganising and heavily discounted Bapcorp.
Read the previous week’s Investment matters about the RBA raising rates
Confession season
This week: ASX v Wall Street
FYTD: ASX v Wall Street
Macquarie Group FY24 result
Macquarie Group (MQG) is among the largest holdings in clients’ Australian shares sub-portfolios and is our preferred bank exposure. The company’s valuation is built on a long-run view of its ability to generate profit across a range of sectors over a considerable period. Many of the sectors in which Macquarie Group is now a dominant force were developed from ideas and business units first envisaged more than a decade ago.
When the units grow, their earnings can fluctuate, partly due to the nature of operations and partly due to the sheer size of the profits sometimes possible in such ventures. Last year, for example, there were outsized profits in Commodity Markets.
Critical to our valuation, however, is the stable underlying momentum in revenue and profits across the franchise.
Our review of the FY-24 result highlights volatile short-term earnings, stable growth, and an emerging business unit in Green Energy.
Macquarie Group’s FY-24 result was a tale of two halves. The company’s profit rebounded strongly (49%) in the second half, to $2,107m for the full year.
As noted, 2023 was the cyclical peak in earnings for the business, leveraging off favourable energy price movements in its Commodities and Global Market (CGM) business and asset sales in their Green Investments business (Macquarie Asset Management) in the prior period, meaning the Group profit exceeded $5bn.
Green Energy Funds – Promoting medium-term over near-term earnings
An important business development in the results announcement emerged around the establishment of MQG’s Green Energy funds business. This should contribute to less near-term gains on sale from its portfolio of Green Energy assets and should lead to more annuity-style earnings (and higher multiple) in future periods.
Background
MQG accelerated its position in Green Energy through the acquisition of Green Investment Group (GIG) in 2017. This initially sat within the MacCap business, where it managed the development and eventual sale of green assets. Given the demand and increased price of green energy assets, this has proven to be a successful model. However, running this as a proprietary business is capital-intensive. Every new development is expensed through MQG’s P&L, utilising capital. When MQG gets to the stage where it believes it should exit the asset (often at the time of signing a power purchase agreement), it recoups its development costs, cost of carry and a gain on the sale. While this has proven lucrative, it is capital-intensive and, therefore, not scalable.
In FY23, MQG decided to establish Green Energy as a fiduciary business and moved it to the Macquarie Asset Management (MAM) business. This would enable third-party investors to fund green assets’ development, growth and ownership over time, with MQG generating a base and performance fee. It would also reduce the amount of capital required to be invested, replaced with a limited co-investment in the funds.
So, what is MGECO?
Macquarie established the Macquarie Green Energy and Climate Opportunities Funds (MGECO) to accelerate this model. This fund is designed to develop and manage green technologies like wind and solar energy. Importantly, it is a platform rather than a specific fund, implying that many different investment vehicles could be established over time. For example, there could be MGECO Europe, North America, or just Funds 1, 2, 3…
The ability for these funds to develop their assets over time minimises the risk of MQG being seen as a “build/buy and flick” partner. The investors in the funds could cultivate these assets throughout their lifecycle.
First assets transferred
On 17 April, MQG announced that MGECO had acquired a portfolio of six solar, wind, energy storage and natural climate solutions investments, representing >17 GW of green energy capacity in development, construction and operations. These assets were Galehead Development, Treaty Oak Clean Energy, Aula Energy, Blueleaf Energy, Outer Dowsing and Forliance. MQG stated that investors in this portfolio included UniSuper, LGPS Central, and Border to Coast Pensions Partnership.
Based on MQG equity investment disclosure, we estimate that transferring these funds will release around $600m to $800m in capital. This will lead to the recovery of development costs and a return on capital employed by Macquarie, with some of this falling into FY25E.
Macquarie Group Outlook – the underlying business
While earnings volatility can occur at any time, given the timing of asset realisations and commodity and market pricing changes, we remain encouraged by the business’s underlying growth trends and steadfast in our belief that Macquarie is one of Australia’s great companies.
When supported by a strong balance sheet and excellent risk management capability, we think the future remains bright for continued earnings growth across the medium term.
Assets Under Management were up 7% in FY-24
Figure 2: Banking and Financial Services business is consistently growing in chosen segments n FY24)
Figure 3: Commodities and Global Markets business also has underlying client growth
Along with increasing revenue in ongoing businesses, Macquarie Group carries investments on its balance sheet that will be sold and generate future profits. While not being included in current earnings, monitoring the size and performance of these investments is also important. At at the end of FY24, Macquarie Group held such equity investments available for future profit realisation with a carrying value of $13.2bn. This amount grew considerably in FY24, and are detailed in the table below.
Figure 4: Equity Investments
Perpetual – Strategic Review Complete – What was the answer?
Perpetual’s best asset, its Corporate Trust business, will be purchased by the global private equity firm KKR (Kohlberg Kravis & Roberts) for $2.18bn.
Perpetual is a company that has been subject to various takeover suitors over recent years. It has three main business lines within it:
- ‘Corporate Trust’;
- ‘Wealth Management’; and
- ‘Asset/Investment Management’
Soul Patts overture
In December 2023, Washington Soul Pattinson (‘Soul Patts’), the largest shareholder of Perpetual, confirmed that it was a bidder for the Corporate Trust and Wealth Management businesses in a scrip offer valuing the equity of the entire business at $3.06bn. Shareholders were being asked to accept Soul Patts stock as the bulk of consideration and the Investment Management business was to be spun back out to existing shareholders.
At the same time, Perpetual’s board rejected this overture and indicated that it would undertake a Strategic Review of its business to maximise shareholder value.
Strategic review complete – to KKR go the spoils, including the brand
On May 8, Perpetual’s board announced the outcome of the long-awaited strategic review.
The outcome was both complicated and poorly explained. The deal’s nuts and bolts are simple: Perpetual’s best asset, its Corporate Trust business, and also its Wealth Management business will be purchased by the global private equity firm KKR (Kohlberg Kravis & Roberts) for $2.18bn.
The price received was higher than expected, but the deal will take longer than expected to complete.
Failure of governance, transparency and manners
Everything else about this deal was a dramatic failure of corporate governance, market transparency and good manners.
The company and its board either refuse to or cannot provide the market, much less shareholders, with details or estimates of the details vital to the deal’s ratification.
Allowing a board to determine the merits of the agreement without such information is one aspect, but allowing the market to trade in its stock without such information is another.
Remember that Perpetual’s market cap was only $2.7bn before the announcement, so the materiality of spelling out a $2.1bn sale should be evident. So, what details were missing?
- Sale price
The sale price is a gross figure only. Net proceeds will be determined after separation, tax, and transaction costs are paid. These costs could be very high given the complexity of the separation, the extended time frame and the fees commanded by the firms completing the task.
- Tax
The tax implications, a core factor in the construction of any deal involving these assets and one explicitly dealt with in the Soul Patts deal, are not specified at all.
- Net proceeds
Expected net cash proceeds (after debt payment) will not be released until the full-year results are released in August.
- Information
The Scheme booklet, with full detailed information, will not be available until late 2024.
Net sale price variation
The possible variation in the net sale price, the only price that matters, is very large.
The variation is, in fact, so large that the market cannot determine for itself whether this deal is indeed better than the one offered in December 2023.
As a result of this failure of corporate governance, the share price fell this week to the minimum feasible value of the deal, the worst-case scenario.
For clarity, we have presented some charts showing the deal’s structure.
Fig 5 Breaking up is hard to do – KKR to purchase the Wealth and Corporate Trust businesses
The remaining Global Asset management business will be streamlined, have more than $227bn in assets under management, and be debt-free. Its cash generation capacity will be significant.
Fig 6 – Global Asset Management business to remain.
First Samuel thoughts
Ostensibly, this is a better outcome for shareholders than the ‘Soul Patts’ offer. However, the lack of detailed information means it is difficult to attribute how much upside remains to the worst-case scenario. The market has currently adopted this worst-case in today’s share price.
The ongoing damage to the reputation of the company is considerable. This is important because Asset Management businesses are already heavily discounted in the market.
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.