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Perpetual – finding a way to unlock value

The Markets

This week: ASX v Wall Street

FYTD: ASX v Wall Street


Another week, another takeover target

In the past year, we have often commented that we’ll exhibit due patience as part of our investment approach. This is required as we often seek to invest in businesses that are significantly unloved and misunderstood and where assets may therefore be mispriced.

As a reflection of the merits of this investment strategy, our portfolio has benefited from several takeover offers in the past year – think of names like United Malt, Costa, Pushpay, Pointsbet, Eildon Capital, Newcrest Mining and Origin.

Perpetual Limited (PPT) is a once revered, but now a somewhat maligned, corporate trust, asset management and wealth management firm. It now enters that sphere of companies that are ‘in play’; that is, the company is for sale to possible suitors, and its assets are available to be bid for by interested parties.

In August, we wrote.

“…we think there is an opportunity for management to break up the business in the event that the market doesn’t recognise the fair value of the company over the next couple of years.

Our meeting with senior executives confirmed to us that this path is potentially part of the thinking at Perpetual, should the market continue to fail to assess the overall value in each component of the business. In the meantime, management is committed to bedding down its recent acquisitions with a view to stabilising outflows and realising synergies.”

Its businesses

Source: Company reports

The purchase by Perpetual of the Pendal Investment Management business (formerly BT Asset Management) in 2022 has added considerable scale to its asset management franchise, but the business has since suffered significant outflows. Accordingly, both the sell-side (brokers) and the buy-side (investment managers) investment community have chosen to spurn the stock, with it having recently traded on a lowly 5x forward earnings multiple.

Source: Company reports

The Corporate Trust business, the jewel in the original Perpetual Trustees business, has strong and stable margins, a sticky customer base and continues to grow. Our standalone valuation for this business is more than ~$1 billion (including debt) within a total market capitalisation of Perpetual that reached a low of $2 billion last month.

Washington H. Soul Pattinson (‘Soul Patts’ – SOL.ASX) revealed on Wednesday 5th December that it has made a non-binding indicative proposal to purchase Perpetual for $27 per share. Under the terms of the offer, there is no cash component, with PPT shareholders receiving $1,060m worth of SOL scrip. SOL will retain PPT’s Trust (PCT) / Wealth Management (WM) businesses (and all of the debt and corporate overheads of the existing PPT business) and the remaining value will be shares in the demerged asset management business. As per the offer, investors would still hold the Perpetual Asset Management (PAM) shares and additional shares via a shareholding in SOL.

This offer was rejected by the PPT board, which is unsurprising given it had already declined an offer of $33 per share ~12 months ago by a consortium of investors including Regal Funds Management and EQT Group (a Private Equity firm).

PPT suggests the SOL offer introduces significant execution and operational risk over a protracted implementation period. This would present negative value impacts for shareholders. While a demerger brings complexity and cost, it remains unclear who would bear the financial risk of this, given SOL is assuming all group net debt and stranded costs. In addition, we note an attractive aspect of the SOL scrip offer is the avoidance of triggering CGT for the Trust and Wealth Management transaction. We understand this could be a material consideration if the businesses were sold given the low-cost basis of these assets.

In response, on the morning of 6 December, PPT announced it would be exploring the separation of its Trust/Wealth businesses.

We expect that this scenario is a positive for shareholders. While the $27 offer from ‘Soul Patts’ still appears opportunistic and undervalues the business, we think that there remains more scope for upside by them as an acquirer.

Alternately, we expect the offer to now flush out further interested parties. Since bidding for Perpetual in 2022, Regal Partners has continued to look for alternate Asset Management businesses to acquire, including being an underbidder for Pacific Current Group as well as entering into discussions with PM Capital.

On balance, an offer closer to $30 would see us realising a tidy profit on our portfolio holdings.

National Accounts – a softening economy or underestimating the impact of immigration?

The release of quarterly ABS National Accounts figures receives much attention from market participants and often the broader media. Such was the case this week when the quarterly snapshot of Australia’s economic performance between July and September 2023 was calculated.

The soft economic performance that was announced sparked the share market as the outlook for ongoing interest rate rises was pared back. We agreed with the market’s interpretation; the GDP numbers reduced the risks of further rises and provided a positive backdrop for various companies.

There were broad takeaways for citizens and investors alike. We thought that we would highlight some themes relevant to your portfolios. The impact of migration policy government spending and higher interest rates in a heavily indebted economy shone through.

Key takeaways:

  • Real GDP, that is, total output after removing price increases, rose 0.2% in the quarter and 2.2% across the past 12 months. This is relatively weak, considering population growth was at least 2.6% (official measures systemically understate actual growth, in our view).
  • Underlying softness in the economy was highlighted by the ongoing ‘per capita recession’, with per capita falls in GDP (-0.5% q/q) and consumption (-0.6% q/q). This is the third consecutive quarterly contraction in GDP per capita. Lower consumption is a function of higher prices and constrained incomes.
  • Weak growth in the quarter reflected flat household consumption, much slower growth in business investment (with non-mining investment contracting) and a fall in net exports. The main contributors to growth were inventory building (making goods that are yet to be sold) and government spending.

By removing the export/import sector, we can see in the chart below that all of the growth in domestic demand in the quarter was provided by government (public) demand, none by the private part of the economy.

Source: Macquarie, ABS National Accounts

As noted for many years and reflected in your portfolios, this economy is built around growing the total pie, not the size of the slices. Disposable household income (after taxes and interest rates) per household continues to fall precipitously for the segment of the population aged under 60.

The chart below highlights real disposable income is now back at levels first reached more than 15 years ago.

Source: Ben Phillips ANU, Macrobusiness.com.au

Weaker incomes and the impact of higher interest rates have forced significant variations in consumption outcomes by age. Using CBA’s banking transaction data they created the following highly informative chart. Note that all age groups whose spending growth from Q3FY22 to Q3FY23 hasn’t kept up with inflation have suffered from declining living standards.

The household consumption figures (spending after inflation) in the chart below show “the bigger pie and not bigger giant slices” argument. Since 2014, total consumption has risen from an index of 88 to 105 (up 20%), whereas each slice (per capita – has increased from 96 to 101 (up only 6%). That is a meagre return for ten years of declining urban amenity, time lost in traffic, sacrificing future generations’ housing affordability, etc. Meanwhile, as a stockholder of Woolworths, you appreciated the absolute growth in demand.

Source: Macquarie, ABS National Accounts

We remain holders of supermarkets, insurance companies, domestic consumption good producers, and companies that benefit from public investment and government contracts.

The weak growth in consumption has occurred despite a run down in savings ratios over the same period. Increases in household debt, rising interest rates and modest impacts from tax bracket creep have had an influence on savings levels.

Source: Macquarie, ABN National Accounts

Holding the economy together is a surge in consumption and investment for the 700k+ temporary visa holders who have arrived in the past 18 months. Necessarily, along with other services such as the NDIS, the government must spend vast amounts of money (ongoing and investment) to sustain such growth. The temporary visa holders remain a critical source of demand, representing a pipeline for future housing construction, support higher house prices, and help reduce wage growth.

In what might be correctly termed a chicken and egg argument, the rapid growth also sustains critical government and public support for future government investment in various areas, notably infrastructure and energy transition. The chart below shows the quantum of investment undertaken by the government and the size of the pipeline of work yet to be completed.

Source: Macquarie, ABS National Accounts

This reflects Australia’s economy. It is not necessarily the one described in economics textbooks of the 1980s or envisaged by Fraser or Hawke alike, but it is still effective. How did we get here? The household sector is tapped out by vast swathes of household debt, not invested in productive assets but rather speculated in the prices of each other homes.  As global interest rates have risen, the price households must pay for this debt is growing, and the capacity for living standards to increase has been constrained. But the capacity for growth to continue nonetheless remains in the extraction of our mineral endowment, and the sale of our lifestyle to the rest of the world (via immigration).

So despite global-leading population growth, household consumption is contracting as a percentage of the economy.  The changing role for government, business and households can be seen in the chart below.

Source: Macquarie, ABS National Accounts

Thank goodness for the money we saved in superannuation, the funds invested in mining assets, and the catch-up in infrastructure investment because business investment remains subdued, and mining investment faces headwinds on cost and supply chain uncertainty.

The significant upside that is possible in our economy from this starting place remains in full view. Turbulence between here and there remains possible, but the critical components for sustainable growth are in place.

  1. We must transition wealth from an older generation in a stable way.  This will require ongoing moderate inflation, moderate interest rates that reflect the impost of debt burdens on younger generations, and huge amounts of investment in infrastructure.
  2. Areas of future growth in business investment, including in the mining sector, are rapidly building and include energy transition and technology-assisted productivity growth. Making our cities work better for public and private investment is also critical.
  3. In return, we must derive higher productivity from the workforce we have cultivated and imported. The first signs of some productivity improvement came through the National Accounts. As discussed in the recent CIO dinner series, we also see as many exogenous improvements in productivity as possible.

In this environment, especially if interest rates and inflation have peaked, future returns for financial assets that benefit from broad economic activity and cash flow will be well supported.

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