Pendal’s Transformational Shift Into Value

This story features PENDAL GROUP LIMITED. For more info SHARE ANALYSIS: PDL

Completely overshadowing Pendal Group’s result, revelations the company is fully acquiring US-based fund manager Thompson, Siegel & Walmsley consummates management’s long-standing desire to add global value funds

-US acquisition to be double-digit EPS accretive
-Rebound in investment performance across UK/EU expected to enhance performance fee prospects
-FUM attrition risk could undermine EPS accretion
-100% acquisition of TSW fundamentally changes the incentivisation structures of the business

By Mark Story

While Pendal Group’s ((PDL)) strong first half 2021 result demonstrated some improving fundamentals for the fund manager, the announced 100% acquisition of Thompson, Siegel & Walmsley (TSW) overshadowed the result, with brokers quick to conclude the deal will be double-digit earnings per share (EPS) accretive.

Benefiting from a large but expected increase in performance fees, Pendal delivered 1H21 cash profit of $82.6m and operating profit of $102.4m, in-line or slightly below most broker’s expectations.

Despite cost overruns, Pendal reiterated its FY21 fixed costs guidance growth, confirming continued cost control, and resulting in little change to brokers’ fixed cost estimate on an organic basis.

With short-term investment performance for key strategies much improved, Citi believes Pendal is on the path of recovery. Meantime, while higher than some brokers had expected, base management fees dipped -2%, driven by slightly lower average funds under management (FUM) while fee margins were broadly stable given positive mix shifts.

The TSW acquisition aside, Macquarie’s attributes its FY21-22 earnings upgrades for Pendal to not only better fee margins, but also lower non-employee expenses, albeit partially offset by higher employee expenses (linked to higher revenue).

Taking the view that any value accretion from the TSW acquisition remains uncertain, JP Morgan (which shares its research with Ord Minnett) believes the underlying Pendal business appears to show indications of a turnaround in flows. As a result, the broker has retained an Overweight recommendation and believes the current price provides an attractive opportunity over the medium term relative to other ASX-listed asset managers.

Pendal enters the second half with staring FUM around 4.5% higher versus 1H21 average and broadly positive market moves since March 2021. Overall, during the March quarter, Pendal’s FUM increased $4.3bn, up 4.4% to $101.7bn, driven by a 2.6% jump in investment returns, 0.9% organic growth and a 0.9% currency tailwind.

Morgans has witnessed a marked improvement in the investment performance recorded in several larger of its JO Hambro Capital Management (JOHCM) value funds (notably UK funds), while relative performance in major Global/International funds remains solid.

The broker expects the meaningful rebound in investment performance across UK/EU to not only support flows but further enhance performance fee prospects. While flows are expected to remain subdued, Morgans expects investment improvement to assist reversing the outflow trend of recent years.

While outlook commentary accompanying the 1H21 result was fairly brief, management expect FY21 fixed cost growth of around 8% (prior guidance 8-10%). Management also flagged strong early demand for the company’s standalone responsible investment business Regnan, and noted Australian performance fees which crystallise in June are currently tracking at $16.8m.

Lastly, management indicated that the Hambro business has likely seen the tail end of outflows, and is now better positioned to grow.

Diversification into value

While the market may be surprised Pendal is pursuing an acquisition with a new CEO just starting, Morgan Stanley reminds shareholders the company had flagged for several years plans to add global value equities.

Pendal has entered into an agreement to buy 100% of US-based value-style investment manager fund manager TSW for $413m. TSW is currently owned 75.1% by BrightSphere Investment Group and 24.9% by TSW management.

The TSW deal will be funded from a mixture of new equity ($190m institutional placement and SPP), new US$ denominated debt ($200m) and $47m of available surplus liquids.

Mainly sourced from the US and primarily institutional and sub-advisory in nature, TSW has a FUM base of US$23.6bn across ten investment strategies, including Global Equities, US Mid and Small Cap Equities and Fixed Income.

Citi believes Pendal’s impending acquisition of TSW is strategically sound – lifting total FUM by circa 30% to $130bn – and further diversifying the business into value strategies. However, the broker notes the TSW business is skewed to institutional sourced FUM (84%) with one client accounting for around 35%.

Pendal seems relatively confident the risk of FUM leakage is small, but Citi highlights the lumpy nature on inflows, with TSW’s top ten clients accounting for around 75% of FUM.

While Citi broadly agrees with Pendal’s conclusion that the single biggest client has long term sub-advisory relationship with TSW, hence inferring minimal downside risk, the broker believes FUM attrition risk cannot be fully ignored.

In light of Citi’s concerns it’s worth noting, US$1.3bn outflow at TSW post-1H21, while the company had three quarters of inflows prior.

Highly EPS accretive

Goldman Sachs has not incorporated the proposed transaction and associated capital raise into forecasts at this stage. But the broker thinks the TSW transaction looks complementary from a product and distribution perspective, and sees solid scope for a range of ‘cross-sell’ revenue synergies in coming years.

However, on the strength of the 1H21 result the broker has downgraded FY21-FY23 earnings forecasts due to higher costs and tax, which leaves Pendal trading at 14.5x the broker’s 12 month forward earnings. The broker maintains a Buy rating with the target price moving to $7.79 from $7.81.

Meantime, Jarden expects the TSW acquisition to offer estimated earnings per share accretion of 28% in FY22, which lifts the broker’s price target to $8.40 from $6.30. With the exception of Morgans (8% cash EPS forecast in FY21/22), brokers are unanimous in their expectation of the TSW acquisition leading to double-digit EPS growth (pre-synergies) for the first full year.

Nevertheless, JP Morgan also reminds investors the transaction is not without risk, especially given the EPS accretion guidance assumed 100% FUM retention. The broker also reminds investors that Pendal's 100% acquisition of TSW fundamentally changes the incentivisation structures of the business and potential alignment with clients (i.e moving from 25% employee ownership of the TSW business to shareholders of the Pendal Group).

But that said, the broker admits the transaction is not a huge bet (with around 8% of equity being issued) also given that Pendal already has a presence in the US through JOHCM with the new Group CEO now also based in the US.

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