IOOF Merger With SFG Increases Scale And Diversity

This story features INSIGNIA FINANCIAL LIMITED, and other companies. For more info SHARE ANALYSIS: IFL

-Accretion targets achievable
-No allowance for attrition
-Underperforming IOOF share price offers potential for re-rating
 

(This story was re-published to remove incorrect information regarding a take-over of Equity Trustees)

By Eva Brocklehurst

IOOF Holdings ((IFL)) will acquire SFG Australia ((SFW)), expanding funds under management and advice by 25%. The scale achieved by the acquisition means IOOF becomes the third largest financial advice group in Australia after Commonwealth Bank ((CBA)) and AMP ((AMP)). Brokers believe the acquisition is priced reasonably and laud the company's discipline, given IOOF was previously out-bid on the acquisition of The Trust Company. The transaction has been recommended by the SFG Australia board.

Macquarie believes an FY16 earnings accretion target of 8% is achievable. The ability to retain advisers and maintain productivity will be central to the transaction, and the broker considers adviser attrition is the main uncertainty that will only become clear with time. Revenue synergies will focus the market but these are related to scale and buying power. Macquarie observes the stock underperformed the market after the earnings season, as wealth management stocks experienced a broad-based correction. IOOF now trades at a discount to the sector and presents an opportunity for a re-rating and two years of growth derived from this acquisition.

JP Morgan upgrades IOOF to Overweight from Neutral in the wake of the announcement, expecting material synergies from the combined businesses. Considering the stock has underperformed in recent months there is upside to the broker's valuation. The transaction is expected to create a better company structurally, and provide greater scale. JP Morgan is forecasting earnings accretion of 6% in FY16 from this transaction. The broker notes the company has a good record of achieving expense synergies from prior acquisitions and the scale from this acquisition should provide better negotiating power.

JP Morgan is now forecasting underlying earnings growth of 11% from FY15 onwards. Moreover, with speculation that ANZ Bank ((ANZ)) and National Australia Bank ((NAB)) are looking to divest some non-core assets, the broker thinks IOOF could be a participant in such a consolidation. The stock has underperformed but JP Morgan thinks this may be pending entry to the ASX100, which could lead to some small cap investors selling up, or using the stock to fund recent initial public offerings. In this scenario, the broker thinks trading weakness will unwind. Large cap managers are expected to become more interested in the stock over time.

To UBS, this merger is a timely and logical boost for IOOF. The transaction is expected to provide a 35% revenue uplift and create greater diversity across the value chain. The transaction will mean IOOF is less dependent on margin revenue from its platforms. The broker believes it is important that IOOF successfully leverages this enlarged footprint and drives organic growth, as accretive acquisitions of this size will become more rare. UBS is also wary of revenue assumptions that make no allowance for adviser attrition. The company is not making any allowance for attrition. Rather, it argues that the combined group will now present a more compelling proposition for planners, both from within and outside of the group. Aside from this, assuming full pre-tax synergies by FY16, the broker estimates the acquisition to be 8% earnings accretive in FY16.

Strategically, Credit Suisse believes the acquisition is a positive, providing scale and reducing the skew towards platform income. Even if SFG Australia did not grow over the next two years and IOOF only extracted $15m in synergies, the broker estimates the deal would still be accretive. The transaction is an all-scrip deal with an option for up to $100m in cash instead of scrip. The implied offer price of 85c per SFW share represents a 16% premium to the closing price ahead of the announcement and total consideration of around $621m. IOOF intends to fund the acquisition via 0.104 IFL shares for each SFW share. Credit Suisse is yet to incorporate the acquisition into forecasts and retains a Neutral rating.

On the FNArena database IOOF shows two Buy ratings, four Hold and one Sell. The consensus target price is $9.27, suggesting 8.8% upside to the last share price. This target has risen from $9.07 ahead of the announcement. The targets range from $8.35 to $10.60. The dividend yield on FY14 and FY15 earning forecasts is 5.5% and 6.0% respectively.

SFG Australia was formerly known as Snowball Group and operates a financial planning, accounting practice and stockbroking business.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms