Future Looks Bright For Generation Development

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Generation Development Group could well prove to be in the right places at the right time.

-Generation Development Group’s interim beats consensus estimates
-Upcoming managed account synergies for Evidentia and Lonsec
-Investment bonds a key focus, but annuities could become the next growth engine
-Risks include regulatory changes and slowing net inflows

By Mark Woodruff

It has been a busy period for Generation Development Group (GDG), a specialist provider of “innovative, tax-effective investment solutions” with a dominant market position in Australia across investment bonds, annuities, and managed accounts.

Last Friday, the group was included in the ASX300 as part of the March quarterly rebalance. One week prior, released interim results beat consensus profit and EPS forecasts by 10%, with strong contributions across all business areas.

Management commentary implied to Morgan Stanley strong momentum for all segments has continued into the second half.

In early-February, Generation Development also announced the acquisition of Evidentia Group Holdings Pty Ltd for -$320m, one of Australia’s leading providers of investment management and tailored managed account solutions.

Shortly thereafter, the group raised $233.3m from institutions, as well as $54.8m via a retail offer to fund the purchase.

At the time, management stated the acquisition and subsequent merger with Lonsec Investment Solutions (LIS) “will bring together two of the leading and fastest growing managed account providers as the undisputed leader in the market, with a combined total of over $25bn in funds under management (FUM)”.

Since August last year, the group holds full ownership of Lonsec (encompassing Managed Accounts and Research) after increasing its stake from the initial 37% acquired in September 2020.

Model managers like Lonsec assist with managing portfolios to meet objectives such as growth and income for the managed account.

Providing structural tailwinds, financial advisers need platforms and model managers to use managed accounts, which have been a key driver in FUM growth for platforms like Hub24 ((HUB)) and Netwealth Group ((NWL)).

While sharing common tailwinds, a valuation discount is warranted for managed accounts given platforms are not exposed to underlying portfolio performance, explains Morgan Stanley.

Unlike mutual funds, managed accounts are tailored to meet customers’ specific financial objectives, risk tolerance, and time horizon.

Under such a structure, individual securities are owned in the customers’ portfolio (e.g. stocks, bonds), which may offer tax advantages and more control over investments.

Management further noted the Evidentia acquisition will build on Generation Development’s presence in the rapidly expanding managed accounts market, currently valued at over $200bn and estimated to grow at approximately 15% per annum to $474bn by 2030.

Reducing the risk of cannibalisation, Morgan Stanley points out Lonsec is dominant in the off-the-shelf segment of the market, while Evidentia is stronger in the tailored segment. The union now makes Generation Development the clear number one player in managed accounts, with around 12% market share.

Evidentia positions its services as an “outsourced Chief Investment Officer” for large wealth managers, notes the broker, offering customised investment portfolios.

Making its funds under management (FUM) more secure and long-term, observe the analysts, Evidentia is deeply integrated with clients given consulting services are also provided.

Management expects the acquisition will be low double-digit EPS accretive in the first full year of ownership (FY26 exclusive of synergies) and deliver other material benefits.

Generation Development also owns Generation Life, which markets Investment Bonds and Annuities.

Appealing to individuals with higher marginal tax rates, investment bonds can hold a broad range of asset classes, with earnings and distributions taxed at a maximum effective rate of 30%, but the actual effective tax rate incurred can be substantially lower, due to tax credits and active tax management strategies.

Investment Bonds are a core focus for the group, notes Morgan Stanley, driving outsized share gains (more than 50% of industry inflows), noting FUM is very sticky given the tax benefits from customers holding for greater than 10 years.

The group holds the number one position in inflows with a 52% market share in investment bonds and ranking second in total FUM at 32%, highlights Moelis.

Separately, investment-linked lifetime annuities provide income linked to market performance while guaranteeing payouts for life.

While failing to gain traction so far, Morgan Stanley suggests the opportunity could be even bigger for Annuities than for Investment Bonds given the material shift of money moving into retirement phase over the next decade.

For perspective, Managed Accounts, Investment Bonds, Research, and Annuities currently comprise 61%, 36%, 14% and 1%, respectively, of Morgan Stanley’s sum-of-the-parts base case valuation.

Interim result

On a pro forma basis, based on 100% ownership of Lonsec, revenue in the first half jumped by 23% to $65.6m.

Morgan Stanley highlights profit/EPS beats were driven by higher revenue margins and a stronger contribution from Lonsec.

The Life business also delivered a better revenue margin coupled with the number of bonds written trending significantly upwards on an annualised basis, highlights Petra Capital.

Underlying profit of $12.4m beat the consensus estimate for $11.3m, with profit for the Lonsec business of $8.8m coming in ahead of Ord Minnett’s $7.6m forecast, with the Research gross margin expanding to 59% from 56.1% the year prior.

This Lonsec segment continues to be a key driver of growth, highlights Moelis, with FUM reaching $12.7bn, delivering a 78% four-year compound annual growth rate (CAGR).

Managed Accounts are benefiting from rising adviser adoption, boosting productivity and efficiency, while Investment Bonds gain from growing demand for tax-efficient growth and alternatives to superannuation, explains the broker.

Even if mooted tax hikes for superannuation are not implemented, Morgan Stanley thinks the process highlights ongoing rule changes, which should be a tailwind for the more predictable IBs.

The board declared a fully franked interim dividend of one cent.

Notwithstanding restricted cash required for regulatory capital (around 25 basis points of FUM), Petra Capital believes management has ample capacity to increase the payout ratio during FY26, along with retiring inherited borrowings from Lonsec.

Outlook

Petra Capital raises its assumed terminal growth rate for Generation Development to 3.5% from 3.0% given strong mandated flows into superannuation, growth of the in-retirement segment, plus the Evidentia growth profile.

As the group reinvests further, Morgan Stanley anticipates a widening scale advantage across product, technology, sales and adviser support.

For both recent acquisitions, Lonsec and Evidentia, this broker sees scope for revenue synergies via cross-selling with Investment Bonds and cost synergies relating to corporate overheads.

Morgan Stanley still sees an opportunity for more bolt-on M&A in the Managed Accounts space.

According to Morgan Stanley, risks include a slowing in net inflow momentum, unfavourable regulatory changes, and rotation away from high-growth, high-multiple stocks in a risk-off environment.

From among brokers monitored daily by FNArena, Overweight-rated Morgan Stanley raised its target to $6.30 from $4.90, while Morgans (Add) is yet to refresh its research following the interim results.

Outside of daily monitoring, Petra Capital increased its target by 40 cents to $5.58 and upgraded to Buy from Hold, while Moelis is currently under research restriction, after being appointed as a joint-lead manager for the equity raising.

The average target of Morgan Stanley and Petra Capital is $5.94, suggesting nearly 20% upside to the closing share price of $4.97 on March 10.

The author owns shares in Generation Development Group.

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