Pexa To Contest Major Revenue Hit In Australia

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The regulator has proposed a significant cut to digital conveyancer Pexa Group’s service fees but the company intends to fight back.

• Regulator’s proposed cuts hit Pexa Group’s revenues by -20%
• Draft report only, some wind-back is possible
• Pexa will contest the changes
• Forecasts and valuations are downgraded

By Greg Peel

Pexa Group’s ((PXA)) world-first digital settlement platform has revolutionised the way property is exchanged in Australia, connecting individual conveyancers, financial institutions, governments and investors with innovative and secure online solutions.

Today, over 20,000 Australian families safely settle their homes each week using the Pexa exchange.

The Pexa investment thesis has always centred on a core, monopoly-style Australian exchange generating high returns and cash flow, Morgans notes.

IPART is an independent regulatory and pricing tribunal established by the New South Wales Government in 1992 to oversee key markets and government services. Its main goal is to ensure that consumers receive safe, reliable services at fair prices, particularly in sectors where there is limited competition or market failures.

IPART’s recently released Draft Report on a new pricing model for Pexa was more onerous than the market expected, sending the stock down some -21%. UBS notes risks were asymmetrically skewed to the downside heading into this.

IPART’s estimate of the regulatory initial asset base (IAB) was low ($367m) and implies a -20% revenue hit to Pexa’s key Australian Exchange division from FY28 on.

As a starting point, this implies circa -30% pro-forma impact to Australian earnings, UBS calculates, although the hit may be tempered or include a gradual price transition in IPART’s Final Report due on September 30.

Pexa management stated that IPART’s draft report on Electronic Lodgement Network Operators (ELNO) service fees is expected to reduce revenue by -$70m in the first year (FY28).

How bad is it?

The changes will take effect from July 1 and run for four years to FY31, with Pexa’s current CPI-linked fee cap continuing to apply for FY27.

IPART has recommended a -33%-36% cut to transfer fees (single title $146 to $93) with most other ELNO services fees unchanged, resulting in a circa -20% revenue impact.

Pricing will be indexed for inflation from July 1 and reviewed on a four-year cycle with a demand volatility adjustment mechanism if volumes differ from forecast by plus-minus 5%.

In addition, while transaction activity is weakening into FY27 following macro (RBA rate hikes) and property-related tax changes (budget), IPART forecasts a further compound decline of -0.7% per annum over FY28-FY31.

Overall revenue impacts are thus much more severe, UBS notes, with price reductions leaning into cyclical softness in volumes. UBS now forecasts FY27 volumes down -3% and allows for a gradual implementation of price cuts over the four years to FY31.

Analyst forecasts for the revenue hit from the pricing changes, ahead of the report, varied widely, but a -20% cut to exchange revenue sits clearly at the worst-case end. Morgans had only modelled something closer to -10%.

Given the largely fixed-cost structure of the core exchange business, that revenue reduction translates into a far more severe hit at the profit line, with Morgans estimating around -40% in FY28.

Pexa said price cuts of this magnitude would require significant cost cuts, though it was too early to detail how these would be achieved.

While cutting costs would boost near-term profitability, Pexa faces a structural challenge under the proposed pricing methodology, Morgans notes.

Any savings it achieves risk being absorbed into the new IPART baseline, resulting in lower prices at the 2031 IPART pricing reset.

While the majority of key inputs in IPART’s building block methodology compared to Macquarie’s estimates were broadly comparable (total billable transactions, IAB, weighted average cost of capital), operating costs were materially different, with IPART adopting Pexa’s actual cost base in its assessment rather than a theoretical assessment of where an efficient ELNO should operate at.

This was the sole driver of the cut versus Macquarie’s estimates.

What can be done?

Pexa management said the assumptions around the IAB are almost entirely responsible for the -20% revenue cut recommended by IPART.

Management described these assumptions as “highly contestable”, noting they imply the exchange assets were worth only $600m in 2019, despite state governments and other investors having sold them for $1.6bn at the time.

Macquarie sees the draft report as an initial view, with price cuts likely to be partially walked back given Pexa, industry participants and investors will push back on elements of the report.

Elsewhere, while cost-out is limited given it could impact the next pricing review, Macquarie suggests revenue opportunities are genuine, with IPART confirming some ancillary products will not be regulated. This should offset some of the price cuts.

While the draft report has recommended -20% price cuts implying a -$70m FY28 revenue headwind for Pexa, Macquarie adopts a -$50m forecast on the assumption that either:

(i) the price cut in the final report will improve from here (closer to -15% price cuts) and/or

(ii) Pexa generates revenues elsewhere to offset the price cut.

Macquarie sees upside risk to downgraded estimates.

The Impact

Macquarie’s optimism leads this broker to retain its Outperform rating on Pexa.

Formal commitment from additional Tier-1 lenders is likely to incentivise the other Tier-1 lenders to onboard with Pexa quickly, Macquarie believes, driving rapid market share gains.

Macquarie has cut its price target to $16.00 from $19.30.

Its prior $19.30 target was already well ahead of the three other brokers monitored daily by FNArena covering Pexa. Morgans was on $14.23 and UBS on $12.80.

Morgan Stanley (Overweight) is on $15.50 but has not yet updated on the IPART report.

Morgans noted the Pexa investment thesis has always centred on a core, monopoly-style Australian exchange generating high returns and cash flow.

These IPART price changes strike at the heart of that thesis, Morgans warns, raising questions about the appropriate valuation multiple for the business and its capacity to fund new growth areas.

Pexa is seen as a quality, defensive technology play and a unique piece of Australian financial infrastructure. Morgans remains optimistic about the company’s UK expansion following the signing of NatWest.

However, the IPART pricing outcomes have introduced significant uncertainty around the future profit profile of the core exchange and its broader operating environment. While there is likely value in Pexa at current levels, Morgans believes there are too many unknowns at this stage.

Morgans downgrades to Hold from Accumulate, cutting its target to $9.35 from $14.23.

While valuation headroom is now emerging, UBS retains a Neutral rating given ongoing regulatory and earnings uncertainty surrounding final IPART outcomes, downside risk to transaction volumes post the budget, and a potentially slower UK roll-out progress suggested by recent UK leadership changes.

UBS’ target falls to $9.80 from $12.80.

Macquarie’s $16.00 target clearly stands out.

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