Ann: IOOF update on acquisition of ANZ P&I, page-8

For what it’s worth, I sold out of my entire IFL holding this morning.

My reasoning was broadly along the following lines:

My original investment thesis was clearly broken: I had started buying in May 2018 (around the 9$ mark) on the assumption that, save for market movements, underlying earnings would hold up reasonably well, both for the existing IOOF and for the acquired ANZ businesses, plus there would be synergies to be realised over time.

It turned out that, despite a net increase in markets and net of all interim disposals, underlying earnings from IOOF’s advice/platforms/WM showed a deterioration to the tune of -7.0% YoY; the ANZWM side was even worse, with a -12.5% YoY decline for the profitable P&I component and an increased loss for ADGs.

Yes, there was the Royal Commission in the middle of all this; but, when it comes to identifying the main driver of the earnings decline, it was not so much FUMA but Net Operating Margin that shrank the most. And it is arguable whether the squeeze in NOM had anything to do with the disruption caused by the RC, or with the changes in the structure of fees for financial advice that followed from it.

What seems more likely to me is that margins shrank simply because of increased competition, and that the changes in fees for advice (such as opt-ins, upfront invoicing, etc.) are still to be fully reflected in the corresponding earnings. And, because of this significant residual uncertainty, the PE multiple that needs to be used to value the business must embed an appropriate discount to the broader market.

In an earlier post (see link below)

https://hotcopper.com.au/posts/41178774/single

I had worked out that taking FY19 UNPAT (net of all the required adjustments) as a base, a 30%-20% PE discount to the ASX200 would value IOOF+ANZWM at 7.38$-8.48$.

Repeating the same calculation, but using the annualised 2H19 UNPAT figures instead (to better capture the ongoing earnings deterioration), it turns out that the 7.38$-8.48$ range above actually represents a PE discount of just 27%-16% to the broader market.

So, being given the opportunity to exit at a ~20% PE discount to market on the jump this morning, and since my original investment thesis hadn’t played out, I personally decided that the SP had got close enough to its “new” fair value to justify selling out altogether.