Investing is a great leveller, as well as a moderator of egos...

Investing is a great leveller, as well as a moderator of egos and they say that if you get 7 out of 10 right in the stock market, then you are doing OK.

IFL is one that looks like I have got wrong (although I suspect it will be another 9-12 months before I will know for sure if my loss of capital has been merely temporary, or indeed permanent).


In the meantime, as things stand at the moment, the company's earnings base is $190m (FY18 Underlying NPAT).

Yesterday's ANZ announcement indicated that the business that IFL is buying off ANZ is operating at Underlying NPAT of some $80m.

So, on a pro forma basis, once the ANZ wealth acquisition is finalised, IFL will be generating NPAT of some $270m.

That figure becomes well north of $300m if even half of the $180m of synergy potential, which is said to be on offer, is to be believed (and given that the ANZ business's Cost-t0-Income ratio is running at some 68%, compared to IFL's 53%, I think it would not be overly libertine to factor in several tens of millions of dollars of synergy accrual.

So, using a base case Underlying NPAT of $300m, the current $2.4bn market value of the company capitalises its pro forma earnings at a multiple of 8.0 times.

As I have been scratching my head in recent weeks wondering why that is the case, prima facie, it is clear that there are three possible explanations for it:

1.  The deal with ANZ will be scuppered, for whatever reason;
2.  A significant slug of IFL's earnings are going to disappear due to some regulatory reason (e.g., forced structural separation); or
3.  The market, simply has been jumping at shadows and is mis-pricing the stock.

Ignoring  Point 3 for the minute (because we will only know for certain whether or not that is the case depending on the veracity of Points 1 and 2) and dealing with Points 1 and 2:

Based on the body language of the counter-parties, and the tone of their announcements relating to this deal, the probability of the transaction not completing is, I think, slim (of the order of magnitude of a 10% probability of it falling over).   

And even if it came to pass that the deal didn't close then we'd be left with the situation of a $190m pa NPAT business, capitalised at $2.4bn, but with in excess of $0.5bn of net cash.  That, combined with the implied valuation multiple of 12 times, would see the mother of all share buybacks kick in and I strongly suspect that the company would quickly be valued at a level meaningfully higher than it current valuation.

So, Outcome 1, were it to eventuate, would result in my loss of capital being mostly temporary, I stringly suspect.

Therefore, when it comes to scope for meaningful damage, Outcome 2 is the most noxious, i.e., some major structural change happens in the business which causes a slug of earnings to disappear forever.

Now, I'm not smart enough to know what that structural change might look like, but what I can do is back-solve for what scale of earnings disappearance is being factored into the current share price:

For most of its listed life, IFL has traded on a P/E multiple which was a modest premium to the broader market, i.e, in the mid- to high-teen teens (15-17x).  Of course, it would be naive to expect those valuations levels to recur any time soon because there has clearly been a de-rating (probably a permanent one) of the earnings in this sector given the events of 2018.

So, assuming (conservatively, I think), once the dust is all settled and the market has some certainty of what it is dealing with when it comes to IFL, that the stock will settle at a valuation multiple that is at a 20% discount to the broader market, so around 12-13x.

On that sort of level, the current market value of the company would be capitalising ~$200m of Underlying NPAT.  It means that the current share price is factoring more than a third of IFL's pro forma going up in smoke.  

That's a big call the market is effectively making, and it feels like the "Fear-O-Meter" is red-lining.

But, hey, the market might ultimately be right... as I say, its a great leveller, this investing lark.