Link Administration (LNK.AX) – Merger Arbitrage – 10%+ Upside

Current Price: A$4.91

Offer Price: A$5.40+ (updated, see comment below)

Upside: 10%+

Expected Closing: TBD

Press Release

  • IMPORTANT - the case has been updated and brought back among the active ideas - see this comment. The write-up below refers to an earlier arbitrage situation from 2020 (was closed with 15% gain in Dec'20, although the merger eventually failed) and provides a background for the current case.

 

On the 12th of October, Australian superannuation fund administrator Link Administration received a preliminary non-binding takeover proposal from a consortium of PE firms PEP and Carlyle Group at A$5.20/share (valuing the company at $A2.8bn). PEP has a long history with Link - took it public at higher prices in 2015 after 10 years of ownership - and should be highly knowledgeable about the company and its business. This offer was quickly rejected and a few days later the consortium revised the proposal to A$5.40/share and included an alternative option of $3.80/share in cash + indirect ownership in one of the subsidiaries (PEXA). The board stated that the updated offer still did not represent compelling value 'on a control basis', but allowed the consortium to proceed with due diligence. 17% of shareholders already support the revised proposal, however, Yarra Capital (5.4% stake) is not satisfied with the offer price. Historical business valuation, comparison with other peers, and recent transactions indicate that Link is cheap and there's plenty of headroom for an improved offer to convince the board and remaining shareholders.

So we have a relatively cheap valuation, credible buyers with intimate knowledge of the business, the board that in principle is willing to sell, support from 17% of shareholders, and a 10% spread to the latest offer which might still be revised upwards.

The downside to pre-announcement price is -19%. However, the company is cheap with a stable business (83% recurring revenues) and is only facing what seems to be temporary headwinds from COVID and regulators. As stated by Yarra Capital, most of these issues are "in the rear window" now, while strong foundations for recovery are present - certain segments of the business saw very favorable acceleration from the COVID. PE firms and the board also clearly value Link above A$5.40/share. Taking all these points into account, it seems that the real downside in case the transaction fails should be lower than 19%.

With this set-up, an 11% spread is hard to explain. One of the reasons is that the market is skeptical towards a non-binding offer as last year, several other large PE firms (including BGH Capital) showed interest in Link, but no proposals were made. However, this time it might be different due to the lower price + strong growth of Link subsidiary PEXA as well as buyers' intimate knowledge of the business.

Worth noting that this is the largest PE transaction in Australia this year, so it is not an undiscovered situation and the spread might correctly reflect the outstanding risks.

 

Timeline of events

  • 12th October. Link announces a non-binding offer from Pacific Equity Partners and Carlyle Group at A$5.20/share. The offer is conditioned on due diligence, securing debt financing, and regulatory approvals. Additionally, some kind of alternative offer including scrip (securities) was mentioned without unveiling further details. The largest shareholder Perpetual (9.65% stake) supports the offer, however, another major shareholder Yarra Capital opposes. Yarra states that the proposal "materially undervalues great assets" and that the company should wait for a better offer as current the headwinds causing depressed market price are "in the rear window".
  • 23rd October. Link board also decides that the offer materially undervalues the company citing several aspects - the value of PEXA and its accelerated take-up during COVID, early progress of the transformation plan, highly conditional nature of the proposal, etc. The company also notes that the consortium proposed a certain structure to allow Link shareholders to take a direct interest in PEXA, but no numbers were provided.
  • 26th October. Consortium issues a revised offer to A$5.40/share. 6 weeks due diligence period is requested, while the deadline for the board is set for the 28th of October. The revised proposal includes an alternative option for a cash offer for Link (ex-PEXA) at A$3.80/share + ability to take a direct interest in PEXA. 14.6% of shareholders gave their support.
  • 27th October. Another shareholder agrees to vote in favor of the proposal bringing the supporting stake to 16.94%.
  • 28th October. Link board notes that the proposal is still undervaluing the company on a control basis, but allows due diligence to proceed "so that it can develop a proposal that may be capable of being recommended to shareholders". Additional stand-still agreement is included for the consortium.

 

Link Group and PEXA

Link Administration Holdings provides administration services for major superannuation (i.e. retirement) funds. 83% of the company's revenues are recurring.

PEP has acquired Link in 2005 at A$135m and 7.9x EBITDA multiple. After 10 years of growing the company, Link was very successfully IPO'ed at A$2.3bn market cap (A$6.37/share) and at 15.9x EBITDA forecast for 2016. PEP remained a major shareholder until 2018 when it exited the company completely at around A$8.40/share price levels and substantial profit for the PE firm (total return was 7.6x according to one of the firm's investors).

Since the IPO the company has done two large investments:

1. 2017 Acquisition of Capital Asset Services for A$1.5bn at a valuation of 12.4xEBITDA. The merger increased Link's revenues by 70% (to pro-forma A$1.3bn) and EBITDA by 55% (to pro-forma A$329). Operations were expanded to 17 other jurisdictions globally (mostly Europe). Pre-acquisition 93% of revenues were from Australia & NZ, while post-acquisition the figure was reduced to 55%.

2. Incremental investments in Property Exchange Australia (PEXA) increasing LNK stake from 11% to 44%. These incremental investments were carried out in two rounds one in 2017 and another one in 2019. The last transaction valued PEXA at A$1.6bn and Link's stake in the company at A$710m. Worth noting that PEXA is carried on Links books as an equity investment meaning that the reported Link revenues and EBITDA exclude PEXA results. However, it is likely to be one of the key reasons for the interest from PE groups. As this article put it:

Carlyle Group and Pacific Equity Partners are circling Link Market Services. But their main target might just be its 44 per cent stake in the PEXA online property settlements exchange.

PEXA is the leading electronic processing platform for property transactions in Australia. It assists members – such as lawyers, conveyancers and financial institutions – to lodge documents with Land Registries and complete financial settlements electronically rather than by way of a paper based system. The company has shown remarkable growth over the last few years and reached EBITDA profitability.

Management recently indicated that if the transaction with the consortium does not materialize, PEXA might be spun-off (no details provided yet):

The Board continues to examine the structural alternatives as disclosed in Link Group's annoucnement dated 23 October 2020, including a separation and demerger of PEXA.

Aside from the great performance of PEXA, the remaining Link operations have been impacted by aggressive competitor activity, negative business sentiment in the UK due to Brexit,  certain regulatory headwinds in AU, and finally, the COVID outbreak. For example, the law changes in the Australian superannuation industry introduced last year meant that accounts of less than A$6k must be transferred from superannuation funds to the AU tax office (hitting AUM of Link's customers and in turn Link's revenues). In March'20, to tackle the pandemic, the Australian government allowed certain workers (whose jobs have been affected by COVID) early access to their pension funds. This program doubled the workload of the company - as of Aug'20, 83k accounts were closed and A$16bn early-access payments were made from Link's administered funds. The exact impact on Link is not clear yet but the program is expected to continue until the end of this calendar year. As of June'20 fund segment's AUM was A$102m (+6% YoY).

All these headwinds have negatively affected the financial performance. Recent FY2020 (June'20) results showed revenues falling by 12% (YoY), operating EBITDA by 26% and EPS at A$-0.22 vs A$0.60 in 2019 (PEXA results are not included from these figures).

Note: Operating EBITDA is slightly not the metric used in the next section, where we use EBITDA after significant items for better comparison with peers and more accurate valuation multiples.

 

Valuation

The revised proposal values the core business (excluding PEXA stake) at A$3.80/share and then PEXA stake at A$1.60/share. I believe both figures are too low and have room for the improved offer.

Let's start with the value of the core business.

Despite recent negative trends, the core business has grown significantly since the IPO. However, the offer price (A$3.8/share) values the business at almost the same enterprise value as the company had at the time of its IPO, with hardly any credit given to revenue and EBITDA growth.

  • At the time of IPO. EV=A$2.6bn with forward revenues of A$776m and EBITDA of A$167m (actual FY 2016 results)
  • At A$3.8/share offer price. EV=A$2.8bn with trailing revenues of A$1230m (up 60% since IPO) and EBITDA of $246m (up 47% since IPO).

Keep in mind that 2020 results were strongly impacted by the COVID and regulatory headwinds. However, as stated by Yarra Capital, most of these issues are "in the rear window", while a strong business foundation exists for the recovery.

The valuation seems also low compared to currently ongoing Onevue Holdings acquisition. The initial offer for OVH.AX came at 14.9x EBITDA but then was increased to 16.1x. Other peers are trading at mid-teens EBITDA multiples as indicated in the table below (the last example in the table is Link acquisition of Capita Asset Services in 2017)

Note: PEXA financials are not included in the table above as it is recorded as equity investment on Link books.

Now on PEXA stake. The revised proposal values 44% PEXA stake A$1.60/share or A$850m. This compares to $710m valuation in 2019 transaction when Link increased its stake in PEXA from 20% to 44%. Thus the offer does not seem to reflect the impressive growth of PEXA since then. Between FY2018 and FY2020 PEXA revenues have increased 3x and EBITDA turned from negative -A$30m to profit of $A$60m. The amount of the transactions done on the platform also tripled to 2.4m from 0.8m. This take-up was substantially accelerated by COVID and currently, the number of transactions stands at 250k/month.

Thus, the numbers are very different from the time Link increased its stake in PEXA and it seems that the value of this subsidiary should be materially higher. PEXA's value has also been the first point Link CEO used to explain why consortiums proposal is too low :

The significant value inherent in PEXA, which has delivered strong growth and established a leading market position in digital property settlements. PEXA demonstrated accelerated take-up during COVID-19 and is expected to deliver a material return of capital in the coming months

Overall, no matter how you look at it, the price of the proposal seems quite low and there is plenty of place for an improved offer.

12 COMMENTS

  1. Daniel

    I like this idea because I think the PEXA spin-off lowers your downside, as you are effectively acquiring LNK at $3.39 per share ($5 current LNK price less $1.61 for its share of PEXA, based on last round valuation). This equates to around 9X EBITDA vs. Computershare at 12X and equiniti 9X – so the risk reward skew of this deal looks very appealing.

    I also think PEXA is likely to be rated extremely high given it is still relatively small (AU$150m revenue), growing very fast (50% topline growth last year), extremely profitable (34% EBITDA margins and incremental margins of 80%+) and in a large industry that will skew towards winner take all (marketplace).

    My friends at large cap shops back home are salivating over PEXA, so there is a reasonable chance it could go higher, with some people telling me $2 wouldn’t be unreasonable. The current valuation is a slight discount to ASX on an EV/Rev basis, and the growth difference is enormous (ASX is a great Company, but 3-5% grower).

  2. fishwithwings

    Any idea how spin offs in Australia are treated for US shareholders (tax wise)?

  3. Daniel

    In a trading halt pending news around a transaction. I’m hearing $5.80 being thrown around, which is much more likely to get a rec from the Board.

  4. Daniel

    Edit/update: it’s a new bidder, SS&C (NASDAQ company) with a $5.65 cash offer (highly conditional). Let the games begin

  5. Ilja

    The board has issued a similar response to SS&C – “does not represent compelling value for Link Group shareholders on a control basis.” However, DD was still provided so that the buyer can develop a more attractive proposal.

    DD period for PEP and Carlyle should now be over, so it will be interesting to see their next move. An overbid is very likely.

    https://cdn-api.markitdigital.com/apiman-gateway/ASX/asx-research/1.0/file/2924-02320482-2A1269370?access_token=83ff96335c2d45a094df02a206a39ff4

  6. dt

    It seems that PEP and Carlyle consortium lowered their stake in LINK from 17% to 12.6%. This could indicate that after the DD, they do not plan on making further bids for LNK. SS&C is still conducting the due diligence and spread to the proposal now stands at only 1%. The offer is still non-binding and there’s some risk that after the DD, SS&C could decide to withdraw the offer.

    Overall, it kind of looks like the likelihood of a further bidding war is diminished, and I am closing this idea with 13% profit in 1.5 months. 

  7. ijw

    Merger seems to be off, did SS&C find something they did not like?

    If there truly is value in PEXA, and a spin off happens, this might become interesting again.

  8. snowball

    Carlyle returned with a new bid at A$5.38, consisting of A$3 per share in cash and a distribution of Link’s stake in PEXA worth A$2.38 a share.

    1
  9. Ilja

    Current Price: A$4.61
    Offer Price: A$5.20
    Upside: 13%
    Expected Closing Date: TBD

    Quick recap: Last year, PEP and Carlyle tried to buy Link Administration for A$5.20/share and then upped the offer to A$3.80/share for the core business and around A$1.60/share for Link’s 44% stake in PEXA (combined A$5.40/share). Both offers were pushed back by the management, but eventually, due diligence was allowed in order to continue discussions. Then another bidder, SS&C, appeared with a superior A$5.65/share all-cash proposal but withdrew the offer after a month of DD. After months of silence PEP/Carlyle also withdrew the offer in April’21. Link then went on to IPO PEXA, which was completed in July’21 – at A$17.13 per PEXA share (A$3bn market cap). Before the IPO, PEXA received several other PE bids, including one from KKR at A$3.1bn. Currently, PEXA trades just under A$2.8bn market cap valuation.

    So Carlyle has decided to return alone with a current offer at A$3/share for the core business (ex. PEXA) + distribution of Link’s 42.8% stake in PEXA to Link’s shareholders. The offer is now valued at around A$5.20/share. The situation offers 13% upside and 6.5% downside to pre-announcement levels. We are bringing the case back among active Quick Ideas. The main problem is that PEXA’s hedge is unavailable, at least not on IB. However, PEXA is trading at the lowest levels since the IPO. KKR’s bid just before the IPO strongly supports current valuation suggesting that any further PEXA share price deterioration likely to be limited. Thus betting on this arbitrage without hedging is also an option.

    Offer announcement – https://investors.linkgroup.com/DownloadFile.axd?file=/Report/ComNews/20211105/02447824.pdf

    The offer is still non-binding and conditioned on due diligence. Link has suspended its open market buyback program (5%, has already purchased most of its for an average price of A$438/share), and is now considering the offer. Looking at the total consideration, the current offer is rather in line with the last year’s proposal, however, ex. PEXA, the price offered for the core business has dropped substantially – from last year’s A$3.80/share to the current A$3/share. Part of that could be justified by the lackluster business performance – due to pressures from competition and regulators financial performance has been dropping rapidly over the last two years (pressures from competition and regulators):

    Historical performance

    Shareholders are clearly disappointed – before the recent proposal announcement the core LINK business (excluding PEXA stake) was trading below A$2/share, so the offer actually comes at a substantial premium. Perpetual still owns 5% of Link and has apparently said that it is hard to argue that the offer is too cheap. A minor shareholder Van Eck Australia (owns A$3.5 shares) says the offer looks good in the short term but is uncertain about the value in the medium/long term.

    So the set-up looks interesting. Link’s board is clearly pressured by the poor financial performance (shares declined 15% after annual results in August) and by the two previous bidders (PEP/Carlyle and SS&C) walking away after DD. Carlyle should know the business pretty well by now and has decided to return. Further DD (if granted) will likely be short and with no surprises. A major shareholder (Perpetual) is likely to support the current bid. PEXA is already listed and its valuation is no longer ambiguous. Valuation of the core Link business comes at 11x FY21 EBITDA (after significant items) – in line with 11.3x FY20 last year’s offer.

    Overall, I think it is likely that the board will at least allow the DD and try to push for a small price bump. Share price will likely jump up after the DD announcement.

    5

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