Australia | May 14 2019
Further delays to the acquisition of the OnePath wealth business have meant brokers are reassessing the earnings outlook for IOOF.
-Coupon rate on ANZ debt note steps down significantly
-Uncertainty surrounding acquisition leads to downgrades to earnings outlook
-If acquisition does not proceed would a buyback ensue?
By Eva Brocklehurst
The acquisition of the OnePath pensions & investments business by IOOF Holdings ((IFL)) has hit another snag and brokers suspect time is running out for the company to complete the transaction as it stands.
ANZ Bank ((ANZ)) has completed the separation of its pensions & investments business but a sign off by the trustee is yet to occur. Moreover, in order to obtain an 82% economic interest prior to the completion of the transaction, IOOF has been receiving a 14.4% coupon rate on an $800m debt note issued by ANZ.
This coupon rate, now ANZ has completed its successor fund transfer and split the life and wealth business, reduces to 2%, so IOOF is no longer receiving any economic interest. Brokers assume, given the cost of debt is more than 2%, that IOOF will redeem the note and repay the debt.
Completion of the transaction remains conditional on receipt of notices of no objection from OnePath custodians. Steps are being taken to satisfy the requirements but it appears completion of the deal could be delayed. Should the delays extend to July 5 additional approval will also be required from the Australian Prudential Regulatory Authority, following recent legislative amendments.
This, in turn, is likely to extend the completion date further. Macquarie notes that on October 17 it will be two years since the initial agreement was signed and both parties will have the option to terminate the agreement. IOOF would have the opportunity to walk away at no cost or revisit its offer price.
Hence, given the changing industry landscape, the broker suspects this could give rise to a redrawing of the deal. Macquarie downgrades estimates for earnings per share by -4.9% for FY19 and -8.4% for FY20 to reflect a lower coupon rate.
Morgan Stanley pushes back the timing for realised synergies, although continues to target $75m in the longer term. The broker assumes the deal is completed in the first quarter of FY20. Were the acquisition not to proceed, earnings per share would likely fall -15-20% in FY21. Morgan Stanley assesses the downgrade to profit would be partly offset by the repurchase of over 20% of shares outstanding at the current stock price using the company's cash balance.
UBS lowers estimated pre-tax profit for FY19 by -4.6% to reflect a lower contribution to the second half earnings from the step-down in the coupon. The broker agrees IOOF is likely to redeem the note and reduce debt until the outcome for the transaction is clear.
In addition to the uncertainty around the acquisition, Credit Suisse also points out the company's estimates of customer remediation costs are significantly below its peers. Pro rata, remediation costs are calculated to be around $500m. Remediation costs, therefore, could consume the company's excess capital and the business is also facing a large amount of brand damage and industry pressure. Hence, the broker finds no appropriate risk/reward trade at current levels.
Citi envisages downside risks, including the need for IOOF to materially change its business model, while advice remediation costs would eat into profit and/or capital. The broker recognises the initial review of the advice business found no systemic issues and IOOF has limited exposure to the more problematic corporate super plan business. However, with banking peers expecting costs to the tune of $1-1.7bn each, it would be surprising if IOOF's final exposure can remain at $5-10m.
Bell Potter is quite incredulous that IOOF has only earmarked up to $30m in client remediation, all of this just to perform client file reviews. There is nothing, at this point, allocated to refunds and the broker considers this a major risk. Findings suggest major banks have provisioned or expensed on average above $1bn per adviser whereas IOOF barely registers as a comparison.
An increase in provisions is anticipated over coming months which could be in the hundreds of millions of dollars. Earnings are revised down because of changed assumptions around income payments from the ANZ notes and the broker, not one of the eight monitored daily on the FNArena database, retains a Sell rating with a $4.39 target.
Setting aside the risk of remediation costs and fines, if the acquisition is not completed in its entirety then the business will have around $500m in excess cash and, potentially, as much as $600m in debt headroom, depending on gearing. Credit Suisse calculates it would only take a buyback of $775m to deliver earnings per share of $0.86, which would be in line with estimates for earnings per share if the acquisition were to proceed.
Still, such a move would remain dilutive for IOOF. The largest risk to excess cash, Credit Suisse points out, is still customer remediation costs. Citi concedes it possible that additional remediation costs would temper the size of any buyback if the acquisition of OnePath fails to occur. The broker estimates a buyback could be up to $400m.
There are five Hold ratings on the database. The consensus target is $5.78, signalling 4.1% upside to the last share price. The dividend yield on FY19 and FY20 forecasts is 9.2% and 8.8% respectively.
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