Small Caps | Oct 14 2020
This story features GENERATION DEVELOPMENT GROUP LIMITED. For more info SHARE ANALYSIS: GDG
Generation Development is branching out with a new investment annuity product while taking a stake in Lonsec.
-Annuity provides scope to leverage adviser network
-Lonsec provides entry to market niche
-Investment bond business share expanding
By Eva Brocklehurst
Generation Development ((GDG)), formerly Austock, is expanding its horizons by acquiring a stake in investment research firm and launching an annuity to address longevity risk. The company, a provider of development capital to the financial sector, has completed a $35m capital raising to fund the initiatives which include a 37% stake in Lonsec.
Morgans assesses, while this acquisition may be outside the current line of business, the strategic rationale makes sense. Lonsec is a defensive business with a structural tailwind, in that it entails an increasing reliance on independent specialists within financial services.
Generation Development will invest around $10m in the lifetime annuity product, which will assist retirees to hedge longevity risk while making minimal disruption to pension entitlements. Moelis notes around $5m of the capital is required for regulatory purposes and the remainder for product development.
The broker assumes the annuity business reaches break even in FY24 on reaching $700m in funds under management, amid similar unit economics to the existing bond business.
The product would be linked to investment rather than a traditional guaranteed annuity. Hence, advisers could make ongoing allocation choices rather than just "setting and forgetting". Importantly, Moelis notes Generation Development will use re-insurance to remove any investment risk from its balance sheet.
Annuity development costs will more than offset the accretion from the stake in Lonsec over the short term but it is a logical step, Morgans believes. It is differentiated and light on capital, as investment and longevity risk are not borne by Generation Development.
There is a large addressable market, as around $70bn in investment funds are shifting to post-retirement phases in Australia. The product will take time to reach profitability, which Morgans also estimates is around FY24.
The larger annuity market size, compared with investment bonds, supports an enhanced longer-term profile, although Generation Development will need to prove up the concept. Morgans believes the company is well able to deliver compound earnings growth over time and retains an Add rating with a $0.97 target.
Generation Development has acquired the stake in Lonsec for $20m with up to $6.6m of additional deferred scrip at $0.70. This implies an FY20 enterprise value/operating earnings ratio of 8x, on Moelis calculations.
Pricing also appears reasonable, to Morgans and the deal is considered around 6% accretive in FY22 and 2% in FY23. The broker expects reasonable efficiencies after the current upgrade of the technology platform while noting funds under management in the Lonsec SMA product have reached $650m, growing 5% per month.
Lonsec offers growth prospects based on market tailwinds, internal productivity investments and emerging opportunities that are reaching scale. Moelis highlights the core research & ratings business operates in an attractive market niche, with only three major providers delivering what is an essential/regulated service.
The investment solutions segment leverages its position as an independent research provider without internal product conflicts. Moelis estimates around 20% compound growth in Lonsec earnings between FY22-24 and retains a Buy rating and $1.10 target for Generation Development.
Generation Development operates two main divisions, life insurance and financial services. The life insurance segment is a specialist issuer of tax-effective insurance bonds while the financial services provide specialised administration for providers.
Moelis asserts the company's investment bond business continues to increase its lead in the industry, now encapsulating around 40% of industry flows. The investment bonds have higher recurring revenue and average customer tenure of 13 years.
First quarter investment bond sales inflows were $82m and, while lower than the prior corresponding quarter, included a record individual bond of $14m. Meanwhile, quarterly revenue drivers remain well ahead of the prior year including the number of new bond applications and number of new advisers.
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