Morningstar analysts believe Perpetual’s $2.4 billion offer for asset management rival Pendal Group is likely to go higher and attract new bidders as the funds management industry looks to consolidate in its struggle with poor performance and low-fee passive investment alternatives.

Coming on the heels of a months-long share price rout, Morningstar equity analyst Shaun Ler labelled the bid as “opportunistic”. He expects negotiations over a higher price and even the possibility of a competing bid for the fund manager. The price is a 0.3% premium to Pendal’s average price since last October.

“We maintain our fair value estimates for Perpetual and Pendal as we don’t think the intended acquisition will proceed on the current terms,” says Ler. “Pendal’s shares are under-priced, and there may be room for it to negotiate a higher price from Perpetual or elicit a competing bid from others.”

Under the terms announced on Monday, Pendal (ASX: PDL) shareholders would receive a mix of Perpetual (ASX: PPT) shares and cash for an indicative value of $6.23 share, a 39% premium to Pendal’s closing price on Friday. Pendal shareholders would own roughly 48% of the combined entity.

Shares jumped 17.6% higher to $5.28 on Monday, well short of the indicative offer price in a possible sign of uncertainty over the deal’s future. Shares have traded flat since then. Perpetual shares fell 6.7% before recovering ground to end Wednesday down 4.4% for the week.

In a nod to the offer price, Pendal’s board responded saying that geo-political instability, the pandemic and market volatility have “materially impacted the trading values of global asset managers which may not currently reflect their long-term potential.” Shareholders do not need to take any action at this time.

Monday’s bid comes in the wake of a steep selloff among locally listed asset managers as volatility engulfs global equity markets. The sector has also been caught up in the disentanglement of Hamish Douglass from heavyweight player Magellan Financial Group, says Jun Bei Liu, lead portfolio manager of the Tribeca Alpha Plus Fund which owns a position in Pendal.

“Everything was priced relative to Magellan,” she says. "When Magellan fell, it dragged the entire sector lower.”

Shares in Perpetual and Pendal are down 22.4% and 39% since 31 August. Magellan has collapsed 64% over the same period.

Active managers are facing down growing competition from low-cost passive strategies distributed by the likes of Vanguard or BlackRock. In the year to 31 March 2021, Australians poured $24.5 billion into passively managed funds, while actively managed equivalents shed $6.7 billion, according to Morningstar data.

Ler believes the selling down of Pendal shares is overdone and argues the firm’s recent run of strong investment performance should translate into more flows for its family of funds. The “overly pessimistic” pre-offer share price implied outflows and portfolio returns well below historic levels and discounted the manager’s growing product breadth, he adds.

“The language from Pendal’s market release suggests its Board agrees,” he says.
Shares closed on Tuesday at $5.28, a 38% discount to fair value.

Under the term of the deal, Pendal shareholders will one Perpetual share for every 7.5 Pendal shares plus an additional $1.67 per Pendal Share.

Morningstar modelling shows Perpetual shareholders could see earnings per share (EPS) grow more than 20% thanks to the higher-priced Perpetual shares forming part of the deal. Any EPS accretion is contingent on how Perpetual finances the deal’s cash component and whether cost-cutting targets are met. The manager estimates that $50 million in annual cost savings are possible.

Both fund managers have turned to acquisitions in recent years to diversify their product offerings and grow assets under management. Perpetual, a diversified financial services company with multi-asset investment management, advice and corporate services, bought US fund manager Barrow Hanley in late 2020. Pendal, which focuses primarily on global investment management, followed seven months later with the takeover of US value manager Thompson, Siegel & Walmsley.

Potential merits to a tie up—if the price is right

The deal would see Perpetual more than double funds under management in a move that could allow the fund manager to cut investment fees and broaden its ESG businesses, says Ler.

Funds under management at Perpetual would more than double to $240 billion under the proposal, creating one of Australia’s largest fund managers. The addition of Pendal’s ESG-house Regnan would boost Perpetual’s responsible investing offering and potentially lower fees in the fast-growing segment, says Ler.

Perpetual called itself and Pendal “highly complementary businesses”, in a statement released to the ASX on Monday. It said the deal would create an asset manager with “significant scale, diversified investment strategies, strong ESG capabilities and a world-class global distribution network”.

Bringing together two managers with overlapping approaches comes with three major risks, says Ler. First, the merged entity may struggle to hold onto staff if people are employed across similar strategies. Second, growing funds under management cuts costs but may make it harder to outperform benchmarks if assets grow faster than they can be deployed. Third, institutional investors may also look for the exit amid a change.

“It’s not uncommon for institutional clients to redeem their money if there is a change in management control,” says Ler.