The proposed acquisition of narrow-moat Perpetual’s (ASX: PPT) wealth management and corporate trust businesses by KKR, unanimously recommended by its board, vindicates our view that their values are not reflected in the current Perpetual stock price. News of the deal sent the shares lower by more than 7% in trading on Wednesday.

The face value of the offer is above our expectations and represents a step toward a capital return to shareholders. However, the lack of cost details on the transaction, the separation, and the capital gains tax make it difficult to ascertain whether or not the deal is accretive to our current intrinsic assessment. We retain our stand-alone fair value estimate of $26 per share for now.

The acquisition is to be conducted via a scheme of arrangement. The gross cash consideration of $2.2 billion, or $19.20 per share, exceeds our combined $1.5 billion valuation for wealth management and corporate trust, or $13.60 per share. The wealth management and corporate trust segments comprise nearly half of our fair value estimate for the Perpetual group, excluding corporate costs.

This means that for the deal to be accretive to our fair value estimate, associated costs and taxes need to be below $630 million. While we anticipate transaction and separation costs to be contained within 10%-20% of the deal value (as with past asset management mergers and acquisitions), tax implications are uncertain, seemingly even to the Perpetual board and management.

If the deal is consummated, Perpetual shareholders would retain ownership of Perpetual Asset Management. They would likely be exposed to greater earnings volatility than before, as the asset management business faces more competitive intensity than wealth management and corporate trust. Our intrinsic assessment for Perpetual Asset Management is $15.40 per share, while total corporate costs amount to negative $3.10 per share.

Business strategy and outlook

Perpetual has three business units: an asset manager, a private wealth advisor, and a corporate trust service provider. Acquisitions form part of the group’s strategy to build scale and expand its products and services.

Product, channel, and geographic diversification is a key focus for the investments business. It is executing this by acquiring fund managers. This follows a history of pedestrian performance in its domestic investments business and its inability to grow organically.

Acquisitions of Barrow Hanley, Trillium, as well as Pendal expand its addressable market and add to its asset class offerings. Priorities include growing its distribution offshore, expanding its clientele, and broadening its product suite.

The private wealth business with KKR is attempting to acquire caters to the established wealthy, medical professionals, business owners, family offices, and aged care providers. It increases the value add to clients by providing a variety of services beyond financial planning. These capabilities are propped up by acquisitions. The Fordham acquisition is one example, where it allows Perpetual to extend accounting services to its clients. In return, its acquirees also act as referrers of new business.

The other part of the proposed acquisition is the corporate trust business. It provides outsourced responsible entity, custodial, and trustee services to debt capital markets as well as to managed funds. Ongoing agendas include acquisitions to add scale—in the process allowing it to further lower its pricing—as well as the provision of value-added services such as data and analytic solutions to help increase the stickiness of its client base.

We believe management’s initiatives will support more maintainable earnings growth and margin stabilization. Investments in distribution and staff retention would constrain profitability, but we expect them to support improvements in net flows and revenue growth.

The moatworthy private wealth and corporate trust segments that KKR is attempting to acquire are strong drivers of earnings growth—the former is positioned to gain market share in the domestic financial advice industry, while the latter benefits from growing securitization volume and increasing demand for outsourced responsible entity services.