Activist’s prescription for Magellan goes back to the future

Source: Financial Review

By: James Thomson

Sandon Capital says its push to restore value at Magellan is based on a return to the things that made the fund manager great. 

In many ways, Sandon Capital’s activist campaign against Magellan Financial Group is built around restoring the thinking that turned Magellan into one of the country’s most successful fund managers.

The circumstances surrounding Magellan’s performance problems, the spectacular departure of its talismanic leader Hamish Douglass, and the 90 per cent fall in its share price are well known. Magellan chief executive David George is trying to win back the market’s trust by rebuilding funds under management, which peaked at $116 billion in November 2021 and now sit at just $41 billion.

But Sandon managing director Gabriel Radzyminski says George’s goal of getting FUM back to $100 billion within five years is too risky, as it will require product launches and acquisitions that may not work, and could further swell a cost base that already looks too large.

Sandon might own less than 1 per cent of Magellan as the 13th biggest shareholder, but it has form as a mouse that can roar, after being part of successful campaigns at Iluka, City Chic, Fleetwood Corporation and A2B.

Its Magellan case is simple. To win back the market’s trust, the fund manager should focus on restoring the performance of its flagship global fund, return to shareholders’ excess cash and some of the capital it has invested in its own funds, and try to get back towards the lean operating model it was once known for.

“We’re not arguing that Magellan has not had difficulties. What we’re saying is that you’ve got this franchise that yes, it’s tarnished, but not irretrievably so,” Radzyminski says.

Sandon’s base case says that if Magellan’s funds management business can be valued at an enterprise-to-EBITDA multiple of closer to its peers at 6 times, rather than the 2 times it trades at today, the stock could be worth $11.79, compared to Monday’s close of $8.60; its bull case values the group at $15.29.

Radzyminski is at pains to point out he is not suggesting anything Magellan hasn’t previously considered.

For example, George himself is focused on fixing performance in the global equity fund in a way Radzyminski says is more attuned with the investment philosophy Douglass espoused way back in Magellan’s 2007 annual report: buy outstanding companies – defined as “those that have sustainable competitive advantages which translate into returns on capital materially in excess of their cost of capital for a sustained period of time” – at attractive prices, regardless of how they fall into traditional categories such as “growth” or “value”.

Radzyminski says the fact Magellan’s global fund is now beating its benchmark on a one-year basis and for the calendar year to date, despite not holding the world’s hottest stock in chipmaker Nvidia, indicates George is having some early success with a back-to-the-future approach.

Sandon estimates Magellan could return at least $300 million to investors from surplus cash and by redeeming $205 million worth of investments it holds in its own funds. Again, Radzyminski says this is not a new idea; back in 2018, Magellan itself reviewed its capital structure and noted its business was capital light and that “excess capital materially above what is needed to grow and support the business is unlikely to be valued by the market”. This is exactly the predicament the company is in now, Sandon argues.

Returning Magellan to a cost base more in line with historic levels would help boost its earnings and valuation, Radzyminski says. If Magellan can’t grow FUM, its cost guidance suggests a cost-to-income ratio around 50 per cent, compared to a peer average of 29.2 per cent and Magellan’s own ratio of 28.7 per cent. Sandon’s base is for a ratio of 35 per cent, but Radzyminski says it’s a commitment to lower costs that the market first wants to see.

Sandon says Magellan has engaged on its plan, which has two final planks: providing relief for the share purchase plan that has left some staff nursing big losses following the plunge in the group’s share price, and adding more diversity to a board that embarrassingly has just one female member.

Magellan declined to comment on the Sandon pitch.

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