Magellan risks come to pass

Magellan’s (ASX: MFG) share price crashed this morning after it announced it has lost its biggest mandate accounting for 12% of revenue.

To quickly estimate the impact:

Magellan makes ~$330m of adjusted NPAT (my estimate, see my previous article) on $720m of revenue
12% of revenue is $85m. That will almost all flow through to the bottom line, which is about $60m post tax. Call it $50m assuming they recoup some savings over time.
That’s a 15-20% reduction in long term earning capacity assuming you place no value on the chance that they get the mandate back.

The share price was down 33% today. Can’t the market do maths?

Well, on top of that first order profitability impact, one can expect second order effects as a result of this announcement. There’s a feedback cycle here between perception and reality. Investors thought Magellan was a winner so they won as a business. Now Magellan is thought to be a loser, and that will actually cause them to lose.

Imagine you’re an institutional allocator and you’ve just seen your bigger and better-resourced peer leave Magellan abruptly. What would you be thinking right now?

This was not a trim. St James’s Place pulled the rug on an entire £10bn mandate. Someone entrusted with a shitload of money did some digging and really did not like what they saw.

If Magellan had another 12 months of poor performance and you hadn’t trimmed your allocation to it, your arse would be on the line. It would be an indefensible blunder not to have avoided this obvious train wreck.

To recap Magellan’s current situation:

Material underperformance of 15% over the past year, undoing all of the outperformance underpinning the firm’s reputation
The CEO has just left
The key fund manager has separated from his spouse in recent weeks
According to rumours, the best of the rest of the team are leaving and joining Barrenjoey
Their biggest and presumably best-informed customer has pulled the pin

The rational response of a self-interested allocator, optimising for continued employment rather than the best returns, is to remove funds. Better to fail conventionally by taking off risk at the wrong time than sticking your neck out and betting on the turnaround.

And what of retail investors? Magellan’s struggles are all over the front page of the Australian financial news, and if retail investors didn’t already know their funds were underperforming, there’s a good chance they have just found out that both their investment returns and the company that have delivered them are a shambles right now.

Magellan’s value has been materially and permanently impaired with the loss of the mandate, and it may trigger further losses in FUM.

At today’s price of just below $20, Magellan is down 55% since my article of September 1 when it traded at $43.50. I thought it was pretty expensive at the time. It’s now materially less valuable and the risk of further FUM loss has increased. But it’s less than half the price.

To put ballpark figures against it:

There’s been a -15% to -20% hit to earnings from SJP
The stock is down -55%
The gap of about -35% represents changed expectations.
Some of that is accounted for by the new information of the mandate loss and associated feedback described above. It’d be a miracle if today’s news doesn’t drive further outflows in the immediate future.
But a good chunk of this change in expectations is not related to immediate impacts of the mandate loss, but rather the market realising this is a more fragile business than it had previously assumed.

The price of Magellan has moved more than my estimate of intrinsic value and it’s now much closer to fair or even good value. Previously the asymmetry was all to the downside. It’s certainly a more symmetrical bet from here but it’s not obviously cheap to me yet.

As for Platinum, it now trades down at $2.60, down 35% since my last article, which is not much prettier. But Platinum’s earning power, in my estimation, has not changed since a couple of months ago. I consider that price drop to be pure valuation improvement. At this price I consider Platinum very cheap.

Disclosure: Platinum is currently one of my larger positions.