AMP’s recent misadventures provide a business school case study in how to mismanage a number one market position in a fundamentally attractive industry. The shocking mishandling of the public relations associated with the Financial Services Royal Commission is one more in a long line of management missteps, exacerbated by festering doubts about the long-term viability of AMP’s business model.
It is evident to us (with justification to follow) that AMP shares represent an attractive value at current levels. For that value to be realised the new management team needs to publicly defend the virtues of the company’s business model, and restore the company’s good name in the eyes of its planners and their customers. The good news is that there are few executives better equipped to represent AMP’s case than new Chairman, David Murray.
The business faces two principle regulatory threats. The first is that its vertically integrated model is broken up, and the second is that regulators call an end to advisers receiving pre-FOFA/grandfathered commission structures.
In respect of the threat to vertical integration, ASIC made its position clear last Thursday, giving support for the model in a submission to the Royal Commission. This is a positive development for AMP which went largely ignored by the share market and its commentators. Specifically, ASIC noted the benefits of vertically integrated companies to its customers (i.e. larger economies of scale, stronger balance sheets and higher compliance standards). The conflicts of interest of vertically integrated companies are well known but manageable. Given how widespread this model is across the financial services sector and following ASIC’s statement last week, it seems unlikely that the Royal Commission will be the catalyst for meaningful changes to vertical integration.
More likely however, is an acceleration in the phasing out of grandfathered product commissions – products that pay a trail fee to advisors – to a pure fee for service model. Last week ASIC recommended that grandfathered commissions should "cease as soon as reasonably practical and to the maximum possible extent". Speaking to industry participants we understand the transition was already underway. If this process is accelerated by the regulator, the implementation would require several years for advisors across the industry to contact and re-underwrite their clients’ needs.
In order to model the downside case for AMP shares, we might assume AMP loses 25% of its Australian Wealth platform AUM and that 3-4bps revenue margin pressure in that business continues indefinitely. Australian Wealth Management profits (roughly 35-40% of the group) may fall by 20-25% over three to five years, but with earnings growth in the other businesses; some cost-cutting; and buying-back modest amounts of shares with excess capital, the company should be able to maintain EPS at around 34c. On that basis, AMP shares are trading on a current P/E multiple of 11x. No comparable companies of AMP’s six business units trade on P/E multiples anywhere near that low (more like 13 – 17x), suggesting the fundamental downside for the stock is limited. We would also note that 34c of EPS in 2020 would imply a 30% reduction in the expected profitability of the Australian Wealth business in comparison to where the market consensus was before the Royal Commission – that is a large reduction.
AMP’s Australian Wealth business is not worthless, and there seems little appetite from the regulator for a UK-like scenario where financial advisors’ ability to charge has been so restricted, that financial advice is unattainable for people on modest incomes. On the upside for the shares, the company might make more than our stressed EPS case of 34c a share. It also seems feasible that AMP shares should re-rate from such a low multiple once the recommendations of the Royal Commission have been worked through. Assuming 36c of EPS and a more normal 13.5x P/E this returns the stock back towards $5.
Prior to the Royal Commission, most analysts calculated the sum-of-the-parts value of AMP to be $5.5 to $6 a share. Surely that sum-of-the-parts value will be lower today, but there are scenarios where it is only modestly lower, and the share price is now 45-60% below that range. David Murray has a reputation as a deal-maker; and in time, he may even decide the best way to realise the value in the company is to sell it.