I'm not keen on fund administration business Link Administration Holdings Ltd (ASX: LNK) at current share prices. There are 3 primary reasons for this stance:
- It is expensive
Link is priced at approximately 32 times earnings, or 13x estimated full year operating earnings before interest, tax, depreciation and amortisation (EBITDA). Using the debt load from the half year results, it has an Enterprise Value (market cap plus net debt) to EBITDA ratio of approximately 11, which is also expensive relative to the market.
- It is an average business
Neither its profit margins, its growth opportunities (see below), or the quality of its systems justify investors paying such a premium. Its systems are adequate, but in my view they're largely not differentiated from competitors like Computershare Limited (ASX: CPU) or minnow Advanced Share Registry Limited (ASX: ASW).
- It has limited growth opportunities and must buy growth
I've written previously that Link appears very highly priced for a business that was growing profits primarily by cutting costs. We saw just two days ago that Link has now resorted to buying growth; a further sign that it is struggling to find ways to invest in its own business to generate growth.
I think that today's prices are far too high for a company of this quality that is growing primarily by acquisition and cost cutting.
Of course, I could be wrong about Link. If I was, it would be for some of the following reasons:
- High levels of recurring revenue combined with possible pricing power and sticky customers might allow for price increases
- Price is not unusually high relative to peers like Computershare or targeted acquisition, Capita
- Cost cutting could achieve a lot more than I expect as legacy systems are retired, resulting in more respectable margins
- Recurring revenue plus continued acquisition of competitors could be a winner over the long term
For now however, I think Link is quite overpriced and I would consider selling my shares today.
