The Magellan (ASX:MFG) share price fell 4% last week. Here’s why.

The Magellan (ASX: MFG) share price dropped 4% last week, with analysts critical of the company’s stake in a start up investment bank

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Magellan Financial Group Ltd (ASX: MFG) saw its share price lose 4% last week, significantly underperforming the S&P/ASX 200 Index (ASX: XJO). This was despite an AGM presentation which included a forecast that FY21 costs would remain flat. Nonetheless, Magellan’s critics have expressed concern over the company’s planned investment of $155 million in start up investment bank Barrenjoey.

What is weighing on the Magellan share price? 

In a report in September, CLSA analyst Ed Henning said of the investment in Barrenjoey: “At face value the investment looks questionable, given investment banks tend to trade on lower multiples versus Magellan and the investment will likely initially be loss-making, although a $155m investment for a $10bn company that is highly cash generative is only relatively small.”

To illustrate further, the Magellan share price is trading at a price-to-earnings (P/E) ratio of 27, while investment banks tend to trade at a P/E of between 10 and 14.

For instance, Macquarie Group Ltd (ASX: MQG) is an diverse financial group. However, the investment banking arm is regularly in the top 3 deal makers every year. Macquarie currently trades at a P/E of 16. Another example is Bell Financial Group Ltd (ASX: BFG), a stockbroking and financial services company with an investment banking arm built in. Bell has a P/E of 12.5.

What is more, another rule of thumb metric for an investment bank is between 1 and 1.5 times revenue. Given that Magellan has paid $155 million for 40% of Barrenjoey, we know that the full valuation would be just under $400 million. Meanwhile, the start up hasn’t earned a cent yet, even though they have managed to capture some top flight operators from UBS. The Magellan share price fell by 5% on the day of this announcement.

The view from Magellan

Although listed in the AGM notes as a principal investment, $155 million is modest for a 10 billion dollar company. Chair and chief investment officer Hamish Douglass is dismissive of such criticism. During the company’s AGM he argued that Barrenjoey’s partnership model allowed for a nimble and entrepreneurial approach, designed to “uniquely position the business in the Australian market”. 

He went on to explain how the market opportunity likely extended beyond Australia and New Zealand. Moreover, that the company would boost Magellan’s intellectual capital through new, highly skilled staff entering the business.

Mr Douglass added:

We are excited about the prospects for Barrenjoey and it reminds me of the early days here at Magellan… Fourteen years later, it is incredible to see what can be achieved by talented people who are aligned in a common goal, with a common purpose, backed by a strong balance sheet, and not being constrained by existing systems or processes.

Magellan has also taken a sizable stake in FinClear. An unlisted financial services company that provides infrastructure to financial planners, stockbrokers, wealth managers and fintechs. The company’s technology plays a hand in at least 50% of transactions on the ASX. 

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Motley Fool contributor Daryl Mather has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Macquarie Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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