As you are aware, Leighton was subject to a 3 for 8 offer from major shareholder Hochtief at $22-50 cash per share, which we accepted on behalf of clients. Payment for the proportional shares sold has been received and the remaining shares are no longer trading on an “ex-Offer” basis.

As a result of the proportional offer Hochtief now owns 69.62% of Leightons, with its Spanish parent company ACS having taken effective control of day-to-day management of Leighton. While we still believe that Leighton offers value on a medium term basis, given the lack of free float and likely exclusion from the S&P ASX indices in due course combined with the increased uncertainty and lack of clarity around strategy given recent management changes and the general risks associated with being a minority shareholder we are selling the remaining holding in Leighton.

Proceeds from the sale will be used to purchase Perpetual, an independent financial services group providing funds management, wealth advice and corporate trustee services to individuals, financial advisers and institutions. Perpetual comprises three main businesses being Perpetual Investments, Perpetual Private and Corporate Trusts.

We have added Perpetual because:

• The compulsory superannuation system provides regulated growth in the medium to long-term. Perpetual Investments should benefit from this as they enjoy both strong reputation and brand recognition with financial planners and the investing public. Continued good performance across their funds saw a number of the company’s products receive initial or upgraded ratings from asset consultants in FY13;
• Perpetual is very leveraged to the level and performance of the Australian market on which we have a positive medium term view. Lower fixed costs from the Transformation 2015 project will increase this operational leverage even further;
• Margins in Perpetual Investments stand to benefit from changes in the mix of assets held by investors from cash (lower margin) to equities (higher margin). Not only are the management fees higher, but certain equity products also provide the possibility of earning performance fees; and
• The corporate restructure has led to an improved distribution network with Perpetual’s funds included on more approved product lists and platforms. This enables the group to capture a greater share of system flows. Perpetual Investments has enjoyed 3 consecutive quarters of net retail inflows and we expect this trend to continue.

The Primary Risks to our Positive View are:

• The largest drivers of group revenue are the level of funds under management (FUM) within Perpetual Investments and funds under advice (FUA) within Perpetual Private, both of which are heavily influenced by the level of the Australian equity market. Any sustained market weakness and volatility will pressure net FUA/FUM inflows and hence revenues i.e. Australian equity markets are the key source of earnings leverage but also a key risk;
• Greater distribution capability may come at the cost of needing to sacrifice some margin to access platforms and approved product lists where fee pressure is a feature of the industry landscape; and
• The Corporate Trust division faces challenging conditions if the securitisation markets remain subdued. The purchase of the Trust Company does however provide strength in fund services and greater geographic diversity.

In essence we believe that over the next few years Perpetual is well positioned to take advantage of improving market sentiment and the mandated growth in the superannuation industry given its strong brand and solid fund performances, with market volatility posing the greatest risk to the share price in the near term.

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