MMS – is it still a good company?
On Wednesday this week I wrote in Alan’s Eureka Report:
“Postscript: I note that McMillan Shakespeare, a salary packaging specialist many readers know I have followed for some time, saw its founder sell a significant number of shares. You should know that it is not the quantum of the sale that should pique your curiosity or set off alarm bells, but the timing, coming as it does ahead of the findings of Dr Ken Henrys first major overhaul of Australias tax system in 50 years, which could include potentially adverse changes to fringe benefits tax and thus salary packaging demand.”
“My experience as a fund manager is that when major owners or founders are selling it has sometimes been the start of a negative period for the company and its shares (CCP). At other times, founders and major stakeholders have sold and the shares have gone on to do great things (TRS). In this case I have been leaning to the cautious side – as it seems Anthony Podesta, MMS’ founder has.”
Addendum 16 Dec. 2009: The facts remain that MMS is a wonderful company with huge cash generation, high rates of return on equity and net fixed assets and a company that up until recently was trading well below its intrinsic value. That intrinsic value value has also been rising significantly in recent years but some caution is warranted ahead of the release of Ken Henry’s tax review and the government’s determination about what recommendations it will adopt.
By Roger Montgomery, 11 December 2009
First published 9 December 2009, www.EurekaReport.com.au
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
INVEST WITH MONTGOMERY
R Kayll
:
Have to laugh at all the below comments.
Shares now at $13 plus.
I bought at 50c and sold at $2.50 and was rapt!
If i hung on I would now be a rich man.
Great company run by a great man.
Scott
:
Hi Roger, would be interested in your thoughts on the new deal with interleasing. Do you read anything into to fact that they sold off the novated lease portion?. Cheers and thanks for the informative website
admin
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Hi Scott,
I have mixed feelings about this deal. Until we see some numbers, there’s some speculation about what the new value will be. Weighing up the probabilities (with a gun to me head and forced to choose) I am leaning to the positive side of the fence but to be sure I need numbers. Of course there is still the subject of the Henry Tax Review and while I have heard some ‘experts’ say nothing will happen in an election year, we aren’t investing for just one year. My valuation projections go out three years, so I would like to see some hard evidence that there is a big margin of safety. You have my current valuations and we can make some estimates about how they might change, but we just won’t be sure until perhaps the full years results come in or these is some guidance from the company. This will be one of the first companies I meet with in a few months.
Vishal
:
Hi Roger,
Do you have a view on the Acquisition of Interleasing (Australia) Limited that MMS is currently undertaking? It seems to me like they are entering a business with lower ROE (given the price they are paying) and far higher competion. Yes there is diversification from their existing business which is reliant on the current tax laws, but is this the right move? What I dont want to do is use the increase in share price today as a guide to whether the deal is good or not for MMS!
admin
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Hi Vishal,
I am looking into it right now.
Scott Graham
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As with everyone above I’m a MMS shareholder and have been watching with interest the recent implosion of the share price.
I’ve read briefly the term of reference and some of the submissions to the Henry review and it would be a great outcome for example if the novated leases FBT framework for example was maintained and some of the finer details tweeked, eg, instead of rewarding a greater number on KM been driven, the framework could be used to encourage people to purchase more environmentally friendly vehicles and reduce the effects on the environment. This would be a win/win in a election year, the current novated lease FBT framework stays in place and the goverment can spruke “Clean/Green” initiatives. without having to reinvent to wheel with regard to administration of these incentives.
Might be speculation as discussed in some posts above.
admin
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I agree. And you are also right; It is speculation until it is known.
Barry
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A few thoughts(from an aging man!)
PBI charities are a significant employer, provider of low margin business needing Gov’t assistance to survive.
PBIs are a significant supplier of “needed” services for the Aus community, espec Aged Care, gen services that no one wants to provide to the underprivelaged..mental health, domestic issues, drug rehab, etc. A massive fabric of our AUS society…how many local PBIs in places like Indo, Iraq, India, etc..plenty of internationals..how many Aus people go over seas to help out the less fortunate?
Where am I going with this comment? Well, I reckon the PBI sector is needed in Aus, the sector has limited $$, the Gov wants to encourage the sector, …QQQ how do we fund it? Send $$ to he employers (oh forgot…how sound are salaries in the PBI sector…pretty poor compared to normal industry..lots of unskilled employees as well!) FBT benefits go to the employee to top up salaries. Employers have to manage the FBT system. Just imagine is more $ went to the emloyer…who might get the $$ employees??? Some would get “lost” long the way. Would the govt want to manage the benefits direct with the employees? Doutful…how many employers verses a significant number of employees….why would the govt want to deal with more people?
I’m not sure of the likely outcome, but I don’t think its’ as simple as “cancel the FBT benefit!”
Employees would get hurt, and I Can’t imagine the gov would seek to take that direction…the govt might make it harder for employers to obtain PBI status though.
Who would take up the Aged care slack for instance? Bulk of aged care is provided by PBI sector, and the aged as a group are growing…can’t imagine the gov wanting to go into the aged care business!
Am I a MMS shareholder..yep and for some years..not happy with the current price reduction, but I’m confident nothing material will change in this industry. I’m thinking of buying more whilst they are so cheap!
rogermontgomeryinsights
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Nice detail and nice line-of-thought Barry. Thanks for your valuable contribution.
rogermontgomeryinsights
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Thanks Dan for your question. Of course I am happy to shed some light here. Keep in mind that I cannot give specific advice about MMS however I can say generally that on the one hand the sell off on large volume suggests some fund manager(s) may have been reducing their holdings amid fear of the consequences of the Henry Tax Review. MMS packages up the salaries of employees of hospitals, government departments and charities who can receive up to $9000 tax free as reimbursement for things likes restaurant bills. With MMS earning two thirds of revenues from salary packaging there is a fear that a review of the taxation arrangements impacting charities could be detrimental. The outcome of the Ken Henry Review however is not known nor clear and even if the recommendations were detrimental to MMS, they may not be applied by government, so the sell off is speculative however its timing, following as it does from the sell down of the personal stake of the founder smells a little fishy. That too is speculation but my previous experience in these circumstances was the reason I sold.
Based on current facts the shares are below their intrinsic value however, as you can see from the December 11 post, when the shares were $3.97, (Now $2.82) I wrote that I thought it was preferable for me personally to sell and sit this out.
If the Henry Review turns out to be a non event then the company and the shares will do well. If the worst case scenario were to occur however the company’s profits could halve.
As always seek professional, independent and qualified advice from someone familiar with your particular needs and circumstances.
DanP
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I have followed various announcements by MMS and from time to time they have hinted of new products and initiatives to expand the buisness. Although so far they haven’t provided any details, I Suspect that management are preparing contigiencies should Ken Henry’s review prove negative.
Even though I’m speculating, I think that given the buisness is well run, has heaps of cash and no debt and will have time to react to any negative changes. They should be able to bridge any changes to the tax system with other initiatives.
The only question is valuation, and perhaps Roger could help us out?
ChrisB
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Some could take this as a good opportunity to buy – I used a reduced ROE of 30% and a 15% discount rateto arrive at a valuation range of $3.95 to $4.05. That’s only a 20-22% margin of safety (I would prefer at least 30%)
I think this is a case of a market over-reacting to news, rumour and the words of a government official (who in my opinion has no idea about taxation reform, but that’s another thing entirely!!)
As MattB says, the worst case scenario still sees a business, with a great staff and management trained in dealing with government regulation and legislation, with a lot of cash, no debt and the ability to mold its operations as required (a bit like a financial planning firm does through the “matrix” of CLERP, FSR etc).
rogermontgomeryinsights
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Hi Chris,
I have made some comments already about the recent fall in the price of MMS. The value of MMS (assuming nothing changes) rises from just over $4.00 to closer to $5.00 in a couple of years. But there is risk of change and I just don’t like the timing of Podesta’s sale. Under the worst case scenario, MMS profits could halve but remember at the moment any conclusions about the recommendations within the Henry Report and whether the government will adopt them is speculation.
rogermontgomeryinsights
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Looks like that margin of safety got big enough for you today Chris!
ChrisB
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Indeed Roger, indeed!
I confess I couldn’t help buying some, just before the close (super only). I can’t help myself when I see a bargain like that staring me in the face.
Peter
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MMS was punished on Monday the 25th Of Jan. It lost 15.54% or 0.60c. Does anyone know why ? There were no News that I am aware of.
Is it just the market been Jittery and overeacting ?
MattB
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Hi Peter.
MMS was punished because Dr Henry has made several comments in media interviews that he dislikes FBT especially as it is used by charities and other groups.
Given that accounts for a lot of MMS core business it has scared the market.
Once the review is released the market will be able to see what Dr Henrys recommendations are. Then of course the Government has to agree to the recommendations. So while there is nothing concrete and we are two steps away from anything definitive, the worst case scenario is that MMS loses a large amount of its core business.
The best case scenario is not much changes and MMS continues to make lots of money.
So in summary the market is acting on rumour and won’t be settled until the facts are released.
rogermontgomeryinsights
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Hi Peter,
Yep. Looks like speculation. See my other comments and warnings.
JohnC
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It is not as if the company has been caught short by the Henry review. Podesta was closely involved in the process and at the last AGM, there were pretty clear indications from the company that the game was up and a shift in the business model was in order. Podestra still retains enough of a stake and as seems likely, a personal interest, to see through whatever transformation is necessary.
There is currently a relatively low-volume sell-off at what I view as panic-driven prices. This review is not a blueprint for law. Henry’s mandate was to improve the efficiency, fairness and cost of the tax system. Many of his recommendations require coordination with other policy areas, such as transport and social work. This is not something that will happen within two years at the least. Keep in mind that the GST took 15+ years to come into being.
Also keep in mind that Wayne Swan and Macklin had just last June committed to protecting charities and the NFP sector to distinguish themselves from the Howard era. We know there is pressure on the government to cut spending as the Australian economy rises out of its slowdown. “Expanding the tax base” is not a platform for re-election. Simplifying tax is better but try selling that with the charities and NFP folks crying foul. I suspect means-testing of FBT exemptions are more palatable. I do not expect such an outcome to have a material impact on MMS’ earnings.
That being said, I am more mindful of what Podestra and his team do from here, more than what Canberra might do. Good businesses change ahead of the times. Kimberly-Clark comes to mind.
rogermontgomeryinsights
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Excellent thoughts JohnC. Everyone should read your post. Good to remember that the market isn’t rational either.
MattB
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In the last two months the share price chart is doing its best to resemble a roller coaster. Down approx 10% after Podesta’s sale, then back up 10% over the course of a week then hammered again today on no fresh news.
I still see it trading below its value by at least 5-7% with a high ROE. Its next report can’t come fast enough for me.
ChrisB
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Good points Roger, yes I am “speculating” about the outcome of the Henry review (I would call it assigning probabilities – as against mere trading) and as such I am holding off investing in MMS for the time being, even though it is well below my intrinsic value. As a disclosure, I do own the shares in my super fund and have no intention of selling at this time.
Of all the risks involved in investing, facing the headwind of regulatory or legislative reform can be the nastiest, as usually, rationality goes out the window!
I believe, a good opportunity will arise if the Henry review outcome appears, at first glance, to be negative for MMS, and hopefully the market will overshoot the newly calculated (probably lower) intrinsic value.
The same thing could be said about Cabcharge when the ACCC court action is finalised….
ChrisB
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Chris on the 14th says surely MMS mainly caters to HNWI?
Actually, their main business is public servants, particularly in QLD, with a typical salary range in the $50-70,000 region.
As this is the cusp of the 30% MTR plus a host of Centrelink issues, and the fact that public servants get certain FBT exemptions that you and I don’t, means salary packaging is extremely worthwhile (and profitable for MMS).
As for Ken Henry’s tax review, it has already become clear that FBT will only be tweaked and made easier to administer, but the fundamental philosophy behind will not change (i.e a “progressive” (sic) system to discourage employers rewarding high paying employees).
Further, any change to salary packaging that affects tens of thousands of public servants will be met with extreme hostility by Labor leaders. This is their core base, and given that electricity is about to go up 50-100% (one of the FBT exempt items), amongst other things, the actual risk of major change is quite low.
I think the outcome for the Henry review, which already cannot touch super, and has already denied touching dividend imputation, will be weak at best.
A cut to the corporate tax rate, an easier way for the average taxpayer to do their annual ITR and some minor administrative changes.
The Labor government, nor the Treasury has any guts or wherewithal to make wholesale changes that would benefit our economy.
As for MMS, even if there is a change – we are talking about a cashed up company, with no debt, with an infrastructure of personnel that can change their sails to the prevailing legislative/regulatory winds. That is their economic intangible.
As for Mr Podesta – why is there a rule to say a director selling some of his holdings should be negative? What if he had other losses during this year and needs to cover them? What if he is readjusting his portfolio to carry more cash (a prudent option in these times of over-valued stocks and economies stalling around the world)
I think the more important “Director watching” event is actually when they buy more (when options are not involved of course), particularly at a “low” price.
rogermontgomeryinsights
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Chris makes some good agruments. Let me add a riposte however to Chris’ speculation about what the government will and won’t do and remember it IS speculation. Indeed Chris writes in his own words “I think”. I have lunched with a number of journos in a last few weeks a couple of whom have suggested that the review may consider the environment when looking at FBT’s structural incentive to drive more.
Regarding MMS, Chris I agree with you. This is an outstanding business that has identifiable competitive advantages and throws off enormous amounts of cash – reasons why I bought it in the first place. Moreoever, being “cautious” – as I wrote in my original post – does not immediately mean sell.
Regarding Mr Podesta’s selling let me repeat the reply I wrote to Peter:
… I have deliberately been quite careful in my choice of words. In my original post I gave two contrasting examples – one positive and one negative – of my own investment experience when I have seen founding shareholders sell. A founder selling shares is not an automatic sell. When investing, you have to work with knowns. It is important not to speculate and therefore it is important to know what you are speculating about – for example about the outcome of the tax review or about the reasons for Podesta selling. What we know is that he did sell. The value of the company has not changed. An article in the SMH with podesta’s reasons for selling is neither positive nor negative and should be discounted.
Finally I would not regard the purchase of shares as an indication of anything. I have seen it often and know from painful professional experience it can be used as a form of window dressing and ‘price promotion’ this is particularly true where margin loans are involved.
The facts remain however that MMS is a wonderful company that up until recently was trading well below its intrinsic value. That intrinsic value value has been rising significantly in recent years but investors should be cautious ahead of the release of Ken Henry’s tax review and the government’s determination about what recommendations it will adopt.
Peter
:
Roger,
How has this new information impacted on your valuation of these shares. Is your intrinsic value still around the $4.56 mark ?
rogermontgomeryinsights
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Hi Peter,
Please understand I have deliberately been quite careful in my choice of words. In my original post I gave two contrasting examples – one positive and one negative – of my own investment experience when I have seen founding shareholders sell. A founder selling shares is not an automatic sell. When investing, you have to work with knowns. It is important not to speculate and therefore it is important to know what you are speculating about – for example about the outcome of the tax review or about the reasons for Podesta selling. What we know is that he did sell. The value of the company has not changed. An article in the SMH with podesta’s reasons for selling is neither positive nor negative and should be discounted.
Would you sell your shares? If you bought them well below intrinsic value and 1) they were now well above, and 2) you were overweight the shares in your portfolio and 3)you had another opportunity with better metrics, then you would consider it.
Would you buy ahead of the review? Perhaps you could wait.
I made the following comment last week in my Article for ALan Kohler’s Eureka Report.
Postscript: I note that McMillan Shakespeare, a salary packaging specialist many readers know I have followed for some time, saw its founder sell a significant number of shares. You should know that it is not the quantum of the sale that should pique your curiosity or set off alarm bells, but the timing, coming as it does ahead of the findings of Dr Ken Henry’s first major overhaul of Australia’s tax system in 50 years, which could include potentially adverse changes to fringe benefits tax and thus salary packaging demand.
darren
:
Roger,
These are some quotes from Anthony Podesta in the SMH:
(nothing sinister if you ask me),
Anthony Podesta sold $6.6 million worth of shares in McMillan Shakespeare, the salary packaging business he set up 22 years ago.
He got $3.90 for the shares, which compared with $4.60 a share from the sale of nearly $12 million of stock in 2007.
Asked yesterday about the latest sale, Mr Podesta said, ”I’ve still got over 11 million shares left. It was just a personal financial issue that necessitated the sale.
”I did have 20 per cent of the company and I’ve still got 16 per cent, it was a minor adjustment to the portfolio. I’m still the major shareholder by a long way.
”The company floated in 2004, so it’s almost six years, and I’ve only sold down a very modest amount of shares in that period of time,” he said.
McMillan floated at 50¢ and by every measure they’ve done very well, with earnings and dividends improving every year.
Yesterday, the shares closed at $3.97.
rogermontgomeryinsights
:
Hi Darren
Thanks for that. Good stuff. Having interviewed dozens of managers, CEO’s and founding shareholders in my career as an analyst and fund manager, I don’t place any positive or negative weight on these ‘reasons’. Let me clarify that selling $6.6 million is not minor for Mr Podesta whose salary fell from $628k in 2008 to $180k in 2009. Further, moving from 20% to 16% is not minor either. Having said that the changes make no difference to the estimated intrinsic value of the company.
Chris
:
As an assumption, surely the people who use these kind of services are executives or HNWIs ? (High Net Worth Individuals). The ‘average joe’ probably doesn’t get a look in to want, get offered or need these services ?
To use a few metaphors, you do not want to “kill the golden goose” or to annoy it so much it stops laying eggs – remember that these people are the ones who pay the most tax (for being successful, high wage earners) and thus are wanting to legally manage their tax better through such structures that MMS would provide.
Again, remember the story of the “ten men” at dinner – http://www.snopes.com/business/taxes/howtaxes.asp
The people at the top (MTR 40% – 45%) get the most benefit from any changes to the tax laws. The people in the middle (MTR 30%) don’t, and the people at the bottom (MTR 15% or lower) get some benefits, probably because of the way that I imagine the MTR bell curve is (as a guess and just to touch on the histogram / statistics).
Tax this top lot too much, annoy them too much – and they will leave the party and take their money with them. There are lots of places for them to put their money quite legally, and there are some very nice restaurants in those same countries as well.
rogermontgomeryinsights
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Thanks for the post Chris,
My understanding however is that we aren’t talking about HNW’s. In fact we are looking at the lower middle rung that receive the maximum benefit from salary packaging and government workers that receive a wider berth for the purposes of FBT.
MattB
:
Hi Roger,
I am a believer in the balance sheet. Until Dr Henrys tax review is out, MMS still looks the goods. Still it is a little annoying when a company I see as a low debt high ROE is exposed like this. I don’t like Podesta’s no confidence vote in his own business’s adaptability either.
rogermontgomeryinsights
:
You are right Matt, the value of MMS has not changed at this juncture. More importantly this is a business with outstanding economics throwing off tonnes of cash and whose intrinsic value has increased at a dramatic clip every year since 2004.
tim clare
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Hi Roger,
Re my post below in “Is there a headline gabbing event…”, does leaning to the cautious side mean selling shares? I have considered selling half my holding in MMS which is sitting on a 50% capital gain. But it is a dilemma for me! Selling seems the prudent thing to do in a time of such uncertainty, yet reeks of speculation (about possible future events that we have no certainty about yet) – which is anathema to value investing.
rogermontgomeryinsights
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Hi Tim,
Arguably when new information comes to hand you must re-evaluate. Sometimes that new information is not quite in the form you anticipated. For example: “I forgot to consider something and now I am receiving a friendly reminder”. Are you redefining speculation because you are selling something that you bought on a reasonable basis? Or did you buy without complete information and now more complete information is coming to light? In other words, if the uncertainty had existed at the time of purchase would you have bought? Only you know the answer to that, I don’t. And how you respond to that information must be a decision you make yourself.
Wing
:
Hi,
I think that’s the reason why it requires margin of safety for our investments.
The taxation system in Australia is thought to be one of the most complicated; and MMS’s main businesses are Salary Packaging and Novated Leasing, which their clients can be benefited from avoiding the hassles of administrating FBT, GST etc reports and potentially cost effective.
But it seems MMS’s business model is highly reliant on the tax system: the more complex it is, more companies will need their services to minimise the cost of preparing and administrating those reports. So I guess any major changes (simplification) of the tax system will be harmful to MMS.
If compared to JBH, I think the risk of the future cash flows for MMS is a lot higher.