Is Charter Hall’s divergence from real estate a stretch too far?

The market thought little of Charter Hall Group’s (ASX: CHC) announced plans to acquire a 50% stake in Paradice Investment Management (PIM) with the REIT’s share price retreating -5.87% in early trade this morning.

While the investment is expected to provide a strategic expansion of Charter Hall’s $61.3bn funds management platform, a lower share price may signal lingering negative sentiment towards fund managers following Magellan Financial Group’s (ASX: MFG) shock mandate loss last week.

Scale and diversification

While Charter Hall is clearly going to need help growing PIM, the market may be a taking a wait-and-see approach, especially given that the REIT is first and foremost a specialist in unlisted property investments and has little exposure to equities.

However, Charter Hall CEO, David Harrison argues that the group’s partnership with PIM is a rare opportunity to invest in a large scale, high-quality listed equities fund manager.

“It diversifies Charter Hall’s FUM, and earnings streams, introduces new client relationships to both businesses across wholesale and retail equity source segments.”

David Paradice to stay on board

A Sydney-based fund manager with $18.2bn in funds under management (FUM), PIM invests in global Australian and listed equities, with clients including Cbus, Commonwealth Superannuation Corp and Rest Super.

Veteran Australian stockpicker David Paradice, after which PIM is named will, along with his staff, remain with the company and continue investing once the deal – which values PIM at $400m to $450m - is complete.

The acquisition price for a 50% investment (in PIM) is $207m and represents a net profit after tax (NPAT) multiple of 10x, equating to 2.3% of PIM’s FUM.

Effective January 1, 2022, PIM shares will be swapped for shares in Charter Hall. Once the deal is done, David Paradice, who was understood to own 36% of the manager prior to the Charter Hall deal, will be left with 18% with his staff owning the balance.

Subject to certain conditions, shares will be escrowed for four years, with Charter Hall retaining an option to buy the remaining 50% (of PIM) in three years’ time.

Fundamentals

Todays announced 50% acquisition of PIM by Charter Hall follows speculation earlier this month that the REIT is eyeballing a $2bn takeover of Waypoint REIT, within which it currently owns 5%.

While today’s shock announcement may have resulted in Charter Hall’s share price falling, the stock is up over 40% in the past 12 months.

Charter Hall delivered a property investment return of 15% in FY21 and has re-affirmed operating earnings guidance for FY22 of no less than 105¢ per security.

By comparison, PIM’s Australian equities strategy delivered 24.5% in the past year, up 9% on its benchmark.

Once the deal is complete, Charter Hall will have FUM of around $79.5bn.

What brokers think

Due to strong growth, with or without performance fees, Macquarie last week upgraded Charter Hall’s FY22 operating earnings guidance by 26.5%.

A week ago, Citi and UBS both upgraded their FY22 earnings guidance on the REIT for the second time in two months, citing performance fees and high quality FUM as the key drivers.

Consensus on Charter Hall is Strong Buy.

Charter Hall is currently trading at a 9.2% discount to the consensus target of $22.54, according to the six brokers FN Arena reports on as covering the stock.