January 2021

Magellan’s Innovative Capital Raising. 

Is This a Good reason to Sell Magellan Global Fund? And Buy Magellan Financial Group?

Recent restrictions on managed funds and listed investment companies paying commissions to advisers and brokers for successfully recommending that their clients invest in particular listed investment companies and listed investment trusts has generated a different approach.

Funds management businesses depend on growing the assets under management to in turn grow their own businesses. One of the funds managed by the Magellan Financial Group business run by Hamish Douglas is Magellan Global Fund a listed investment trust.

Unit holders in the Magellan Global Fund will be offered the opportunity to purchase one new unit for each four units held at a discount to market price of 7.5 percent with the discount financed by Magellan Financial Group in a prospectus opening on 18 January according to the Australian Financial Review of 6 January 2021. The offer has the potential to raise up to $4 billion, but subscription of around $1 billion is likely given the normal response to capital raisings. If the full $4 billion is raised, the 7.5 percent discount funded by Magellan Financial Group will cost the group $300 million; this raises the obvious question, “what is the reason for this apparent huge generosity to unit holders?”  The answer is that Magellan Financial Group earns 1.35 percent on funds under management, meaning that if the full $4 billion is raised then annual fees for assets under management rise by $54 million—or 18 percent—return on $300 million. The value of funds management businesses, as evidenced by takeovers, lies in the range of 15 to 20 times earnings. On these numbers, if the offer is fully subscribed, Magellan Financial group is investing up to $300 million to increase its business value by between $810 million and $1080 million! It will be a nice earner for the manager, Magellan Financial Group, pretty much regardless as to how the Magellan Global Fund performs.

As fund managers increase the size of managed funds, they find it ever more difficult to invest effectively and are driven toward market average return minus their fees. This brings us back to the question of management expense ratios. Magellan’s 1.35 percent per annum is very high compared to the listed Argo Investments Ltd, with an MER of 0.16 percent, or the Standard and Poor’s 500 Exchange Traded Fund, with a management expense of 0.10 percent. There are a huge range of funds both listed and unlisted. High management fees favor the manager over the investor. The investor in Magellan Global Fund doesn’t share in the increased value of Magellan Financial Group which will receive a substantial reward regardless of its performance.

This is the third major capital raising in the past 12 months by funds managed by Magellan Financial Group; this suggests that the group agrees with Phineas T Barnum’s observation that “there is a sucker born every minute”. 

These days a large proportion of investors are Superannuation Funds. Placing investments with high MERs in SMSFs is a contradictory practice, which over time guarantees mediocre performance.

The Hidden Message

The above numbers suggest that as an investment strategy it is wiser to own shares in Magellan Financial Group than to own units in the investment trusts it manages.

This is general advice and readers must do their own research and take professional advice as necessary.

Personal Disclosure.

I own shares in Magellan Financial Group.

Health Fund Preferred Providers. Do They Make a Practice More Profitable?

Two practices are in equivalent locations in middle class suburbs of a major city. 

Practice A is a preferred provider to major health funds. It estimates that approximately one third of its patients are preferred provider patients. It is a five-surgery practice with about 4.5 chairs of patients, and the size of the practice creates a significant amount of administration.

Practice B is a solid 3 chair practice and is not a preferred provider. 

Both practices have a competent active dentist as practice owner and in both they operate the busiest surgeries.

The difficulties in having two classes of patients in Practice A means that fees are restricted and there are limitations on treatment plans. Its 4.5 chairs struggle to produce as much profit as Practice B with 3 chairs. The dental owner has more staff management problems and in turn the owner’s production suffers. Without realizing it at the time, the owner’s practice A expansion took it through the invisible performance barrier applying to dental practices and the marginal impact of the preferred provider fees yields no extra profit. It is a restriction on efficient practice.

If the two practices are valued by the same valuer using an established well-proven dental practice valuation technique Practice A will struggle to be worth as much as Practice B.

The Invisible Management Barrier in Dental Practices.

Unlike in most occupations, the owners of dental practices spend nearly all their daily work time inside their own surgery. They have very little time to check on the work of others. Observations have indicated that the overall efficiency of one owner practices deteriorates sharply if they have more than three surgeries operating including that of the practice principal. This is an invisible management barrier. As the owner does not pay another dentist to provide the treatment in their own surgery, and as they are usually the best-performed dentist in a practice, that is where the lion’s share of profit is generated in a multitude of practices. For every dollar of fees not earned in the owner’s surgery due to extra administration burdens, up to three extra dollars need to be earned in assistant dentist’s surgeries after payment of normal percentages and allowing for the assistant dentists being less productive. As such, assistant dentists cost more in chairside assistant’s time per dollar of dental fees.

For practices with two associated owners, the limit before deterioration is four surgeries including one each for the associates. Practices with more than two associated owners also magnify the invisible management barrier. The most profitable dentists are not found in practices with three or more associated practice owners.

The questions for dentists are:

Question one. What is the point in having preferred provider patients if a much greater amount of dentistry has to be done to make the same amount of fees? and 

Question two. What is the point of expanding beyond three chairs if you hit the ‘Invisible Barrier’ which means that you face many more management problems?

Do Practice Managers Cost Profit and Reduce Capital Value?

Consider a practice which expands beyond three surgeries, including one operated by the owner. The owner decides to employ a practice manager whose salary, superannuation, work cover insurance, incidentals and, over time, growing long service leave liability amount to additional cost of around $100,000 per annum when compared to a part time contracted bookkeeper who spends a few hours per fortnight at the practice, who reconciles the bank account, updates practice accounts, arranges staff payroll including superannuation and summarizes accounts payable for the practice owner’s approval and perhaps costs less than $10,000 per year. The part time bookkeeper is adequate in a practice with three chairs, but the increased number of staff in a sole owner practice with four or more chairs—particularly if magnified by positions filled with part time dentists and chairside assistants—tempts practice owners toward hiring a practice manager. This leads to a bigger practice but profit falls due to both the manager’s cost and the additional inefficiencies in a too-large practice.

Practice Managers Negative Impact on Practice Value

Practices are valued on their profitability after deducting the amount the practice owner should be paid for the dental treatment provided personally if remunerated on the recommended formula. This is described by economists as their personal opportunity cost. Greater gross fees are meaningless if they don’t add to profit. In many cases reducing practice profitability by all or most of the cost of a practice manager means that the value of a practice is reduced by several hundred thousand dollars. The term practice manager should not be confused with that of a courtesy title sometimes given to a receptionist.

Comments are invited from readers on any of the items in this newsletter.

About Graham Middleton

I retired from Synstrat Group on 30 June 2020 having spent over 33 years advising dentists, doctors and veterinarians on practice and financial strategy, the last 26 years as a founder of the Synstrat group. Having spent over 56 years in the workforce in total and at age 75 I will not be commencing another business. I can be contacted on 0448 784594.

I am currently writing a book on the decisions and strategies which make Australian dental practice owners, including dental specialists, financially successful. These range from the decisions preceding practice ownership through to those entailed in an eventual, financially-advantaged retirement. There is as yet no such comprehensive publication available to Australian dentists. It is my intention to provide a free copy to any dentist or person associated with dentistry who makes a reasonable tax-deductible donation to the Delany Foundation, a registered charity associated with the Patrician Brothers. This foundation contributes to schools in Kenya, Ghana and Papua New Guinea, and is one which my wife Kay and I support. The book may be available in two or three months and further details will be forthcoming. No Australian dentist owning or aspiring to own their own practice including dental students can afford to be without a copy.

For the present those who feel that they benefit from these newsletters can express their appreciation by including the Delany Foundation in their charitable gifts. Since it is run by volunteers its administrative costs are negligible and maximum dollars are spent on those in need of its help.

Best wishes to all,

Graham Middleton