Mainstream BPO share price rockets on new Magellan fund accounting deal

Should you buy Mainstream BPO (ASX: MAI) or Magellan Financial Group Ltd (ASX: MFG)?

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The Mainstream BPO (ASX: MAI) share price climbed 13% or 7 cents to 59 cents today after it announced it has agreed a new deal with international equities giant Magellan Financial Group Ltd (ASX: MFG) to provide investment administration services.

The deal is for 5 years with an automatic renewal term of another 5 years and this is major news for Mainstream BPO given Magellan provides the majority of its business as it has grown to manage more than $80 billion in funds under management.

By way of background a fund administrator such as Mainstream BPO will provide, inter alia, fund accounting, unit pricing, settlement and reconciliation services to an investment and sales focused fund manager such as Magellan that does not want to spend time on 'back office' services.

This makes sense for an independent group like Magellan, although large investment managers sitting under investment banks such as Macquarie Group Ltd (ASX: MQG), Citigroup or Bank of New York Mellon will run their own 'in-house' back office services for their buy-side functions.  

Generally an administrator such as Mainstream BPO will charge fees as a graded fixed-percentage of funds under management to the manager in an agreement actually run by a separate responsible entity (trustee) in charge of legally administering collective investment schemes such as those offered by Magellan. 

Therefore the more FUM Magellan runs the more money Mainstream BPO earns, adjusting for any extra additional fund accountants, other staff or general costs it has to pick up to price funds.

In reality though it doesn't matter whether you're pricing a $1 billion fund or $5 billion fund in terms of material extra work, which is why both Magellan and administrators such as Mainstream BPO boast good operating leverage where revenues can climb faster than costs to translate into higher profits.

However, I'd note that neither business has strong competitive advantages today.

In other words Magellan couldn't significantly lift its fees to investors without them walking away, while Mainstream will be on a tight fee leash with Magellan as there are plenty of fund accountants in Australia desperate for the kind of fee-earning business Magellan offers.  

It makes sense though for Magellan to stick with someone like Mainstream BPO given they both have a long and successful relationship and uprooting its whole reporting processes to save a few basis points in fees would make little sense. 

To me Magellan is an investment grade business, while Mainstream BPO is not the kind of business I'd personally invest in. 

Motley Fool contributor Tom Richardson owns shares of Magellan Financial Group.

 You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. 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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