Update: Rumours link CI to Scotia

There were reports Friday morning that CI Financial is in talks with Scotiabank, to purchase the bank’s mutual fund operations in exchange for an equity stake in CI.

In a report rife with unnamed sources, the National Post speculates that such a deal could result in Scotia holding a 35% stake in CI, which would be equal to Sun Life Financial’s holding.

“If Scotia were to divest its mutual fund family, it would be a radically different strategy from that employed by all of its major banking competitors,” says Rudy Luukko, investment funds editor at Morningstar Canada. “If you look around at the big five banks, there has been the opposite trend including at Scotia, which acquired a minority stake in Dundee.”

Dan Hallett, founder of investment research firm Dan Hallett and Associates, says the possible deal is confusing. He points out that, a couple of years ago, Scotia lured popular managers from RBC and even pulled an RBC portfolio manager out of retirement in order to strengthen its wealth management efforts.

“Admittedly, I’ve been surprised that it’s been quiet since then,” says Hallett. “And I would say that just about every company is for sale at the right price. CI has stated numerous times that it intends to be a buyer and be one of just a handful of major players left standing after many more mergers.”

One industry analyst who asked not to be named says it is a “little strange” that Scotia would sell, since it’s talked about building its wealth management arm. However, he thinks the bank is setting itself up for a bigger move.

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“If they were to do something like this, it’s because they want to free up capital for something larger outside of Canada,” says the analyst. “They’re saying publicly that they want to buy acquisitions abroad, especially in this market turmoil environment.”

Another reason why Scotia might want to sell is that its wealth management division isn’t doing nearly as well as its competitors. The bank has $22 billion in assets, according to the July report of the Investment Funds Institute of Canada (IFIC). By contrast, RBC manages about $109 billion in mutual fund assets, while TD and CIBC have $57 billion and $50 billion respectively.

CI’s total fee-earning assets stand at more than $99 billion.

With the number of takeover targets diminishing all the time, CI might see buying Scotia’s fund division as one of the only ways to grow. As well, the company could still be sore from Mackenzie’s purchase of Saxon, says Hallett.

“CI is probably unhappy to have missed out on Saxon, particularly since Mackenzie was the winning bidder,” he says. “And there are relatively few sizeable fund companies that are really in play today so this development is not surprising. Of the big five banks, Scotia has been less successful and has, relatively speaking, probably the weakest of the fund families among the big five. Accordingly, it is the most vulnerable to a sale.”

Another unnamed financial sector analyst who watches CI says if the company buys Scotia’s mutual fund operation it would open up a new distribution network for the company. As for Scotia, he can’t understand why they’d sell. “What’s in it for Scotia?” he asks. “They wouldn’t be controlling their wealth management; they’d just be renting it out.”

But Luukko says it may make sense that Scotia would want a portion of CI. “The part about Scotia wanting to have a stake in a top-tier independent firm like CI is entirely consistent with its stated strategy of expanding its wealth management operations,” he says. “It’s far less clear whether divesting its proprietary fund family is consistent with such a strategy.”

With a 35% stake in CI, could Scotia be positioning itself to take over Sun Life, if the government ever allows cross-pillar mergers? “There are all kinds of permutations that one could speculate on,” says Luukko. “If there’s any play for controlling interest, it helps to have more than a toehold — which this would be.”

This merger also sparks debate about future M&A activity in the mutual fund industry. Luukko says there’s a “scarcity of top-tier investment fund franchises” that aren’t controlled by a larger Canadian or foreign-owned institution. The only big players still independently owned are AGF, Dynamic Funds and AIC.

Luukko says it’s unlikely that AGF will sell, as the Goldring family — the company’s principal shareholders — have stated on many occasions that they want to keep the business in the family. Dynamic — part of Dundee Wealth — has already sold 18% of its company to Scotia, so the bank might choose to do something with the rest of it at some point, and AIC only has $5 billion in assets, making it a less attractive takeover target.

The real question is whether or not this sale will actually happen. CI Financial issued a terse press release acknowledging that it has been in talks with “a number of parties concerning possible strategic combinations involving CI and its subsidiaries” over the past few months, while Scotia hasn’t responded to Advisor’s request for comment.

The fund analyst who watches CI says he doesn’t think there’s any truth to the story. “They’re in possible discussions every day of the week,” he says. “It seems like there’s a lot of sizzle but no steak to the story.”

Luukko, however, says the rumour could very well be true. “I am convinced that there is some substance to this.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(08/22/08)