Wednesday, March 15, 2006

Scotiabank-AGF Gossip

  
The Globe and Mail, Derek DeCloet, 15 March 2006

When you run the best-performing large bank of the past 20 years, losing doesn't sit well. But every month brings Rick Waugh a reminder of Bank of Nova Scotia's biggest weakness, and a new theory on how he's going to fix it.

The Big Five banks are conducting a stealth takeover of the mutual fund business. Scotiabank is missing out. Its fund division is half the size of the next-biggest bank rival. Worse, the monthly sales data show it's losing market share. This RRSP season, Royal Bank's fund unit took in nearly $2-billion in new money; Scotiabank's got $85-million, excluding sales of funds managed by other companies.

Everyone knows this, which is probably why there's so much life to the rumour that Scotiabank is courting AGF Management.

The gossip has a few incarnations. The most recent says Scotiabank would sell its fund operations (or some part of them) to AGF in return for an equity stake. This is the deal-du-jour in financial services -- Merrill Lynch just swapped its asset management unit for a stake in BlackRock, and Citigroup handed over its funds to Legg Mason. Sun Life Financial set the precedent in Canada four years ago when it gave up Spectrum, its in-house mutual fund company, for about one-third of CI Financial. It's been a fine deal for both sides.

So, how about it? "I don't know where this is all coming from," says AGF chief executive officer Blake Goldring, whose family is the controlling shareholder. "There's nothing going on."

Pity, because the idea looks an elegant solution -- for both.

For Scotiabank, an asset trade might be the only answer. With less than $16-billion in fund assets and few compelling products to sell, it can't grow its way back into the game. (The number excludes about $1.7-billion in Scotia Partners Portfolios, packaged funds-of-funds that are primarily managed by outsiders, such as Mackenzie Financial, Fidelity and, yes, AGF.)

Mr. Waugh has plenty of dough for an acquisition -- the bank carries about $4-billion in excess capital, National Bank Financial analyst Rob Wessel says. Trouble is, most independent fund companies are too small to make a difference to Scotiabank's bottom line. A larger purchase, such as AIC or AGF, comes with a heap of good will, which banks try to avoid because Canadian capital rules punish them for it. But a simple asset-for-equity swap with AGF comes with no capital hit for the bank.

As for Mr. Goldring, it would allow him to make up for lost time. AGF has dropped to 10th place from 6th among fund companies in five years for reasons that are well documented -- the unexpected divorce from Brandes Investment Partners, a 3½-year streak of net redemptions that was stopped only last month. The company has stabilized and the stock is up 35 per cent in a year. "The AGF story just gets better and stronger by the month," Mr. Goldring says. Still, a danger looms: Price competition is heating up and AGF's funds are on the expensive side.

One way for the company to protect itself would be to bulk up. Fund management has great economies of scale. CI, an acquisition machine, has 39-per-cent pretax margins. AGF, which is less than half CI's size, had margins of about 18 per cent last year. The companies are far from identical and there are accounting differences, but that gap is glaring.

Mr. Goldring has tried to turn AGF's independence into a virtue, believing that an asset manager with no ties to any brokerage house is better able to sell its funds to financial advisers and planners from all firms. That may have been so in the 1990s but is less true today. Most advisers just want to make a commission and give their clients a decent return. RBC brokers will sell TD funds, CIBC brokers will sell RBC funds, if that's where the money is. There's no reason to believe they would boycott AGF if it joined with Scotiabank.

The truly sticky issue is power. AGF's minority shareholders have no vote, no annual meeting and no say in the company's direction. Scotiabank, which would probably be its largest shareholder, would want some control. Would the Goldrings give it to them?

If not, it's back to square one for Rick Waugh, and to the rumour mill for everyone else.
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