Thursday, June 08, 2006

Power Financial's Discount to Net Asset Value

The Globe and Mail, Derek DeCloet, 8 June 2006

Deals, deals, everywhere a deal: The mining crowd can't enough of them. The oil guys in Calgary are crazy for them. Every big Canadian bank except CIBC has got money to spend. Manulife Financial is shopping.

But where are the Desmarais boys? They've been awfully quiet lately. Their insurance unit, Great-West Lifeco, hasn't made a major acquisition since it snatched Canada Life three years ago. IGM Financial, formerly known as Investors Group, hasn't bought anything since Mackenzie Financial in early 2001. Money's cheap, yet they sit on their hands.

That might soon change -- and a little bit of mergers and acquisitions activity might be just the catalyst investors are looking for in Power Financial, the holding company that controls both Great-West and IGM.

Power Financial used to be one of those stocks that always seemed expensive, yet just kept going up. No longer. The company is in the doghouse. Power Financial is one of the worst-performing Canadian financial stocks in the past year, earning nothing, including dividends. Manulife is up 29 per cent; CI Financial is up 83 per cent. That doesn't automatically mean Power Financial is a bargain, but it's starting to look like one.

Any analysis must begin with what the individual parts are worth, which is fairly easy because the biggest subsidiaries are publicly traded. By far the most important is Great-West, of which Power Financial owns 73 per cent (directly and indirectly). That's worth about $18.2-billion, using the insurance company's current stock price. Power's stakes in IGM and Pargesa Holding, a Swiss investment company, are worth more than $9-billion. It also has some other small assets that aren't public. BMO Nesbitt Burns analyst John Reucassel pegs their value at close to $700-million.

The result, once you subtract debt and other liabilities, is that Power Financial's pieces are worth about $37 a share. The stock closed yesterday at $31.38, or 15 per cent less. That's not a particularly huge discount. Onex, BCE and Quebecor, to name three other Canadian holding companies, often trade at discounts of 20 or 30 per cent to their asset value -- or more, if investors turn really sour on them.

But suppose you felt the stock market had it wrong. Suppose you felt Great-West itself was undervalued. Then you could make the case that Power Financial's assets are actually worth $42 or $45 a share, and the discount is much wider than it appears -- in other words, that this really is an inexpensive blue-chip stock.

Great-West is a bit of a mystery. It's a big company ($25-billion in market cap) with a habit of producing stellar returns on equity -- usually 20 per cent or better. Yet Bay Street is lukewarm. Analysts complain that the firm is too secretive, that disclosure is awful, that chief executive officer Ray McFeetors has the personality of wet cement.

To these, you can add two more complaints. Great-West derives about one-third of its profit from the United States, so it's hurt by the falling American dollar, and the U.S. unit is arguably too small to be effective. The health insurance business has about two million customers, not nearly enough in a country of nearly 300 million people. Worse, it hasn't really grown since 2004, according to BMO.

The U.S. problems are a big reason why Great-West, which has always carried a premium valuation, now trades at a lower price-to-earnings multiple than Manulife. This is where the M&A part comes in. Great-West, with its balance sheet recovered from the Canada Life deal, needs a U.S. fix. It needs to buy another insurance company, or sell that business to someone larger, in return for a substantial minority stake.

There's risk in either, but the Desmaraises are nothing if not good deal makers in a company that has a surfeit of them. Last year, they installed Jeffrey Orr as Power Financial's CEO, a former investment banker who helped them navigate the Mackenzie acquisition. They didn't put him there just to manage what they've already got.

And if a deal doesn't happen, you've still got a stock that pays 3.2 per cent and has been one of the most reliable dividend-raisers on the Toronto Stock Exchange. "I don't think we've seen Power Financial at these kinds of dividend yields for years," says Saxon Financial's Suzann Pennington, who has been buying. Sure, there are a few warts, and the brokerage firms don't like it much. So what? That's always the way it is when great companies go on sale.