Thursday, August 31, 2006

Sun Life's MFS Unit

Boston Globe, Steven Syre, 31 August 2006

What does the stock price of Canadian insurance giant Sun Life Financial Inc. say about the future of big Boston mutual fund manager MFS Investment Management?

Sun Life shares hit their lowest price of the year four weeks ago, dragged down by the reaction to the company's quarterly financial report and news its president was quitting. Then Sun Life stock turned on a dime, climbing from $37.35 to nearly $41 in a few weeks. One explanation: rumors the company was about make some kind of deal involving MFS, a business it has owned for 24 years.

``The intense speculation on the subject, as well as our observation that management has gone completely silent, leads us to believe that something could be in the works," analyst Mario Mendonca of Genuity Capital Markets wrote in a report last week. He added that ``the market is quickly pricing in a meaningful probability that a deal is forthcoming."

That speculation, noted this week in the trade publication Investment News, may or may not turn out to be true. But the future of MFS as a unit of Sun Life has been the subject of growing public debate this year. The consensus prediction: Sun Life is most likely to merge MFS with another big asset management company, sooner rather than later.

Sun Life hasn't really gone silent, but it isn't saying much on the subject. A spokesman wrote to me yesterday, calling MFS a ``strategic asset," but added the company didn't rule out ``anything that builds greater shareholder value for the future."

MFS, which manages $168 billion in mutual funds and institutional accounts, will probably make more than $200 million this year and earn an operating profit of more than 25 cents for every dollar of revenue. In most industries, those kind of numbers confer star status. In the mutual fund business, they classify MFS as below average.

The average mutual fund company earns an operating profit of about 35 percent. In the most recent quarter, MFS reported a margin of 27 percent. The firm has worked hard to lower costs and boost business to lift that figure, but a year's effort has only yielded 1 percentage point of improvement.

``MFS needs to gain scale and that's unlikely to accrue through organic efforts alone," analyst Jason Bilodeau of UBS wrote in a report last month. Versions of that conclusion echoed in other investment research on the MFS question.

Another option that has been discussed in the past, taking MFS public, might raise money for Sun Life, but it wouldn't solve the investment company's basic problem.

MFS has increased the assets it manages to $168 billion, from $150 billion, in the past year. But much of that gain is due to stock market appreciation and its effect on money the company already manages.

MFS has been most successful adding new accounts from big institutional clients. But its mutual fund business, suffering from involvement in the fund scandals of a few years ago and declining popularity of some of its biggest offerings, struggles. So far this year, the amount MFS has returned to customers exceeded new sales by $3.7 billion, according to Financial Research Corp. of Boston.

Analyst Ken Zerbe of Morgan Stanley & Co. thinks MFS is making progress, but it would take years for the company to get profit margins up to industry averages. He believes Sun Life will opt for faster results through some kind of asset management merger in which it retains an ownership of about 30 percent. That would probably mean combining MFS with a firm managing $200 billion to $400 billion, Zerbe wrote in a May report.

Don't count on any big event soon. But one of Boston's biggest mutual fund companies isn't big enough and that will have to change.
Financial Post, Duncan Mavin, 31 August 2006

Sun Life Financial Inc. is turning in record profits of late and is firing on almost all cylinders, but it's still Canada's "other" global life insurance company, too often in the shadow of giant neighbour Manulife Financial Corp.

Domestically, Sun Life's investment in CI Financial Income Fund has been an undisputed winner (CI's annual earnings have increased about fivefold to more than $100-million since Sun Life's investment in 2002), while its group benefits and group wealth businesses produced year-over-year earnings growth of 20% and 16%, respectively, in the second quarter of 2006.

In China and India, meanwhile, the company continues to expand -- Sun Life now has more than 18,000 advisors in India. In the United States, too, Sun Life is forecasting strong performance, especially as it now has relationships with nine of the top 10 independent life insurance distributors there.

In fact, Sun Life reported earnings of $512-million in the second quarter of 2006, up 8.6% from 2005, while its market capitalization has grown from about $5-billion at demutualization in 2000 to almost $26-billion today.

Nevertheless, the company's stock trades at a discount to both Manulife and Great West Life. Sun Life trades at 13.5 times earnings, while Manulife's stock is priced at 17.2 times earnings and Great West trades at 14.7 times earnings.

One reason is that while most business lines have progressed well in recent years, there is a dark cloud on Sun Life's horizon. The company's U.S. asset manager, MFS Investment Management, has at best stood still, and speculation on Bay Street has it that Sun Life is casting around for a solution.

"Even a cursory review of MFS today makes it difficult not to conclude that this well-respected franchise significantly underperforms its peers," wrote National Bank Financial analyst Rob Wessel in a research note this week. "Although the timing is uncertain, we believe the unlocking of shareholder value through its investment in MFS is one of [Sun Life's] highest priorities."

One problem with MFS is high costs, holding pre-tax margins to about 18% compared with an average of about 34% for other publicly traded U.S. asset managers.

The other main challenge is that MFS's mutual funds don't measure up when compared with those offered by rivals, resulting in persistent net redemptions.

But where others see problems, Mr. Wessel outlines opportunities -- namely, improve profitability, sell a piece of MFS or find another asset manager to partner with it.

Currently, Sunlife is following option number one -- improve profitability. But, as Mr. Wessel said, Sun Life's existing measures to deal with either costs or mutual fund redemptions "have thus far proved somewhat elusive." And, "further improvements in MFS's efficiency could take many quarters if not years," he said.

In contrast, a merger with another asset manager could be quickly accretive, building scale, expanding product mix and leading to cost reductions.

Mr. Wessel said MFS's existing cost base of about US$1.1-billion could be reduced by about 10% following a merger, and he estimates the right deal could add 26 cents per share to Sunlife's annual earnings. (He estimates Sun Life will generate earnings of $3.46 per share in 2006.)

However, Sun Life chief executive Don Stewart and his management team would have to find a suitable and willing merger partner, and that would be a challenge in itself.

Instead, Mr. Wessel's third, and favoured, alternative is to take a portion of MFS public. It is the decision that is "the most within management control."

MFS would be valued upwards of US$4-billion in the public markets, based on the company's current earnings and the price of public asset managers in the United States, Mr. Wessel said. That valuation would create an after-tax gain of about $465-million if just 15% of MFS is sold off, he said.

With MFS publicly traded, the markets would have a clearer valuation of what MFS is worth to Sun Life. Sun Life would also have an extra half-a-billion in excess capital from the sale proceeds, which could be re-invested or returned to shareholders. Under greater investor scrutiny, MFS would be more likely to cut costs and improve performance, added Mr. Wessel.

The result? "Over 10% potential upside to [Sun Life's] share price," he said.

Mr. Wessel rates Sun Life an "outperform" and raised his target price to $52.00 from $49.00.