19 September 2006

Sun Life Hires Investment Bankers for MFS Unit

Bloomberg, Sean B. Pasternak, 19 September 2006

Sun Life Financial Inc. may pay shareholders a special dividend if Canada's second-largest insurer sells its MFS Investment Management unit, RBC Capital Markets analyst Jamie Keating said.

The Toronto-based insurer said yesterday it hired investment bankers to consider a possible sale of MFS, its Boston-based money management unit. The business is worth about $5 billion, or $7 a share, Keating said in a research note today.

The MFS unit contributes 10 percent to Sun Life's net income and about 1 percent to return on equity, a measurement of profitability, according to the report. A special dividend ``would be desirable in order not to depress'' return on equity, Keating said.

Michel Leduc, a Sun Life spokesman, declined to comment. Keating didn't return a phone call seeking comment.
The Boston Globe, Steven Syre, 19 September 2006

To many people inside and outside MFS Investment Management, the question about an ownership change at one of the city's biggest and oldest money-management firms became when, not if. Now the answer seems to be sooner rather than later.

For about a week, the rumor mill has been working overtime on the prospects for a sale of MFS and about the potential buyers. Sun Life Financial Inc. , the Canadian insurance giant that owns MFS, confirmed yesterday that it had hired investment bankers to explore a transaction.

That doesn't guarantee anything will happen, but MFS is in play, and Sun Life is considered a serious seller. Speculation about buyers and prices is all over the map. No fewer than six potential buyers or merger partners have been rumored in print over the past several days.

Sun Life's motivation is clear. MFS, which manages $168 billion, makes lots of money and runs at an operating profit margin that would be considered top-shelf in many industries. But margins at MFS are below average in its industry, and Sun Life believes the business needs greater scale to improve.

Getting bigger means buying, selling, or forging some sort of merger of equals. Analysts who follow Sun Life say the Canadian parent doesn't want to make a big acquisition that will add lots of goodwill to its balance sheet. A sale for cash in return would generate a huge tax bill.

Analysts believe Sun Life wants to merge MFS with a larger money manager, and come away as a stockholder with a substantial minority interest in the much bigger combined investment company.

So who would be the ideal acquirer of MFS, under those circumstances? It's hard to imagine a better fit than Franklin Resources Inc.

Franklin, a public company, manages $505 billion in mutual funds and other investments for clients around the world. A sale of MFS in return for Franklin shares would leave Sun Life with a meaningful minority ownership interest in a well-regarded company and a very liquid asset.

Franklin, based in San Mateo, Calif., is best known for its own fixed-income investment products. But the company also has a track record of buying other well-known firms, integrating the businesses successfully, and operating funds under a variety of subsidiary brand names.

In the 1990s, Franklin branched out into international investing by purchasing the company that owned the famed Templeton Funds. Later, it acquired the company that operated Michael Price's value-oriented Mutual Series Fund.

Those deals and other acquisitions helped Franklin diversify its business over years. But the company remains relatively weak when it comes to growth-stock investing. MFS would fill that hole in a big way.

Growth-stock investing has been out of favor six years, a period that favored value-oriented investment products like the American Funds and funds sold by Franklin. This may be an opportunity to buy a big growth-stock manager at the bottom of the market.

So there are lots of reasons why a sale of MFS to Franklin would make sense. But, of course, there are complications.

At Franklin, the founding Johnson family still runs the show. (Yes, there is another big investment company dominated by a family named Johnson.) It has shown little interest in issuing lots of stock or diluting the combined family interest of the company, which approaches 40 percent.

Another question revolves around price. If Sun Life's bankers subjected MFS to a bidding war that drove up the price, Franklin might walk away. It has tons of cash, and that means it has plenty of other options.

But MFS and Franklin suit each other best. On paper, at least.
Bloomberg, Sean B. Pasternak, 18 September 2006

Sun Life Financial Inc., Canada's second-largest insurer, hired investment bankers to consider a possible sale of its U.S. money-management unit, which has had $16 billion withdrawn from its funds over four years.

Sun Life didn't name the investment bank, which will advise the insurer on ``strategic alternatives'' for MFS Investment Management. Toronto-based Sun Life said in a statement today that there is no assurance of a transaction.

The Globe and Mail newspaper reported on Sept. 16 that Sun Life is in talks with at least four companies for a possible sale or partnership for MFS Investment, which analysts valued at about $4 billion. The newspaper said Sun Life hired Morgan Stanley for the review.

MFS has lost $3.7 billion in mutual-fund shareholder withdrawals this year through July 31, adding to its outflows since 2002, according to Boston consulting firm Financial Research Corp. Its net outflows are the fourth-highest in the fund industry in 2006.

``When you think of Sun Life's alternatives, clearly combining it with someone else is the most advantageous,'' said Robert Wessel, an analyst at National Bank Financial in Toronto. ``There are financial benefits and there are strategic benefits, such as greater scale and better distribution.''

Wessel, who wrote a 52-page report to investors last month discussing Sun Life's options for MFS, said the unit would be valued at $4 billion if taken public, or $5 billion if sold to a rival.

Investors began withdrawing money because of poor growth- fund performance during the 2000-2002 bear market and continued after the company's involvement in a mutual-fund trading scandal and undisclosed sales payments to brokers.

MFS, which manages the oldest mutual fund in the U.S., agreed in 2004 to pay $351 million in penalties for allowing some investors to make improper trades in its funds. The settlement was made with the U.S. Securities and Exchange Commission, New York Attorney General Eliot Spitzer and New Hampshire securities officials.

Shares of Sun Life rose 69 cents, or 1.6 percent, to C$45.29 at 4:10 p.m. trading on the Toronto Stock Exchange, and have fallen 3 percent this year. That trails the 5.5 percent gain in the Standard & Poor's/TSX Financials Index.

MFS's profit was $92 million for the first six months of the year, up from $71 million, a year ago, while revenue at the Boston-based firm rose 8.7 percent to $722 million.

``The company values MFS as a strategic asset and remains committed to growing the business organically while assessing strategic alternatives,'' Sun Life said in the statement. ``MFS is gaining flows on the institutional side both domestically and internationally and has delivered significant margin improvement over the past year.''

Sun Life Chief Executive Officer Donald Stewart wants to hold a smaller stake in a ``much larger firm,'' according to the Globe and Mail report, which cited unidentified bankers. Potential partners include Nuveen Investments Inc., Franklin Resources Inc., Morgan Staney's money-management arm and Putnam Investments, the newspaper said.

Franklin spokeswoman Lisa Gallegos declined to comment, as did John Reilly, a spokesman for MFS, Michel Leduc at Sun Life and Chris Allen, a spokesman for Nuveen Investments. Morgan Stanley spokeswoman Marie Ali declined to comment, as did Putnam spokeswoman Sinead Martin.

The probability that Sun Life reaches a deal for MFS within the next year is 40 percent, TD Newcrest analyst Steve Cawley wrote today in a note to investors.

``While speculation has certainly heated up, there is no guarantee that management has overcome its apparent reluctance to embark upon a company-changing path,'' said Cawley, who rates Sun Life ``hold.''

Cawley said that he's concerned about a ``steady trickle'' of executive departures at Sun Life at a time when the firm considers its options for MFS. The company named Ronald Friesen as chief financial officer of its U.S. operations today, replacing Gary Corsi, who last week agreed to join Protective Live Corp.

In addition, James Prieur, who was Sun Life's president, agreed in August to become chief executive officer of U.S. insurer Conseco Inc. Paul Derksen, chief financial officer of the overall firm, will retire next year and be replaced by Genworth Financial Inc.'s Richard McKenney.
Boston Business Journal, 18 September 2006

Wall Street investment bank Morgan Stanley has been hired to find a buyer for MFS Investment Management, the $168 billion mutual fund division of Canada's Sun Life Financial. The move was announced three days after the Boston Business Journal first reported that T. Rowe Price and Ameriprise Financial were in a bidding war to acquire MFS for between $6 billion and $8 billion.

The Morgan Stanley news comes just four months after Morgan Stanley authored a research report outlining Sun Life's strategic options, relative to Boston-based MFS. The report, written by analyst Ken Zerbe and published May 25, concluded that a sale was in the company's best interest.

"MFS does not have significant scale to generate industry-average margins," Zerbe wrote, noting that Sun Life would likely see a 15 cent earnings-per-share boost after an MFS sale. He said MFS' profit margin is roughly 9 percentage points below the industry's average of around 35 percent of revenue.

"The most likely option, in our view, is that the management will sell a majority ownership position to another asset management firm," Zerbe wrote.

Zerbe said Sun Life would likely retain a 20 percent to 30 percent ownership stake in the newly merged entity. A Morgan Stanley spokeswoman declined to comment when asked about a potential deal last week.

Sun Life responded to the heightened media speculation Monday. "Sun Life Financial continually reviews the performance of all of its businesses to deliver and grow shareholder value. The company values MFS as a strategic asset and remains committed to growing the business organically while assessing strategic alternatives. The company has retained investment bankers to advise on strategic alternatives. However, there is no assurance that a transaction will result," the company said in a prepared statement.

Last Tuesday, Sun Life spokesman Michel Leduc told the BBJ that the company welcomes "any options to grow shareholder value."

In a May interview with the BBJ, MFS CEO Rob Manning said he planned to grow the company both organically and via targeted acquisitions of smaller money-management shops. "We will be a consolidator," he said at the time.

Manning was hired two years ago at the age of 40 to take the reins at MFS, which was close to finalizing a $350 million settlement with regulators stemming from improper trading within its mutual funds. Its senior leadership faced suspension from the fund industry. The company's investment record, which had become largely dependent on growth stocks, was taking a beating at the time. Manning previously managed MFS' fixed-income division.

Meanwhile, The Globe and Mail, a national paper based in Canada, reported Friday evening that four potential bidders -- including Putnam Investments in Boston, Morgan Stanley's money-management arm, Nuveen Investments Inc. in Illinois and Franklin Resources Inc. in California -- are also in the running for MFS. The Globe and Mail said a potential deal would likely garner $4 billion for Sun Life.

A spokeswoman for Marsh & McLennan, Putnam's parent, said she was unaware of any negotiations and declined to comment further.

Other financial services firms have dumped their mutual fund divisions in recent months. In February, Merrill Lynch & Co. agreed to sell its 154 mutual funds to New York money manager BlackRock Inc. Last year, Citigroup Inc. swapped its mutual fund operations in exchange for the brokerage arm of Legg Mason Inc.

Having earned a strong reputation for product innovation and research since its founding in 1924, MFS employed 2,400 people, including 2,300 in Massachusetts, as of Dec. 31. Its Massachusetts Investors Trust mutual fund is recognized as the first mutual fund ever invented.
TD Newcrest, 18 September 2006


According to an article in the Globe and Mail, Sun Life Financial has hired Morgan Stanley to “screen merger candidates for MFS,” its U.S.-based asset manager.


Slight Positive. The announcement that it has hired Morgan Stanley, which has yet to be confirmed by Sun Life, increases the likelihood that a value enhancing deal will get done within the next year, in our view. As such, we have incorporated a probability-weighted valuation scenario in our target price for SLF, which we are raising to $48 from $47. We had previously calculated $2-$3 upside from a spinout of MFS into a larger entity, but did not reflect this amount into our target price. We are now incorporating a 40% probability that a deal gets done within the next year. However, with some of the upside already reflected in SLF’s target price (i.e. it rose over 5% in August as MFS speculation heated up), ongoing executive departures and our concern over operational issues that have led to lackluster H1/06 results, we continue to rate Sun Life a Hold.


What kind of transaction is SLF entertaining?

In past discussions, management has indicated that it prefers to vend MFS into a larger entity, retaining 20-50% ownership, however, did not rule out an outright sale of the company (i.e. through an IPO). In our valuation upside calculations, we assume Sun Life vends MFS into a larger entity.

How do we get to $2-$3 upside?

There are two main drivers to our upside potential calculation, including: (1) improving pre-tax margins to 35% following a transaction from 26% Sun Life reported in Q2/06; and (2) partially removing the valuation discount we currently apply to MFS’ earnings. With regards to the latter point, we note that U.S. asset manager multiples have been increasing the past few weeks, from a low of ~21.0 times trailing earnings in July and August to 23 times trailing earnings today, which leads us to believe that upside could be at the higher end of the range. For more detail on our upside calculation, please read our July 25, 2006 report entitled Wealth Management: These Are Not Simply ‘Lifecos’.

Why only 40% probability?

While it appears increasingly probable that a deal is consummated within the next twelve months, we have chosen to reflect only 40% of the potential upside in our target price. First, while speculation has certainly heated up, there is no guarantee that management has overcome its apparent reluctance to embark upon a company-changing path that would be necessary following a transaction involving MFS. Second, timing of a potential transaction is uncertain. Third, while potential candidates for a tie-up are available, there is no guarantee that the partner eventually selected meets strategic/cultural criteria (described in the next section). We believe the lower probability incorporates the risk that the partner selected is not ideally suited to deliver strategic and financial benefits to SLF.

What do we think of potential MFS partners mentioned in the Globe and Mail article?

We believe the most logical partner for MFS should have: (a) strong management; (b) a strong growth-fund lineup; and (c) sufficient value to maintain Sun Life’s potential ownership in a combined entity to between 20-50%. We also note that cultural differences are important to address in the combination of money managers and that MFS’ “research intensive” culture may stand in contrast to a firm with more bottom line focus; we believe these cultural considerations have prevented an MFS transaction in the past. In Exhibit 1, we profile each of the four companies mentioned in the Globe article.

In our view, Franklin Resources (manager of Franklin Templeton funds) is the only company identified that could meet most of Sun Life’s criteria. Since we don’t follow this company, it is difficult for us to judge management, but the company has had solid operating margins and positive net fund flows over the past four quarters. We also believe the company has a solid growth-fund platform, however, we believe Sun Life would have to accept less than 20% ownership of a combined entity. Nuveen Investments is a possibility, however we believe Sun Life could own more than 50% of the new firm and we believe Nuveen’s growth-fund lineup is limited. In our view, Putnam Investments seems unlikely given struggles with fund flows and relatively small size. We are less familiar with Morgan Stanley’s Asset Management operations and have no major opinions either way to provide support or argue against a combination with MFS.

Are we concerned about recent executive departures?

Yes. A steady trickle of Sun Life executives have left the company ever since Paul Derksen announced his retirement during the Q1/06 conference call. Since then, former Chief Operating Officer Jim Prieur and former Chief Financial Officer of the U.S. Division, Jim Corsi, have left for positions with rival U.S. insurers. We also understand (albeit unconfirmed by the company) that Vice-President Douglas Brooks, who is highly regarded for risk management experience, has also left Sun Life in the last week. The spate of executive departures gives us concern regarding the future direction of the organization, especially at a time when key decisions regarding MFS are being made.

Justification of Target Price

Our $48 (up from $47) target price equates to 12.5x (unchanged) our 2007E EPS plus 40% probability of MFS being vended into a larger entity over the next year, which could add roughly $2-$3 per share. We believe the following Sun Life positive investment attributes remain: (1) long-term value of SLF ownership in MFS and other wealth management operations; (2) leverage in the deployment of excess capital; (3) willingness to buyback stock and/or increase the dividend; (4) traditionally strong and stable Canadian operations; and (5) long term earnings growth potential of Asian operations. On the other hand, operational problems over the past two quarters have led us to apply a lower valuation multiple to Sun Life’s earnings than we do for its main rivals, Manulife and Great-West Lifeco.

Key Risks to Target Price

(1) Further deterioration of the USD; (2) failure of the US division to improve annuity division sales/earnings; (3) integration problems with CMG Asia; (4) sudden spikes in interest rates; (5) significant downturns in equity markets; (6) inability to effectively lower its corporate tax rate; (7) poor mortality or morbidity claims experience; (8) regulatory investigations into industry sales practices; (9) ineffective or unattractive MFS related transaction.

Investment Conclusion

We expect investors to react positively to speculation that Sun Life has hired a strategic advisor to monetize its valuable MFS asset. Due to ongoing operational concerns in Sun Life’s insurance operations and continued departures from its executive team, we are cautious in our evaluation of this company. While a transaction involving MFS could provide a short-term “pop” to the stock, we are less confident in the company’s longterm prospects. We rate Sun Life a Hold.