The latest takeover tussle in the Canadian mutual fund industry — Industrial Alliance Insurance and Financial Services Inc. and CI Fund Management Inc. battling for Clarington Corp. — highlights the challenge facing companies seeking aggressive growth in an increasingly concentrated industry.

No fund firm has been more aggressive in the past decade than CI. In 1995, it was just another middle-of-the-pack fund company, with about $5 billion in mutual fund assets under management and an eroding market share. Today, after a string of successful acquisitions, some good sales and market growth, it’s the top non-bank-owned firm in Canada, with $49.8 billion in investment fund assets.

CI sought to make the pile a bit bigger Oct. 31, launching a $254-million unsolicited bid for the much smaller Toronto-based Clarington. However, within a week, Clarington found itself a white knight. Quebec City-based Industrial Alliance anted up a $273-million friendly bid and CI withdrew.

Yet on Nov. 14, CI was back with a revised bid. It upped its offer to $14.75 a share, trumping Industrial Alliance’s $14.25-a-share bid. As Investment Executive went to press, CI had pledged to mail its offer to Clarington shareholders “as soon as possible.”
The offer will be subject to certain conditions, including acceptance by least two thirds of the Clarington common shareholders, and regulatory approvals. If its bid succeeds, CI will complete the transaction in early 2006.

The hostile approach is a familiar one for CI. Earlier this year, it made a hostile run at Britain’s Amvescap PLC, parent of Toronto-based AIM Funds Management Inc. The deal was thwarted. The company resisted CI’s overtures, brought in a new CEO and pledged to give him a chance to turn the struggling firm around. In late 2000, CI touched off a bidding war for Mackenzie Financial Corp. with an unsolicited offer that eventually saw Mackenzie take refuge in the arms of its white knight, the Winnipeg-based firm now known as IGM Financial Inc.

Hostile bids aren’t an easy sell in Canada’s markets. It can be particularly tough in the financial services industry, in which the value of a company often depends heavily on human capital. Run those people out of town and you lose much of the value of the deal in the process.

But CI CEO Bill Holland has shown he is not afraid of hostile deals. He notes that CI’s takeover of Assante Corp. in 2003 started as a hostile deal, as did its seminal acquisition of BPI Financial Corp. in 1999. “We’ll do whatever it takes to get in the game. And once you’re in the game, you have a shot at winning it,” he says. “If the price works and the business combination makes sense, then you go ahead.”

CI’s track record of integrating its acquisitions — it tends to rationalize aggressively the funds and the managers it acquires — suggests that a little hostility isn’t much of a deterrent for it. There’s less fear of scaring off high-paid talent when the logic of a deal revolves around cutting costs.

Certainly, cost-cutting will be part of a CI-Clarington combination, if it happens. CI pledges that, within 12 months of closing a deal, it would cut the management expense ratios on the acquired funds. It proposed to reduce MERs by as little as four basis points and as much as 54 bps for several global equity funds.

The intensity with which CI is pursuing Clarington highlights that, while there still appears to be room for consolidation in Canada’s fund industry, there are few obvious targets.

Strategic plays and sales trends have created a fairly concentrated business. Data from Toronto-based Investor Economics Inc. show that the top six firms all have more than $40 billion in AUM, with seventh-place Mackenzie slightly below that mark. AUM drop off sharply from there — the next three range from $33 billion in assets down to about $21 billion. Beyond the top 10 there are no firms with more than $20 billion in assets, and below the top 15, no firm has more than $10 billion in assets.

The larger companies are also either bank-owned, foreign-owned or closely held. So, among the top 20 firms, there are only one or two that could even remotely be considered possible takeover targets. Beyond that, there are plenty of smaller firms, but they may not be big enough to justify the risk and expense of an acquisition.

@page_break@“There really isn’t anybody left. The only firms CI would even be interested in — AGF Management Inc. or AIC Ltd. — are firms for which it can’t launch a hostile bid,” says an industry analyst. “Unless a bank or an insurer decides to get out of the mutual fund business, there really aren’t any public mutual fund companies left for CI to buy.”

CI isn’t the only one looking for acquisitions. There may be plenty of rival buyers if anything does come up for sale. Bank of Nova Scotia has signalled its interest in an asset-management acquisition, and several larger independents could be buyers, too.

A divestiture by a bank or an insurer can’t be completely ruled out. Several deals CI has done over the years have been done in conjunction with Toronto-based Sun Life Financial Inc. , which now owns about 35% of CI. Sun Life initially acquired that stake in 2002, when it sold CI its mutual fund businesses. In 2004, it also sold CI a few fund dealers.

On its own, CI has bought BPI, Assante, Synergy Asset Management Ltd. and Skylon Capital Corp. But it has yet to pull off the blockbuster transaction that a Mackenzie, Trimark or Amvescap acquisition would have been.

Holland is quite sanguine about CI’s track record in takeovers. He shrugs off the fact that CI has been rebuffed twice this year in takeover attempts and three times in recent memory, if Mackenzie is added.

CI has been denied many more deals than that over the years, Holland notes. It’s only the deals involving public companies that have become common knowledge.

“At one time or another we’ve knocked on every door in Canada,” Holland says. “I can’t think of one we haven’t — with the exception of Fidelity Investments Canada Ltd. , because it doesn’t do deals.

“When you’re looking for as many ideas as we are, you’re never going to get 50% of them,” he says. “You’re lucky if you get one out of three.”

Holland insists CI is not under any pressure to do another deal. The firm has been the top-selling non-bank-owned fund company this year, with more than $2 billion in net sales and $10 billion-plus in gross sales. “There’s nobody [among] the major independents really close to our performance,” Holland says. “So I don’t feel remotely compelled to do a deal.”

Ranking as the top independent is not the achievement it once was. Many independents have been struggling for sales. Not only have assets become more concentrated, but sales have, too.

Overall, the Canadian fund industry has enjoyed strong sales and even better markets this year. Fund industry assets have been hitting all-time highs throughout the year, although the latest data from the Investment Funds Institute of Canada suggest that overall industry assets slipped a bit in October, to between $536 billion and $541 billion, as markets pulled back.

However, all is not well. While the strong markets may be lifting all boats, investors have become more selective. Fund sales have been very concentrated, with the banks — particularly RBC Asset Management Inc. and TD Asset Management Inc. — taking more than their fair share. The banks have benefited from the popularity of income-oriented asset classes, but have also done a much better job of distribution. It remains to be seen whether they can hang onto sales supremacy when investors’ appetites change.

In the meantime, firms such as CI face a challenge in sustaining the sort of growth they’ve enjoyed in the past. Holland insists the opportunity to grow through sales and market appreciation is still “a darn good story,” although, he admits, it’s “not as good as it was eight years ago.”

In some sense, the challenge is not unlike that facing the big banks in their core retail banking businesses, in which they have found domestic growth constrained. The answer they’ve found is international expansion.

However, there’s not much precedent for success in that arena for Canadian asset managers. Mackenzie’s U.S. venture was abandoned. AIM has launched a handful of U.S. versions of some of its top Trimark funds — AIM Trimark Fund, AIM Trimark Endeavor Fund and AIM Trimark Small Companies Fund — but with limited success.
The small-cap fund has done best, attracting more than US$176 million in assets as of Sept. 30, vs about US$80 million in the mid-cap Endeavor fund and US$30 million in the flagship global equity fund.

The problem for Canadian fund firms breaking into the U.S is that the market is crowded, highly competitive and the margins aren’t nearly as juicy as in Canada. The trick is finding the next Canada — an emerging market with plenty of growth potential, as Scotiabank has done in the banking world. But that would probably be a long road.

Holland is skeptical of the opportunity for international expansion. He suggests that expanding abroad just doesn’t make sense. “Our skill is in running an asset-management business in Canada,” he says. Firms that have tried the U.S. have had a hard time, and, he says, Europe is even harder to crack.

“My feeling is there are still opportunities in Canada; it’s just a lot harder to figure out what they are,” Holland says. Still, he maintains, any deals CI does will probably be designed to take advantage of its Canadian scale.

If it doesn’t win the battle for Clarington, CI has a growing cash problem. It is generating almost $350 million of annual free cash flow that it wants to return to shareholders if there’s nowhere smart to spend it. CI had planned to convert into an income trust to do that. (Analysts see the trust conversion as a signal that CI’s growth prospects may be limited.)

However, conversion plans are on hold while the federal government decides what to do about the tax treatment of trusts. Holland is quite critical of Ottawa’s handling of the issue. CI could raise its dividend instead, but Holland cringes at the thought of the hefty taxes on dividends. “The problem is corporate taxes are way too high. You can’t talk about productivity and then have a 57% tax on distributable income through corporations,” he says.

Alternatively, CI may buy back shares and, if the government more or less leaves income trusts alone, “we’ll become an income trust,” he pledges.

While the government seems to fear that trust conversions herald the end of economic growth, in the case of the Canadian fund industry it may just be an inevitable sign of maturity in an increasingly consolidated business. IE