In the wealth-management business, organic growth can be a painfully slow way to build a business. But growth by acquisition is virtually impossible in the current landscape as most of the attractive targets have been snapped up. Doing a deal now requires either extraordinary circumstances or extreme ingenuity.

It would seem to be the former that propelled the deal that saw Bank of Nova Scotia acquire Dundee Bank of Canada and an 18% stake in Dundee Bank parent Dundee-Wealth Inc. In this case, what drove the fiercely independent Dundee to give up some of its business to a Big Five bank is the credit crunch that has gripped markets since the middle of August.

Under the terms of the deal that was announced in mid-September, Scotiabank will acquire Dundee Bank for $260 million and will add an 18% stake in DundeeWealth for $348 million. The deal also gives Scotiabank the right of first refusal to buy more of the wealth-management firm if its major shareholder decides to sell (Dundee Corp. still controls more than 50% of the voting shares). The firms also adopted a standstill agreement that limits Scotia’s shareholding to 20%.

However, the proposed transaction is complicated by the emergence of a possible takeover battle for DundeeWealth. As Investment Executive went to press, CI Financial Income Fund stepped up with an all-share offer for 100% of DundeeWealth, valued at $20.25 a share. The Scotiabank deal is priced at $12.76 a share, but that doesn’t include the $260 million Scotia is paying for the bank. CI’s bid needs two-thirds of shareholders’ support for it to go ahead, and requires that DundeeWealth’s deal with Scotia does not proceed.

It remains to be seen if CI’s surprise bid succeeds, causes Scotiabank and DundeeWealth to revise the terms of their deal, attracts other bidders or simply falls on deaf ears. But it doesn’t appear that DundeeWealth is looking to sell. In the financial industry, unsolicited bids don’t have a very good record of success. Moreover, CI’s bid requires Dundee to abandon its deal with Scotiabank, which was set to close on Sept. 28. CI doesn’t plan to mail its offer until early October.

Indeed, for a firm that has always been a buyer in the ongoing consolidation of the retail investment industry, it seems that Scotiabank only managed to snatch up this stake in DundeeWealth because of the pressure the latter was under as a result of the turbulent credit market conditions.

The problem is that the upstart bank was heavily invested in the structured products that have been hit by the recent credit crunch, say analysts. “Aside from not yet achieving ongoing profitability, the bank’s business model had become somewhat constrained given the recent credit-market disruption,” says Dominion Bond Rating Service Ltd. , commenting on the deal.

“Without a lending operation, the bank was relying on investments in collateralized loan obligations and asset-backed commercial paper to support its deposit liabilities, a strategy that is no longer practicable,” DBRS says.

DBRS sees the deal as a positive move for DundeeWealth as it removes a source of losses and relieves DundeeWealth’s obligation to keep injecting capital into the Dundee Bank — “as required in the current market environment.”

Unloading the bank to Scotiabank looks like a win/win situation. DundeeWealth can stop supporting a bank that’s under pressure and can focus on building the wealth business, which has long been its specialty. As for Scotiabank, it boosts its exposure to wealth management and adds a niche banking business to boot.

“Scotia is known to have wanted to grow its wealth-management business more aggressively,” says Dan Hallett, president of Windsor, Ont.-based fund industry analyst Dan Hallett & Associates Inc. “This way, it saves Dundee’s banking business and, in return, gets a piece of Dundee’s successful wealth-management business — with first rights to any additional shares that go for sale.”

Assuming the Scotiabank/DundeeWealth deal goes ahead as planned, Hallett notes that a key challenge will be to reassure independent advisors that they aren’t about to be taken out by a big bank. He notes that DundeeWealth’s management has made it clear that it has no intention of selling. Keeping the Dundee name and Dynamic FundServ codes will help reassure advisors, he says, as will evidence that service is being maintained or even enhanced.

@page_break@Indeed, under the terms of the deal, the banking products Dundee Bank created to offer through financial advisors will continue to be available as part of a three-year “white label” service agreement.

“Independent advisors don’t want to sell Scotiabank products, and the initial fear for advisors is that they’ll lose a key independent player in the industry,” Hallett says. “I understand the fear but I don’t think it’s an issue, at least not in the foreseeable future.”

For now, the big benefit to Scotiabank is the ownership stake in DundeeWealth will boost its wealth-management business. But while this means the bank will get more earnings from the wealth segment, the deal doesn’t fundamentally improve Scotia’s lagging position; it will continue to field fewer advisors than the other big banks. Nor does it directly bolster its asset-management division; Scotiabank’s mutual fund operation is the smallest of the Big Five banks. Indeed, it falls just behind DundeeWealth’s Dynamic Mutual Funds in the overall mutual fund market share rankings.

But, Hallett says, while Scotiabank’s stake in DundeeWealth gives it “a piece of a growing and successful money manager and one of the stronger distribution channels, it doesn’t directly impact Scotia’s fund family and distribution capabilities.”

It will earn some fees structuring banking products under the Dundee moniker, Hallett points out, and it holds a privileged position should DundeeWealth decide to issue new shares or sell the business.

But it’s far from certain that such an opportunity will arise anytime soon. In a research report on the deal, Blackmont Capital Inc.notes that the transaction puts Scotiabank in a good position to fend off rivals that might take a run at DundeeWealth. But it also sees difficulty in a bank successfully buying an independent.

“Any changes in future ownership will need to consider carefully the implications for the advisor platform, which represents a substantial portion of overall enterprise value,” Blackmont says.

“Independence remains a coveted status for many non-bank affiliated advisors,” the report adds. However, it suggests that continued pressure on fees and pressure to broaden the product/service offering may “reduce this inherent bias as the benefits of scale and efficiency to overall competitiveness become increasingly apparent.”

Indeed, CI’s competing offer stresses its respect for the, “… entrepreneurial culture of DundeeWealth and its management and financial advisers.”

However, a number of transactions in recent years have dared to court these channel conflicts — Investors Group Inc.’s takeover of Mackenzie Financial Corp., Bank of Montreal’s buyout of the Guardian Group of Funds Ltd., CIBC’s acquisition of TAL Global Asset Management Inc. — all without significant negative consequences. Large institutions, namely Manulife Financial Corp. and Sun Life Financial Inc. have taken minority stakes in independent players (Canaccord Capital Corp. and CI Financial Income Fund, respectively). And, the bank-owned fund companies (particularly RBC Asset Management Inc. and TD Asset Management Inc.) have successfully won independent distribution.

In most cases, quality products and superior service have proven more valuable to advisors than drawing lines between independents and industry behemoths.

Hallett isn’t anticipating a full-blown takeover in the immediate future. “I really don’t see DundeeWealth selling any time soon, but I will never say never,” he says. “Under the right circumstances and at the right price, just about every company is for sale.”

It remains to be seen whether Scotibank will get the chance to take Dundee out. For now, it seems unlikely. But then, who would have predicted this deal six months ago? Extreme, unpredictable markets can produce results that, at one time, would have been unthinkable. IE