Peter Anderson has a problem most of us would envy: The CEO of CI Financial Corp. has too much cash.
Mr. Anderson runs a mutual fund company that kicks off roughly $650-million a year, far more money than CI needs to build its business. While having too much cash would seem to rank right up there with being too healthy or too good-looking when it comes to life’s challenges, CI’s boss faces a challenge that’s going to define his tenure at the helm and the performance of CI shares.
In mature Canadian markets, the leading companies in virtually every sector generate more cash than they need to run the business. Far too many CEOs and corporate boards have squandered this capital, at the expense of shareholders, by making ill-considered acquisitions or simply failing to ensure they’re getting money to shareholders in an efficient manner. Which brings us to recent developments at CI, one of the country’s largest wealth managers.
In early August, as part of its quarterly financial results, Mr. Anderson surprised investors by announcing that the CI was cutting its common share dividend by nearly half. Rather than hand over cash through dividends, Mr. Anderson pledged to buy back up to $1-billion in stock over the next 12 to 18 months, using both CI’s cash flow and credit facilities. That’s double the value of stock that CI purchased over the past year, and approximately 18 per cent of the company’s current market capitalization.
“We strongly believe that the best use of free cash flow is to aggressively buy back CI shares because they offer such compelling value,” said Mr. Anderson in a press release.
CI’s shift in strategy, done with investment bank Infor Financial Inc. as advisor, will be closely watched by most financial service companies. Canada’s banks and rival wealth managers such as Power Financial Corp. have traditionally used increasing cash flow to boost dividends and fund acquisitions, rather than launch aggressive share buybacks. Market leaders in other sectors – Alimentation Couche-Tard in retail, Nutrien in fertilizer, BCE and Telus in telecom – also enjoy the problem of generating far more cash than they need.
Based on the initial investors response to CI’s shift in strategy, no one should rush to cut dividends in favour of buybacks. Mr. Anderson unveiled the new approach at the same time the asset manager reported lousy operating results, and its share price dropped 4.2 per cent following the announcement. Clients continue to pull their money out of CI funds, with net redemptions of $2.8-billion in the most recent quarter. CIBC World Markets Inc. analyst Paul Holden said in a report: “The big negative for us coming out of the quarter is the net redemption situation, not the change in dividend policy.”
The logic of buying back shares, rather than paying out dividends, was clear to analysts. Mr. Holden said the return on investment, or ROI, that CI gets from buying back its own stock is higher than the ROI the company can earn on any potential acquisition. The move is also tax-efficient, as most investors will pay less tax on capital gains on their CI shares than they would on dividend income.
Analysts also agree that CI shares are a value investment, because the stock trades at a valuation significantly below that of peers, a discount that reflects the fact that many CI funds are poor performers and redemptions are expected to be an ongoing issue. Mr. Holden estimates CI stock trades at 8.1 times the company’s forecast cash flow for 2019, compared to an average multiple of 12.5 times forecast cash flow.
If Mr. Anderson can get performance at CI funds back on track and staunch the outflow of assets, while at the same time boosting earnings per share by buying back 18 per cent of his company’s stock, CI’s stock price will take flight. At that point, every public company facing the problem of too much cash will have case study in why share buybacks, rather than dividends, are the better way to return capital to the owners of the business.
Andrew Willis