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As banks' business slows, takeovers may be next option

This is embarrassing but relevant so I'll cop to it. The other day I paid a fee of almost 10 per cent to withdraw forty bucks from an automated teller machine. The ATM owner charged the typical usury of $2.25 and my own bank made up the difference by siphoning off another $1.50 for the privilege of helping pay bank dividends and executive compensation, or something equally noble.

In any case, what a business: Gouging consumers who are too busy or tele-sedated to notice or do anything about it. But even that model has its limits judging from the latest round of bank earnings. Things appear to be slowing down. Even analysts and bankers are getting axed.

So, the inquisitive investor starts to ponder what banks might do to get their profits moving again - in other words, whom they might buy.

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For sharp insights I turned to Jason Donville, principal at Donville Kent Asset Management and a top-drawer stock picker, especially in financial services.

Mr. Donville has led his flagship Capital Ideas Fund to a gain of 88 per cent since inception in 2007, versus 5 per cent for the TSX/S&P composite as of September.

Picking Targets

Mr. Donville's first pick as a takeover target (not necessarily by a big Canadian bank) is Carfinco , which his fund owns as do I. Readers of this column will know that this firm specializes in lending to non-prime used-car buyers. It's been an excellent performer, especially if you bought it during the selloff of 2008.

The fund, Mr. Donville asserts, is already for sale and he believes a bigger U.S. specialty lender will do the deed. Mr. Donville interprets management's actions and comments as strong hints that a sale will come relatively soon, within a year likely.

Other rationales include the fact that two other such lenders have been taken out for a nice premium and that it's cheaper to buy Carfinco, which is superbly run, than to replicate its model from scratch and compete with it.

His second pick is Gluskin Sheff , money manager to the wealthy, and a name in his fund. This is one that Mr. Donville believes a big bank might buy and he thinks the principals are ready to sell. "Ira is selling down," he says, referring to the legendary investor Ira Gluskin. He also believes that Gerry Sheff is ready to move on.

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Gluskin Sheff has scarcity value, Mr. Donville argues, with a very valuable private wealth franchise. It's not just another mutual fund company, "it's generational money. They meet with the parents and the children. It's very sticky revenue."

DundeeWealth, he points out, was just taken out by Bank of Nova Scotia.

His third pick is Guardian Cap. , which also manages money for the wealthy and for institutions.

"John Christodoulou [the CEO and a shareholder]was shopping it at the end of the last cycle," Mr. Donville says. Nothing happened because of the market meltdown but he thinks Mr. Christodoulou will be keen to sell before this cycle ends.

Guardian sold its mutual funds to Bank of Montreal several years ago for bank stock, which it still owns.

Next up is Equitable Group , which makes mortgage loans. The firm's patriarch and chairman, Austin Beutel, is getting on, Mr. Donville reasons, and might be ready to sell, just as Ned Goodman was ready to sell Dundee. "These guys are all from the same generation and there's a real sense that they're wrapping up their affairs."

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Potential Buyer

As for a potential buyer he points to Canadian Western Bank. "Whenever things start booming in the West, as they are now, CWB drops hints about moving east. Equitable's stock is cheap so even with a healthy premium it's accretive" to a buyer.

Interestingly, Mr. Donville doesn't think Home Capital , Equitable's more successful archrival, is a target. He made his name picking this stock a decade ago and knows the business better than any other outsider. It's the biggest holding in his fund (I own this one too). The company's return on equity is so high it trades at a big premium and banks don't like to pay much more than book value or close to it.

Rounding out his top targets are the two big independent investment dealers, Canaccord and GMP .

Both firms have been very successful raising money and selling stocks, he says, "but there's not that much more they can do in equities. At some point you need a bank."

It should be noted that GMP has ties to Richardson Financial Group, which may complicate things. But it doesn't preclude a deal. Richardson has sold a brokerage firm to a big bank before.

Mr. Donville is quick to point out that he doesn't invest in a company based solely on the prospect for a takeover. He buys good, usually smaller businesses that, by definition, are takeover targets or can become one. These stocks should be able to make investors money whether they are acquired or not.

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About the Author
Investment Columnist

Fabrice Taylor, CFA, publishes the President’s Club investment letter, for which he and The Globe and Mail have a distribution agreement. More

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