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What’s CI worth? We’re about to find out

The Scotiabank branch at 2080 Queen St. East in Toronto's Beach neighbourhood is photographed on March 5, 2014.

Fred Lum/Fred Lum/The Globe and Mail

The opening bell will be a referendum on Bank of Nova Scotia's plan to sell a $3.8-billion stake in CI Financial Corp., as there is a significant divergence of opinion on what the bank can get for the shares and the market is going to play a big part in settling that.

Bank of Nova Scotia last week told CI it planned to sell, and that one option was doing a secondary offering to shareholders of some portion of its 37 per cent stake. CI's message back was that the market would choke on such a transaction, and it would cripple CI's share price.

After a week of delay, Scotia said last night it would go ahead with a "monetization" of some or all of its stake. That left the door open to a sale to a strategic buyer, or a sale into the market. Now investors must decide whether they think CI is worth more because of this decision (as an analyst at Barclays suggested) or whether CI is worth less because Bank of Nova Scotia is never going to buy the rest of the company as some thought it would.

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GMP Securities analyst Stephen Boland believes the stock could drop significantly, approaching $30, or about 20 per cent below Wednesday's close.

The crux of the issue will be whether Bank of Nova Scotia can attract interest from another strategic buyer. On the positive side, CI is fast growing and large and in the money management space, an area that other financial institutions covet. On the other side, CI trades historically at a premium to many other asset managers in Canada and the U.S. and its size (a market capitalization of $10-billion) limits the potential range of buyers. For example, Canadian Imperial Bank of Commerce would probably love the idea of owning CI, but it would be a big bite for CIBC. With a takeover premium, CI's market capitalization would approach a third of CIBC's. Another wrinkle is that CI's shareholder rights plan prevents any one buyer from taking more than a 20 per cent stake in CI, which represents a little more than half of the stock on offer. Anyone who wants to own all of CI will have to work around that.

"There is not a long list of potential buyers, in our view," CIBC analyst Robert Sedran said. "In addition, we suspect that whoever buys this stake might like to see a path to control."

Banks are interested in increasing wealth management, but they would have the same issue with tying up capital in a minority stake in CI that Scotia currently faces – that comes with punitive implications from a regulatory perspective unless they can own all of the company. And buying all of CI is expensive and comes with a huge chunk of goodwill that would be dilutive to earnings for the buyer. Life insurance companies would be a stretch given the size. As for foreign buyers, they "are always a possibility, but this is not cheap asset and much as we love our country, there is no burning desire to enter Canada for many foreign asset managers at this time," Mr. Sedran said.

If the market believes there is a strategic suitor out there willing to take the maximum possible stake as a prelude to a full buyout, CI stock could trade strongly. Barclays analyst John Aiken predicts that is possible, saying in a note "a scarcity premium is conceivable and we would not be surprised to see a positive reaction in CI's share price."

But if the market doesn't believe that suitor is out there, and assumes that Bank of Nova Scotia will have to sell the shares to the public in chunks, then look for CI to trade down. A stock offering of that size will demand a discount to the current market price, and the fact that it likely could not all be done in one sale will create an overhang. There is also the issue that this has clearly reopened old wounds between Scotia and CI and may well cause the business relationship between the two to suffer.

A drop in CI's stock is a risk that Canaccord Genuity's Scott Chan raised as well as GMP's Mr. Boland.

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"Our $30.00 short-term expectation removes any takeover premium, the value for access to a bank channel and accounts for possible short selling," Mr. Boland of GMP said in a note to clients. "We are placing our long term target and recommendation "under review" and we would be wary of buying the stock in the short term until this trade occurs. Hopefully, it does not occur in a series of transactions which would only prolong the overhang."

On the other hand, analysts so far are saying they like the idea from Scotia's perspective.

National Bank's Peter Routledge raised his recommendation to outperform from sector perform and boosted his target on Bank of Nova Scotia stock to $73 rom $68, saying Bank of Nova Scotia now has the potential for a much higher return on the capital that is tied up in the CI stake. Mr. Sedran of CIBC said that in the long run, moving capital from the CI stake to Bank of Nova Scotia's international operations will improve returns, but it will take time and he's not moving his numbers for Scotia just yet.

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