It's the word that haunts Don Stewart: "Credibility." Too many investors think he lacks it, which is part of the reason Sun Life Financial trades at a discount to Manulife.
Credibility is what CEOs get when they say they're going to do something, then do it. Mr. Stewart, a hard-working Scot who has been Sun Life's top executive since 1998, has a monster problem in MFS Investment Management, its U.S. mutual fund division. He vowed to fix it, hired bankers to shop it, and came away with dust. The failure, says National Bank Financial's Rob Wessel, "will have a negative impact on" -- here's that word again -- "management credibility."
So the new company line is that Sun Life is going to keep MFS and manage it better. That's fine, but don't count on that as the long-term solution, because so far, Boston-based MFS appears unmanageable, at least by a remote shareholder in Toronto. Mr. Stewart may have decided that the cost of divorce is too high right now, but let's be clear: This is not a healthy marriage, and Sun Life is not done trying to get out of it.
Why can't these two just get along? Because any happy couple has to want the same things, and Sun Life management and MFS brass don't. Sun Life, as the 98-per-cent shareholder of MFS, wants profitability to be as high as possible. MFS's well-fed managers, as owners of the other 2 per cent, may care less about earnings and more about other things. Compensation, for instance. By some accounts, the pay scale is very rich at MFS, even by the usual grotesque standards of the money management business.
This is more than a matter of opinion. In a business where pay is by far the biggest expense, MFS's profit margins, to use the technical term, stink. Yesterday, Sun Life said MFS made about 30 cents in profit, excluding taxes for every dollar of revenue in the third quarter, a dandy improvement from previous quarters. But that's still weak compared with most of the competition. T. Rowe Price made 46 cents (U.S.) per dollar of revenue over the past 12 months, according to data from Standard & Poor's Capital IQ. Nuveen Investments, one of the companies that looked at MFS, makes a similar margin.
But fat paycheques are just one element of the MFS managers' sweetheart deal; they also hold a hammer in any takeover. On a change of control, they are entitled to a 20-per-cent cut of the value (Sun Life has not formally disclosed this arrangement). Plus, there's the usual fear about how the money managers will leave and take assets with them -- though given the mediocre performance of MFS funds, perhaps Sun Life should let them try.
You can see the conflicting priorities here. Sun Life, having failed (for whatever reason) to grab a firmer hand on the operation, needs to outsource its MFS problem to someone else. That means it wants to sell to a strong partner -- a U.S. player with the guts to walk into Boston and start firing people. Sun Life would ride along as a significant shareholder, replicating the formula it has used in Canada with CI Financial.
But if you are an MFS manager, your interests are the opposite. You'd prefer that nothing disrupts your comfortable existence. But if the firm must be sold, you'd rather it went to someone who's weak in asset management -- a player who would need your expertise. Wachovia, a rumoured buyer last week, likely fit the bill from MFS's point of view, but not Sun Life's.
What you've got here is an untenable situation. Mr. Stewart may have been right to walk away from a bad deal, but he has merely deferred the problem. He'll still have to sell a chunk of MFS -- if not to another fund company, then to the public. It will give him better earnings, a better stock price and something else, too. It's called credibility.
© 2007 The Globe and Mail. All rights reserved.
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