Quick Pitch: CI Financial (CIX:TO)

Odd-Lot Tender Offer – C$155 Upside

CI Financial launched a tender offer to repurchase 3% of outstanding shares at C$15.50/share. CIX currently trades at C$14.13/share. The offer includes an odd-lot priority and is set to expire on July 8. On top of that, shareholders of record (as of June 28) will also receive a C$0.2/share dividend.

Investors who are not subject to Canadian withholding taxes can pocket C$155 per odd-lot account.

The opportunity is actionable (yet less profitable) even for shareholders who would be liable to pay withholding tax. Paid-up capital stands at C$10.73/share. Adjusted for the tax, the profit per odd-lot account would amount to C$84.

Management owns 15% and is not planning to tender any shares. They haven’t participated in the previous two recent offers either:

• November 2023 – CIX offered to buy 4%-4.5% of outstanding shares at a price range of C$13.64-C$15.28/share. The tender closed at the upper limit of C$15.28/share and was oversubscribed with the proration at 82%.
• February 2024 – the company tendered for 3.11% of outstanding shares at a price of C$17.5/share. The tender was materially oversubscribed and the proration stood at 38%. During the tender period, CIX traded between C$16.9-C$17.3/share, so quite similar to the offer at hand.

Given the number of buybacks over the last year, CIX has also caught my attention as potentially interesting longer-term investment. This VIC pitch from Dec’23 also argues that sum of the parts value of CIX is C$24-C$29/share. However, upon further research, I’ve decided to limit my involvement to this tender play only. Below I am sharing my notes on the company.

 

CIX as a longer term investment

CI Financial operates across 3 business segments: Canadian Asset Management (C$130bn in assets under management), Canadian Wealth Management (C$94bn) and US Wealth Management (C$222bn). The US segment was created in 2021, when CIX acquired 15 registered investment advisor firms along with two alternative asset managers. This move has substantially levered up the company. The company executed 6 more deals in the US in 2022 and 3 in the last year. The company generates revenue through management fees. All segments have exhibited steady revenue growth (albeit largely through M&A) and substantial free cash flow generation.

For years management has been arguing that CIX is undervalued. Therefore, the company has been buying back tons of stock. Over the last five years, CIX has returned C$2.5bn to shareholders through buybacks and dividends (vs current market cap of C$2.2bn). Over the same period, share count was reduced by 32%. CIX chairman has also been aggressively buying shares in the open market and has acquired C$127m worth of stock since the beginning of 2023. His stake is now at 7.2%.

CIX also has a potential upcoming catalyst – the carve out/IPO of the US Wealth Management business. Management has been talking openly about this for a while. Last year, CIX issued US$1bn worth of preferred shares, convertible into 20% of the equity of its US business. With the issuance of these preferreds, management seems to have committed themselves to carving out the US Wealth Management business within a specified timeline.

If the IPO of the US segment occurs within three years from the issuance date, the preferred shares will convert into the greater of a 20% common equity stake in the US Wealth business or a Fixed Return Price. The Fixed Return Price would be 1.5x the original issuance price, which amounts to US$1.5bn. If the IPO does not materialize within the initial three years, the Fixed Return Price will incrementally increase to 2.25x, reaching US$2.25bn over the next three years. Should the IPO fail to occur within approximately six years from the preferred issuance date, a 15% penalty dividend will begin to accrue. Additionally, starting from the beginning of 2030, preferred holders will have the right to seek a buyer for the US Wealth business and will be able to force CIX to initiate a sale.

These terms imply that the whole US Wealth Management segment could be worth C$10bn in two years (US$1.5bn * 5). In turn CIX’s stake could be worth around C$8bn, equal to the current enterprise value of the whole company.

As of the latest quarter, CIX management has already separated US Wealth Business (i.e. operations, governance, ability to raise financing, etc.) in preparation of the eventual carve-out.

While these bullish arguments for the company seem compelling, I’ve grown more cautious upon deeper analysis. Here’s why.

The company is extremely levered. The reported net leverage (net debt/adj. EBITDA attributable to shareholders) stands at 3.5x. However, this doesn’t include the preferred equity, substantial M&A/contingent payment liabilities and leases. When these factors are counted in, the actual net leverage rises to 5.8x. With that level of leverage, the company’s current valuation of 8.1x adj. EBITDA doesn’t exactly look like a screaming bargain.

The implied C$10bn valuation target for the US segment also seems too far fetched. The segment has generated C$68m adj. EBITDA as of the latest Q1, which amounts to C$264m annualized. At 13x adj. EBITDA multiple (in line where peer Focus Financial Partners got acquired at last year), the segment would be worth C$3.4bn. That also doesn’t account for the pref. equity liabilities. To come even close to C$10bn valuation, the business would have to show massive AUM growth and pull-off a very aggressive M&A spree in the next few years, which doesn’t even look feasible with the current leverage.

While management continues to emphasize M&A during the calls, such aggressive expansion may not necessarily align with shareholder interests. For example, management has just repurchased it’s 4.1% interest 2051 notes at 0.66x PAR value. The transaction was financed with new 7.5% 2029 notes. While this refinancing slightly improves CIX’s leverage ratio – likely a key motive to facilitate more acquisitions – it also negatively impacts the debt maturity timeline and increases the interest expense on this debt from US$36m to US$50m.