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Tuesday, August 1, 2006

MFS: A Time to Acquire?

Reported by Neil Anderson, Managing Editor

What should Sun Life do about MFS? Should Sun Life sell MFS, or should MFS instead be merged with another fund family? According to industry insiders, the Canadian insurance giant has been asking itself those question for some time now. The answers found by listening to the grapevine are all over the map.

MFS' troubles began back in 2003 with Eliot Spitzer and the SEC, and the resulting penalties. But the pain was more than fiscal. The market-timing scandal cost the asset manager in three other ways. First, it forced out MFS' top two executives, then-CEO John W. Ballen and then-president/chief investment officer Kevin R. Parke. Second, it gave the MFS team two extremely watchful eyes, Spitzer and the SEC, to look over its shoulders.

Last, and perhaps most importantly, the market-timing scandal tainted MFS in a way that still has yet to subside. MFS is a victim of a "Google Effect"; it is trying to outrun a public disgrace that is now eternally ingrained in the world wide web, forever easily accessible through your favorite search engines. Since 2003, MFS' sales people have found themselves treading water instead of expanding AUM.

MFS' troubles have emanated from non-Spitzer sources as well. Bill Scott, MFS' long-time head of distribution, retired, to be replaced by Martin Beaulieu. According to industry insiders, MFS has lost a lot of talent in the last several years, and, sour grapes or not, at least some of that has been blamed on the loss of Scott and the ascendence of Beaulieu. Just within the last two weeks the firm has eliminated five distribution positions, several through firings and several through reassignments.

All of this brings us back to the initial question: what should Sun Life do about MFS? While an MFS spokesperson declined to comment for the story, a recent Morgan Stanley report to Sun Life Financial Inc. answered that question by using another question for its title: "Should MFS be sold?" The analysis, submitted at the end of May, outlines three options open to Sun Life: let MFS "grow organically", spin off part of MFS in an IPO, or sell MFS outright. The memo claims that organic growth is possible, but could take too long (roughly three years), while an IPO would not increase MFS' scale. A sale, then, arises in the report as the "most likely option".

This conclusion, however, ignores Sun Life's special position as one of the three largest (it's number two) insurance companies in Canada. Its two rivals, Great-West and ManuLife, are both big players in the US asset management scene, and they are Sun Life's true competitors (thanks to an agreement with the Canadian government, hostile takeover is not one of Sun Life's fears: for a Canadian interest to buy more than 20 percent of the company, or for a foreign interest to buy more than 10 percent, requires prior government approval).

Earlier this year, Sun Life refused to let MFS' defined contribution recordkeeping arm, MFS Retirement, go, so the insurer transferred MFS Retirement to its own direct control. Why? Because ManuLife (through John Hancock) and Great-West both have US recordkeepers. By the same logic, Sun Life cannot afford to simply write off the entire US mutual fund market, particularly when MFS still helps out their bottom line. Additionally, the tax ramifications of selling business Sun Life bought years ago for only $83 million would be enormous, and what would do with the left over money besides roll it into a different acquisition? One source was so certain that Sun Life would not sell MFS, he was willing to cast it in stone.

This leaves a final option not considered in the Morgan Stanley memo: increasing MFS' scale through acquisition. Sun Life could purchase another fund company and merge it with MFS, potentially shifting around management teams and adding strong growth funds, and possibly even rebranding the combined company so as to avoid the tell tale signs of Spitzer (a painful task, to be sure, given the history associated with the name of MFS, the oldest mutual fund company in the US).

What type of fund company might Sun Life be looking to merge with MFS? The picture that emerges is one of a broker-sold fund company, a company that needs MFS' distribution, a fund family with strong growth funds and owners looking to sell, with a strong management team and experience with acquisitions. Insiders speculated on numerous possible targets for such a merger, including AllianceBernstein, Davis, Eaton Vance, Federated, Oppenheimer, Putnam, T. Rowe Price and Van Kampen.

One name, however, comes up again and again when discussing a possible MFS merger: Janus. The Denver fund shop, insiders say, has the growth funds and the management team Sun Life might be looking for, and acquiring it would push MFS into the top seven asset managers in the country. Janus does share the taint of Spitzer with MFS, but Sun Life could give the combined firm a new name entirely.

In Sun Life's eyes, one insider told the MutualFundWire, Janus has its own share of problems, while MFS lacks much experience with mergers and acquisitions. Sun Life may be willing to wait it out, hoping that problems MFS will settle down or that asking prices will drop. Or perhaps management shifts are on the horizon for the fund firm. One thing appears certain, though: Sun Life is not willing to let things continue "as is" at MFS. Change, one way or the other, is coming. 

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