GMP Research discounts AGF takeover bid

It’s not just BMO and RY that are flying! Since so many of your own units in their funds, here is some sober analysis from the equity research team at GMP Securities regarding the takeover spec at AGF (AGF.B:TSX):

AGF has increased nearly 28.8% this week. We would highlight the major factors that are contributing to this increase in our opinion. We believe the move in the stock can be warranted from a fundamental perspective as the risk to a dividend cut and losses in the Trust diminish as the market improves. Beyond fundamentals, investors will need a longer term view if a takeover is being priced in the short term.

We believe there has been rampant speculation that a sale of AGF is going to occur in the short term. We disagree with this premise. We do not believe that a sale would occur in the next 12 months. Over the longer term it is certainly a possibility as the industry landscape continues to evolve. The mutual fund industry is going through a turbulent period and it is too early to tell how the non-bank independent firms will compete against the bank over the next several years. If investors are buying AGF for the possibility of a quick sale we believe that momentum will be lost over the next several weeks. Over the next year we believe a good indicator of the Goldring family intentions will be their actions on the ‘B’ shares. Meaning, if the Goldrings end up selling some ‘B” shares into the market, we do not believe a company sale is imminent.

Behind the takeover speculation, the stock could be increasing mainly due to the increase in the market.

Since the end of February, the S&P/TSX Composite index is up 15.0%. In March alone the index increased 7.4%. The market increase will be reflected in AUM increase which will most likely be ahead of our quarterly forecasts. We typically model a 1.5% to 2.0% per quarter increase in AUM. If the market holds at the current level, AUM in April could increase 3% to 4% (assuming no material redemptions). This type of early material increase in AUM can have significant implications for EBITDA six or seven quarters in the future. More importantly, we believe as the market continues to increase it reduces two key risks that have been on the minds of investors over the past 6 months.

As the AUM increases, so does the free cash flow the firm generates. For the quarter ending February, AGF did not generate any free cash flow due to year end accruals being paid out as well as the lower
AUM balance. Free cash flow including non-cash balances was a negative $6.5 million. Excluding changes in non-cash balances free cash flow was a modest $6.0 million. Debt went up $53 million and
this was used to assist in paying the $0.25 per share dividend.

Normally, AGF generates free cash flow for the remaining 3 quarters of the year as accruals commence once again. We believe as the market
increases the dividend becomes more secure and places less strain on the balance sheet.

A major concern for the market over the past six months was the investment loan portfolio in AGF Trust. The investment loan portfolio was $1.8 billion and the underlying funds which were the major portion of collateral for these loans had fallen. The deficit at the end of August 2008 was $174 million. At the end of November this had grown to $600 million and $700 million at the end of February. The indie is currently at 9,300 and which compares to the market at November (9,200). This could imply the deficit has shrunk to less than $600 million. As the market increases, this deficit will reduce and the risk of AGF having to inject more capital into the Trust or even selling it through a distressed sale. Although we believe the market places little value on the Trust, this may change as it continues to generate profits and book value remains more secure.

On April 6th, AGF announced that it was moving its investor day, originally planned for April 8, 2009 to May 14th, 2009. The reason given for the postponement was pending organizational changes.
AGF has been focusing on reducing operating costs for several months. However, we believe when the company specifically states organizational changes are forthcoming this could imply changes to operating divisions or management changes.

Over the past several months, we have resisted the inclination to reduce targets on asset managers in general to a point where in the event of a modest rally in the stock market the targets would be
exceeded. Our approach has been to focus on balance sheet items and less on the relative EBITDA multiples that have been applied over the past 5 or 10 years. In our opinion, stating that AGF is trading a certain percent below or above its 5 year average really doesn’t apply in the market place when historic lows were being tested each week.
We have not attempted to ‘call’ the market but have left our targets to include the possibility that a quick movement upwards in the market would be reflected in higher AUM and EBITDA estimates. In the short term, relative multiples appeared expensive and unrealistic but that has quickly changed with the increase in the markets. Bottom line is that we believe the group was oversold and reiterate that when
markets increase, the asset manager group is the best performing financial sector from market bottom.

For this reason, we continue to have a BUY on AGF and maintain our target price of $13.50 which is based on EV/EBITDA multiple of 5.5 times on our F10E EBITDA for AGF’s investment operations, with an adjustment for distribution fees paid to limited partnerships. In addition, we apply a 1.0 times P/B multiple on our 12-month forward BV estimate for AGF Trust.

MRM