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CI Financial CEO Kurt MacAlpine, seen in 2019.Tijana Martin/The Globe and Mail

Three analysts have downgraded CI Financial Inc. CIX-T after concluding that a seemingly triumphant financing deal will be far more costly than initially believed.

“After reflecting on events of the past week, we have arrived at the same conclusion the market has: our initial interpretation of the investment in the U.S. wealth platform was flat-out wrong, and the investment actually reflected a higher cost to CI shareholders than it first appeared,” CIBC World Markets Inc. analyst Nik Priebe wrote Monday as he published a downgrade to “neutral” and a sharp cut in his target price from $19 to $13.50 a share.

BMO Nesbitt Burns Inc. analyst Tom MacKinnon took a similar step Friday, cutting his rating to “market perform” with a price target of $17, down from $19. Barclays Capital’s John Aiken also cut CI Friday to “equalweight” and reduced his target price from $21 to $19.

All three analysts’ moves were the equivalent of cutting from a “buy” to a “hold.”

CI, a Toronto-based investment management firm, made an explosive announcement Thursday that seemed to vindicate chief executive Kurt MacAlpine’s U.S. wealth-management expansion strategy, revealing that a group of sophisticated investors were buying 20 per cent of its U.S. business in preferred shares for $1.34-billion.

CI said the deal valued the U.S. business at nearly three times the company’s entire $2.3-billion market capitalization on the Toronto Stock Exchange at Wednesday’s closing price of $12.50 a share. Shares initially jumped by 50 per cent.

“At the outset, the investment in CI’s U.S. wealth platform appeared to be a home run,” Mr. Priebe said.

CI Financial selling stake in U.S. wealth business to pay down debt

As Thursday’s trading continued, however, the share price began to slide, and it collapsed Friday to nearly the predeal levels. The swoon in CI’s share price has left its shares shockingly cheap: According to S&P Global Market Intelligence, the stock trades at less than four times the estimate of the company’s next 12 months’ earnings per share, and a little more than six times its EBITDA, or earnings before interest, taxes, depreciation and amortization.

The key to the decline could be found in the 184-page document of legal agreements CI filed with regulators Thursday morning. It revealed the investors had a “preferred liquidation preference”: a guaranteed price for the preferred shares if the company’s U.S. business did not complete an initial public offering of a given size, by a given time. The price guarantee implied an annual rate of return for the new investors of at least 14.5 per cent on the preferred shares.

Mr. MacKinnon had rated CI shares “outperform” since February, 2018. Mr. Aiken had CI at “overweight” since November, 2020. Mr. Priebe, who initiated his coverage in January, titled his downgrade report “Better Late Than Never.”

CI did not return a request for comment.

CI’s stock has languished as investors have worried about whether the company’s U.S. wealth-management business, built from scratch over the past three-plus years, will generate the profits needed to justify the cost. CI spent $2.85-billion assembling the wealth managers, running up its debt levels to $4-billion in the process.

Mr. MacKinnon said in a report that he believes that for CI shareholders to maintain their 80-per-cent ownership in the U.S. division, the U.S. business must increase profits at the same 14.5-per-cent minimum rate the preferred-share investors will earn each year. His forecast calls for profit growth in the U.S. business to fall to single digits by 2025.

He estimates shareholders of the Canadian parent will end up owning 55 per cent to 60 per cent of the business, as a result of the guarantees given to the preferred shareholders.

If CI has not completed an IPO of the U.S. business by 2030, Mr. MacAlpine told analysts on a conference call Thursday, the new investors “do have a liquidation preference to ensure that they have an ability to get their capital back and return to their shareholders at terms that are fair and reflective of the value of the business, whether we IPO or take a different route.”

Analysts quizzed Mr. MacAlpine about the terms of the deal, but didn’t get the exact numbers until they reviewed the legal agreement.

Not all analysts reacted so negatively. RBC Dominion Securities Inc. analyst Geoffrey Kwan raised his price target from $18 to $20, but maintained his hold rating. Six of the 10 analysts covering CI now rate it a hold, according to Bloomberg. The other four maintained their “buy” ratings, with target prices ranging from $16 to $23. The highest price target implies an 80-per-cent return for CI shares.

Scott Chan, of Canaccord Genuity Corp., said while the cost of the preferred shares “initially seems steep,” his math suggests the investment could drive significant profit growth, potentially exceeding the minimum 14.5 per cent the investors will receive.

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