Power Corp. Puzzle
PAUL CHIASSON/THE CANADIAN PRESS
The Desmarais family’s Power Corp. empire has been treading water since the financial crisis. Now, as a third generation gets ready to take the reins, investors are losing patience. Can one of Canada’s most influential families return the country’s biggest conglomerate to its former glory?
Power Corp. Puzzle
On a cold November Monday morning, two top executives from Power Corp. of Canada sat down in the Royal Bank of Canada’s gold-windowed south tower in Toronto to begin a day of Bay Street’s equivalent of speed dating.
Over the course of the day, representatives from 17 institutional investment firms filed into a lakeview meeting room. Most huddled at a small, round table, where the Power brass took the investors through a 40-minute presentation with 39 PowerPoint slides and one goal: to persuade them that the Desmarais-family-controlled conglomerate’s best days are still to come.
A few of the visitors got lunch. Some were served only a glass of water.
John Hadwen got the water. A vice-president at CI Investments’ Signature Global Asset Management, Mr. Hadwen’s firm is one of Power Corp.’s largest shareholders, and he was in little mood to be wooed. Montreal-based Power sits atop a vast global empire with $1.5-trillion in assets under administration, but the company’s share price has drifted sideways for the past decade. Actually, it’s worse than that: Ten years ago the stock traded for more than $40; now it’s $32.81. “They have been too patient. They need to do more to deliver shareholder value,” said Mr. Hadwen.
After the session, Mr. Hadwen felt sure his message had been heard clearly. “They are feeling the pressure,” he said.
This kind of pressure is an unusual feeling for the Desmarais clan, corporate Canada’s version of royalty. Beginning in the 1950s, family patriarch Paul Desmarais Sr. showed a Midas touch, presciently assembling huge holdings in growing businesses such as life insurance and mutual funds in North America, along with a large array of investments in Europe and China. He cleverly cultivated politicians, policy-makers and business partners to help him along the way. He also assiduously groomed his sons, Paul Desmarais Jr., who is 63, and André Desmarais, 61, to take over from him as co-CEOs of Power in 1996.
Even now, four years after Paul Sr.’s death, the Desmarais name is synonymous with influence at the highest levels; Paul Jr. and André were at the top of this year’s version of the Report on Business Magazine Power 50 list, three spots ahead of Prime Minister Justin Trudeau. But at the same time, the second and third generations of the Desmarais family, collectively worth more than $8-billion, face a what-have-you-done-for-me-lately challenge from investors.
The boys, as many investors and analysts still call the two sons, rarely speak publicly. Jeffrey Orr, CEO of Power Financial Corp., the company immediately below Power Corp. in the organization chart, is often the front man. (He and Power Corp. chief financial officer Gregory Tretiak did the pitching to investors in Toronto.)
After 16 years with the Power group, and two decades spent covering it as an investment banker before that, Mr. Orr has seen it go through periods of slow growth and market skepticism before. Still, in an interview at Toronto’s Shangri-La hotel the day after his pitch marathon, one oft-repeated phrase touched a nerve.
“At our institutional meetings yesterday I heard the words, ‘Is there a sense of urgency?’ by a number of the institutions. And at first I was kind of shocked – no sense of urgency?” Mr. Orr said, as he got up from a conference room table after a nearly two-hour interview with The Globe and Mail. “When I hear that, I just go ‘Wow.’ Like, do you have any idea how hard people are working?”
Mr. Orr, whose parted brown hair with only a faint sweep of grey gives the impression he’s a bit younger than his 58 years, insists that there is a strategy to reignite the Power group. The game plan is based on embracing new technology, returning to the bold dealmaking that was Paul Sr.’s legacy and doubling down on the Desmarais way of doing business – using relationships to unearth investment opportunities.
But the world has changed a lot since 1996. Technology and consumer tastes are shifting rapidly, and the financial services sector is facing its equivalent of a Netflix moment. Most of the great Canadian business dynasties that have thrived for the long term have done so by adapting to changing times and circumstances. The Thomsons switched to specialized publishing and information services and sold virtually all of their newspapers (though they still own The Globe and Mail); the Westons did a massive overhaul of the Loblaw chain and expanded into drugstores; the Rogers family shifted focus from media to cable television to wireless.
One lesson is already clear: Just playing defence is rarely enough.
The Desmarais’ family trust maintains control of its vast global portfolio of public and private companies through their 59-per-cent voting stake in Power Corp. That majority is made possible by multiple voting shares that carry 10 votes for each share; they own about 21 per cent of the equity.
Power, in turn, controls Power Financial, which holds majority stakes in two publicly traded pillars of the family business: Great-West Lifeco Inc. and its subsidiary life insurers, and IGM Financial Inc., the asset management and mutual fund giant. Those two businesses help people save and plan for their future, and they work mostly through networks of more than 13,000 full-service insurance agents and financial advisers.
In addition, Power has large holdings in Europe and China, established and nurtured by Paul Desmarais Sr. in the 1970s and 1980s. In Europe, through a long-standing partnership with the family of Belgian financier Albert Frère, the Desmaraises have held investments in mining, cement, French oil giant Total, sporting good giant Adidas and spirits maker Pernod Ricard.
Back in North America, Power also controls a smattering of green energy businesses and media assets, which include Quebec’s La Presse, and the small but fast-growing new online investment service, Wealthsimple Financial Inc.
Analysts say that the total value of Power’s operating businesses and investments is far greater than the company’s stock market capitalization of $15.2-billion. The shortfall is a so-called holding company discount—the parts are worth more than the whole. That’s common among conglomerates, but analysts argue that Power’s discount is made worse by family control. Minority shareholders have little influence over management, and virtually no ability to force change.
After watching the stock stumble for a decade, many of those minority shareholders want to see the share price finally go up. But the Desmaraises are not easily moved, and are said to place a higher value on stability and steady dividend income.
Investment banks have floated a variety of restructuring plans over the years to reduce or eliminate Power’s holding company discount. The board has consistently turned down any arrangement that would remove the family’s control. Power executives argue that the long-term thinking and relationships that come with the existing ownership structure are an enduring competitive advantage.
“We have a different approach here, which is that we have a family that goes out and builds these long-term relationships. And they create networks, and the networks create investment opportunities,” Mr. Orr said, adding that this skill is particularly useful in Europe and in China.
Activist shareholders tend to oppose these dual-class share structures, and if large institutional investors get restive, they sometimes join them. At Power Corp.’s annual meeting last May, some institutions quietly made their views known in annual elections to the board of directors. Independent directors and Mr. Orr garnered 98 per cent-plus support, but André Desmarais and Paul Desmarais Jr. received about 85 per cent – including their own large block of votes. Shareholders who collectively owned more than 100 million shares voted against them, a meaningful statement.
Of course, Power Corp.’s organizational chart has been tangled and layered throughout the company’s storied history. Paul Desmarais Sr. started building the empire in the 1950s when he dropped out of law school to take over his family’s struggling transport business, Sudbury Bus Lines. In the 1960s, he acquired holdings in utilities, newsprint and life insurance. Over the next two decades, he transformed what was an amalgamation of dozens of mediocre businesses into 15 to 20 market-leading operators.
For decades, the company had a visionary leader and a talented dealmaker at the helm. Power bought Great-West in 1969; Paul Desmarais Sr. led one of the first Canadian trade delegations to China in 1978. In 1986, long before the mutual fund boom of the 1990s and far ahead of the big banks, he expanded into asset management by buying Investors Group.
By 1996, when he named his sons as his joint successors, Power Corp. had grown into a huge conglomerate. Corporate assets had ballooned from $165-million when he took over in 1968 to $2.7-billion, while net earnings had increased from $3-million to $209-million.
Power soon got much bigger. In 2001, the Desmaraises beat out CI Investments to buy mutual fund manager Mackenzie Financial Corp. for $4.2-billion, which they then folded into IGM, along with Investors Group. The family also pushed further into the life insurance sector, which was demutualizing and consolidating, with the $3-billion takeover of London Insurance Group in 1997 and a blockbuster $7.3-billion deal for Canada Life Financial in 2003.
Today, Power has $1.5-trillion of assets under administration, while last year’s net earnings were $1.1-billion.
Paul Desmarais Sr. also wanted his sons to gain overseas experience. Paul Jr. spent several years living in France, deepening ties to the family of Belgian financier Albert Frère and other leading European business families and politicians. André Desmarais made regular treks to China, building on the relationships his father forged.
But Paul Desmarais Sr., who died in 2013, also imbued the boys with a conservative approach to risk-taking. At times, that conservatism served them well. Great-West was more cautious in its investments and expansion than rival insurers and was spared the worst of the 2007-08 financial crisis, which pushed competitors such as Manulife Financial Corp. to shore up capital and American International Group Inc. to the brink of collapse. Great-West’s revenues and profits held up better, and in 2013, it acquired Irish Life Group in 2013 for $1.75-billion, a deal that has been a success.
But big moves like that have been rare since the crisis. Critics say Power has become more passive and shareholder returns have sagged.
Over the past 10 years, Power Corp.’s total shareholder return has been a modest 23 per cent, or 2.1 per cent annualized. All of that has come from dividend payments – $5-billion in the past decade – rather than share price appreciation. Other blue-chip Canadian financial stocks have generated much bigger returns: 188 per cent for Brookfield Asset Management Inc., 184 per cent for Royal Bank of Canada.
Great-West has lagged almost every other major Canadian financial services stock this year; both it and IGM Financial have had to book large charges recently for restructuring costs.
“I think that the needle has moved significantly more towards preservation than innovation,” John Aiken, an analyst with Barclays Capital, says of Power Corp.’s management style. Even when Power executives have promising new ideas, it’s harder for them to have an impact now that the group is so big.
“You could make the argument 15 years ago that absolutely you could be excited about Power in terms of its strategic vision,” says Mr. Aiken. “But because there has been a lack of movement and some missteps on operations, that is no longer the case.”
The biggest problem with preservation as a strategy nowadays is the d-word: disruption. There is so much upheaval in the insurance and investment businesses that doggedly carrying on as before is no longer an option.
The Desmaraises are facing two big fundamental challenges in investment management and insurance. The first is an economic one: Chronically low interest rates and inflation have made it harder for active asset managers to generate superior returns. When rates are low, insurers also struggle to eke out gains on their large bond portfolios, while regulators require them to keep more capital on hand to meet future obligations.
The second major issue is that consumer preferences are shifting rapidly. Young consumers in particular want to manage their finances online cheaply and at their convenience, and many view old-school insurance agents and investment advisers as hucksters and salespeople.
Traditional, actively managed mutual funds that Investors Group and Mackenzie sold so successfully in the 1990s are also struggling. Why pay a yearly fee of 2 per cent or more to an adviser and a fund company if the money manager rarely beats the market, and the expenses on competing exchange-traded funds (ETFs) are many times lower, often just a few basis points? That’s one reason IGM’s growth has been so slow over the past decade, with assets under management rising from $123-billion to $150-billion since 2007.
These are industry-wide challenges, of course. But Power has been slower than some of its competitors to adapt to the shifts. And both Great-West and IGM seem to be caught up in restructuring woes.
Both companies are now on a three-part mission to boost their value. The first step is to upgrade to the range of products and services they sell and deliver them to customers in a painless way. The second is to lower costs, using technology and scale. The third is a return to dealmaking, using Power Financial’s massive balance sheet to make acquisitions.
In October, IGM announced that it would merge functions such as marketing and HR at Investors Group and Mackenzie. A few weeks later, IGM also said that it would take a $160-million charge to change some of it operations, including outsourcing some technology functions.
But those moves came after four years of turnaround efforts at Mackenzie. At IGM’s investor day last month, company management tried to focus the story on growth, and said they now expect to be able to gain market share.
Great-West has also been through upheavals. Earlier this year, the company said it would take a restructuring charge of $215-million before tax to cut its Canadian staff by as much as 13 per cent, or 1,500 positions, over the next two years. The company says it has to get leaner to compete more aggressively in Canada, where older consumers are shifting from growth investments towards retirement income, while younger customers demand faster and more convenient digital service.
To one noisy activist investor, Power’s turnaround efforts are not strong enough. In October, Graeme Roustan, manager of a small Florida-based private equity fund, called for a major breakup of the empire, including a spinoff of all of Power’s non-financial-services holdings. “Rather than diversify into non-core businesses that have no synergies and are a distraction, companies need to focus on making their core business work,” Mr. Roustan said in a phone interview from his home near Tampa.
Mr. Roustan’s influence is hurt by the fact that he’s still smarting from losing his bid to regain control of sports-equipment maker Performance Sports Group, which was bought by Power’s private-equity arm, Sagard Capital, and Fairfax Financial Holdings Ltd. earlier this year. Still, small activist shareholders often gain more substantial allies if management fails to improve performance.
One factor weighing against Power Corp.: complex companies with diverse interests are decidedly out of fashion. In the United States, even some mighty conglomerates are reeling under fire from activists. In June, after a barrage of attacks from Trian Partners co-founder Nelson Peltz, longtime General Electric Co. chairman and CEO Jeff Immelt announced he would step down, and the company has pledged to shrink down to a handful of business lines. U.S. activists have also gone after European food giants Nestlé S.A. and Danone S.A., pressuring them to pursue so-called “de-mergers” to get more focused.
But Power’s Mr. Orr says that analysts and investors have underestimated how much his company is reshaping itself amid “massive headwinds” since the financial crisis. “We’ve had all those challenges to navigate through. So the team is just in a different phase of saying we’ve got to retool some of these businesses,” he says.
Based on Power’s most high-profile retooling effort so far, however, the outlook is clouded at best.
The Power group, through Great-West Lifeco, bought the 80-year-old Boston money management firm Putnam Investments in February, 2007. The timing and the execution could hardly have been worse.
The price was steep: $4.6-billion. Putnam was also struggling with high investment management expenses and poor performance. But Power felt the acquisition would vault it into a leading position in the U.S.
Then the financial crisis hit, and investors started pulling out money. Even after the crisis passed, and Great-West cut Putnam’s staff of more than 2,700 down to 1,400 and improved returns, the business failed to take in more money than was flowing out into other segments of the market. The main culprit was the investor rush to lower-fee index funds.
To earn a profit, Putnam needs to get more money coming through the door. But it’s shrinking. The firm has $169-billion (U.S.) in assets under management, down from more than $190-billion at the time of the deal. In a sector that is focused on economies of scale, Mr. Orr says, Putnam needs to double in size.
Mr. Orr also knows that investors are watching Putnam closely as what he calls a “harbinger” of the Power’s ability to modernize its operations.
“Putnam is a big embarrassment,” says CI Financial’s Mr. Hadwen. “It has far more capacity than they are currently using. If they can buy another active fund manager and make better use of the franchise, that would be sensible.”
Putnam is only a fraction of Power Corp.’s $1.5-trillion in assets under administration. But the firm is still losing money. Many investors and analysts have suggested that Power should get rid of it.
The Desmarais brothers share the sense of embarrassment over Putnam, according to sources close to the company. “I know we haven’t got this working right. I got it. See, there’s the egg,” Mr. Orr says, wiping his left hand over a crisp blue suit lapel. “But this is really important to our group’s long-term future. Running out and just pulling the ripcord doesn’t make sense. It’s a decision that will be regretted long after I’m gone.”
Instead, Mr. Orr says, the answer is to make another big U.S. acquisition. The ideal merger partner for Putnam is a U.S. fund company with up to $150-billion in assets under management and an owner willing to cede control to Power, Mr. Orr says. That would push profit margins up to 30 per cent. But the company would also settle for adding a few smaller competitors on its path to growth.
Mr. Orr adds that there’s no time horizon for any deals, but there is a list of potential targets that all know Power is interested. So far, however, nobody’s willing to dance. Sources familiar with Power’s plans say that its desire to be the controlling owner in any large transaction has been a roadblock.
But is one deal, even a big one, enough to get a dynasty back on track?
If a third generation assumes control at Power, it will almost certainly be led by Paul Desmarais Jr.’s son, Paul Desmarais III (or Paul Three, as he’s affectionately known), aged 35, and André’s son, Olivier, who is 34.
Within the company, the two are seen as having different but complementary business skills. Sources close to Power say the co-CEO structure that Paul Jr. and André adopted may also be suited to the next generation, but the board has not decided who will take the reins.
On April 28, Power announced that André would take a “temporary medical leave from his day-to-day activities” at the company, on his doctor’s advice. But it added that he would continue to oversee and participate in major developments. Power offered no further updates this autumn.
Paul Three is leading investments in fintech. Power’s Portag3 Ventures unit has invested more than $250-million in Canada and the United States. That includes a 77.4-per-cent stake in robo-adviser Wealthsimple, where an aggressive marketing campaign has attracted more than 30,000 clients and $1-billion in assets. Power also invested in California-based online financial adviser Personal Capital, which is even larger than Wealthsimple, with 1.5 million users and $5.5-billion (U.S.) in assets under management.
The idea is to lure the best entrepreneurs in insurance, personal finance and wealth and asset management. But other big established companies have similar ideas. Banks and insurers, in particular, have been adding staff and launching innovation labs to try to prevent so-called disruptors from shaking up their operations.
At the moment, these fintech investments aren’t nearly enough to move the profit needle at Power, either. But that’s not the point, according to Mr. Orr. Instead, the idea is to use the Desmaraises’ strength at relationship-building to cozy up to young entrepreneurs who need money and access to clients, but don’t have an interest in working for an old-school financial institution.
“We kind of said to Paul, ‘Why don’t you go out and figure out how all of these companies are going to disrupt our core businesses,'” Mr. Orr says. “Not a bad way for someone who’s going through a transition into a future leadership role to figure out who’s going to potentially destroy our core businesses,” he said.
Power is diversifying through continued expansion in China as well. The China file passed through André to Olivier. Both have worked and lived in the country. Earlier this year, the Power group boosted its stake in government-backed China Asset Management Co. Ltd. to 27.8 per cent, including a stake held by IGM, and backs the Beijing-based company’s plans to provide financial services to the country’s rising middle class. Power’s investor presentation says that China is due to become the world’s second-largest market for asset management. “By 2030, China will reach over $17-trillion (U.S.) in addressable assets under management, compared to $3.2-trillion in 2017.”
Power, which was founded as a utility company in 1925, is also going back to the future with Power Energy, which invests in the sustainable and renewable energy sector. It has invested about $650-million so far, including buying up hydro plants in New England, solar manufacturer Potentia Renewables and electric school bus maker Lion.
But even with these pokers in the fire, the core driver of about 80 per cent of Power Corp.’s net asset value comes from Power Financial.
“We said, well, what can we do with these assets and where can we be champions, or be number one? We all have our little ideas of how we should run companies. Our thought, my brother and I, was that we should try to focus on being number one in one or two sectors,” said Paul Desmarais Jr. in a 2010 interview with his alma mater INSEAD, where he did his MBA. “And as a family business, knowing that capital is limited at some point for family – you can’t be issuing shares or you’ll get diluted – what we decided to pick [was] financial services, which we already had a good start on.”
The trouble is that there are a lot more Power-type investors out there than there were in the 1990s. Power may have been in mutual funds before the Canadian banks, and in China before the pension funds, but over the 20 years of Paul Desmarais Jr. and André Desmarais’s reign, more businesses have rushed into these areas.
Institutional investors around the world are hoarding record amounts of capital – as much as $1-trillion (U.S.) awaits investment, according to some estimates. And many of those institutions are laying claim to the same long-term values and relationship building that have always been Power’s calling card.
Back in Toronto, Mr. Orr has talked at the Shangri-La longer than he planned. He’s going to have to race to the airport to make his flight. He grabs his jacket and the handle of a boxy, camel-coloured Heartmann briefcase, with a patina of age at odds with his sharp blue suit and tie. “I’m trying to have a one-briefcase career,” he says. He has had the case for 30 years. He’s trying to get it to last 20 more.
Like the briefcase, Power has endured, but it needs to be refurbished every so often. Mr. Orr has seen struggles before, and he’s confident that the coming decades will justify his loyalty.
“Within the company, it hasn’t just been straight line. It’s a journey, and we’ve gone through our own phases. And that’s all that’s going on right now,” he says. “The circumstances are different, but the drive, the energy, the desire is all there.”
Power Corp. Puzzle
Power Corp. Puzzle