Less than a week after CI Financial (CA:CIX) CEO Kurt MacAlpine triumphantly announced its deal to sell 20% of its U.S. wealth management business for $1.34 billion, the crowd is questioning the proposed transaction.

The agreement values CI’s entire U.S. wealth management business at $7.1 billion, nearly 26x the unit’s first-quarter 2023 annualized adjusted earnings before interest, taxes, depreciation and amortization (EBITDA). Investors were initially ecstatic, driving its share price nearly 50% higher on the news.

“The deal enterprise value exceeds all of CI’s total enterprise value and the deal equity value is ~3x CI’s current equity market capitalization (as at May 10, 2023),” stated CI’s May 11 press release.

However, in the intervening days, as analysts have had a chance to consider all the facets of the transaction, some on Bay Street and beyond are questioning the terms of the 20% sale, downgrading CI’s stock.

Now back where its share price sat before the announcement, CI’s got a 14.5% problem that could alter the long-term success of the transaction.

What’s the 14.5% Problem?

The investors acquired 20% of CI’s U.S. wealth management business at favorable terms. Specifically, they received preferred shares for their $1.34 billion investment.

The preferred shares come with a “preferred liquidation preference” that guarantees buyer Bain Capital and the rest of the investor group a specific price for these shares should an IPO not be completed within a specific time and at a given size.

Fintel discussed the 14.5% payment-in-kind (PIK) in an article earlier this week about the 20% sale. The investors stand to make up to $2.5 billion on their investment from this PIK. Further, they can force CI to liquidate the U.S. wealth management business as soon as 69 months if they’re not happy with the direction of their investment.

“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 in a Monday note to clients, The Globe and Mail reported.

He downgraded CIX stock to ‘neutral’ and knocked down his 12-month target price to $13.50 from $19 a share.

Two other analysts downgraded CIX stock due to the deal: BMO Nesbitt Burns analyst Tom MacKinnon cut his target by $2 to $17, knocking his rating down to ‘market perform’. Joining was Barclays Capital analyst John Aiken, who downgraded the shares to ‘equalweight’ while cutting his target price by $2 to $19.

With yesterday’s close at $13.14, both are still considerably higher than where CIX currently trades. However, that could change in subsequent quarters as more information emerges.

Ultimate Consequence

What CI didn’t explain to investors in plain English were the possible consequences to shareholders given the transaction terms.

BMO Nesbitt’s MacKinnon pointed out that the U.S. wealth management business will have to deliver at least 14.5% annual earnings growth in the coming years, or CI’s ownership stake will fall from 80%. The analyst estimates that the unit’s profits will experience single-digit growth by 2025, reducing CI’s stake to 6o%, or perhaps as low as 55%.

Were that to happen, there’s no question that the $7.1 billion enterprise value trotted out by the otherwise triumphant MacAlpine and CI for the entire business won’t be anywhere close to reality in a few years.

In the meantime, despite the deleveraging provided by the sale, the U.S. wealth management business will have to grow through additional acquisitions funded by expensive debt.

The best hope for CI investors is that the IPO market recovers to the point where it can finish the job it started by taking the U.S. wealth management business public. Then, the unit can use its stock as payment for future deals.

Until then, the preferred share investors sit in the driver’s seat, putting the 14.5% problem front and center.

This article originally appeared on Fintel

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