Why Sprott’s selling its mutual funds arm

Sprott Inc. is selling its Canadian mutual fund arm for approximately $46 million to executives.

A suite of 38 funds representing $3 billion in AUM will be sold to a management group led by John Wilson, currently CEO of Sprott Asset Management, and James Fox, president of Sprott AM. The $3 billion represents 32% of Sprott Inc.’s pre-transaction AUM.

“The best way for both sides of our business to continue growing and thriving was to separate them,” said Peter Grosskopf, CEO of Sprott, on a conference call. He acknowledged the company’s diversified structure created challenges and said the firm will now focus on metals and resources.

“Clients and employees thought we might be attempting to do too much,” he said. “Our shareholders and analysts believed that our structure was confusing […] and they were possibly right.”

Grosskopf added that in 2016, both the precious metals business and the mutual funds business reached “enough substance to continue alone.”

Going forward, Sprott Inc. will focus on precious metals, natural resources and real assets, including private agriculture and private energy. “On the private resources side, our AUM, pre- and post-transaction, remains intact,” Kevin Hibbert, CFO of Sprott noted on the call. He said its AUM will “grow meaningfully over time as we begin to deploy $750 million worth of capital committed to our private resource lending funds.”

Sprott Inc. will continue to subadvise 10 of the 38 funds with precious metals mandates, representing $865 million in AUM. It will also retain $7.5 billion in AUM, including the subadvisory agreements, and its predominantly U.S.-based exchange-listed products business, with $5 billion in AUM.

Sprott was founded in 2000 by Eric Sprott, now 72, who will step down as chairman of Sprott Inc. on May 10. The company went public in 2008, though its stock price has been falling since 2011.

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Affected funds

The following funds will be purchased by the management group:

• Sprott Energy Fund
• Sprott Energy Opportunities Trust
• Sprott Global Infrastructure Fund
• Sprott Global Real Estate Fund
• Sprott Real Asset Class
• Sprott Enhanced Equity Class
• Sprott Enhanced U.S. Equity Class
• Sprott Enhanced Balanced Fund
• Sprott Enhanced Balanced Class
• Sprott Enhanced Long Short Equity Fund L.P.
• Sprott Enhanced Long Short Equity RSP Fund
• Sprott Canadian Equity Fund
• Sprott Focused Global Balanced Class
• Sprott Focused Global Dividend Class
• Sprott Focused U.S. Dividend Class
• Sprott Focused U.S. Balanced Class
• Sprott Diversified Bond Fund
• Sprott Diversified Bond Class
• Sprott Credit Income Opportunities Fund
• Sprott Alternative Income Fund
• Sprott Small Cap Equity Fund
• Sprott Private Credit Trust
• Sprott Private Credit Trust II
• Sprott Bridging Income Fund LP
• Sprott Bridging Income RSP Fund
• Sprott Canadian Senior Debt Fund
• Sprott Short‐Term Bond Fund
• Sprott Short‐Term Bond Class

The following will be subadvised by Sprott Inc.:

• Sprott Gold Bullion Fund
• Sprott Silver Bullion Fund
• Sprott Hedge Fund LP
• Sprott Hedge Fund LP II
• Sprott Bull/Bear RSP Fund
• Sprott Gold and Precious Minerals Fund
• Sprott Silver Equities Class
• Sprott 2017 Flow‑Through Limited Partnership
• Sprott 2016‐II Flow Through Limited Partnership
• Sprott Resource Class

The sale price

An analyst on the call noted that the $46-million price tag “seemed low.” As the Globe and Mail reports, CIBC World Markets analyst Paul Holden projected last month the mutual funds business would go for between $75 million and $125 million.

“The transaction multiple paid was not only fair but within the range of values our business has commonly been quoted as, and that includes the split of business,” said Grosskopf.

Hibbert revealed that the departing mutual funds contributed amounts that were “not material” to Sprott Inc.’s EBITDA. When pressed for a number, Hibbert confirmed that in 2016, Sprott AM represented $16 million in EBITDA, including the ETF and bullion businesses being retained by Sprott Inc. “What I can say is the majority of that SAM EBITDA is geared toward the assets we’re keeping,” said Hibbert. “We’re all pretty confident we can make up [the remainder], and then some, in other areas like our lending business and Sprott Capital Partners.”

Grosskopf added the price may seem lower than expected because “we structured the transaction very carefully to optimize our after-tax proceeds; we didn’t want to pay any more tax than we had to on the disposition.”

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What stays, what goes

As a result of the sale, Sprott Inc.’s headcount will be reduced by 50%, to approximately 100 employees. Sprott will retain all management contracts for its exchange-listed products business and institutional precious metals strategies. Further, the team managing the Sprott Physical Trusts and ETFs, as well as the Sprott AM precious metals investment team, will remain.

Sprott expects departing executives to free up about $5 million in profit sharing “to be allocated to future compensation programs.”

One analyst asked if Sprott Inc.’s compensation would fall disproportionately going forward, since “a lot of active managers will no longer be with Sprott.” Grosskopf responded that “with a higher weighting toward passive, you’re probably right.”

Another analyst asked whether Sprott Inc. would owe “additional contigent payments” if the departing mutual funds had AUM losses.

“Because it was an employee group that understood these assets intimately and is already responsible for their management, the contracts are as clean as you can get,” responded Grosskopf.

Performance fees for the departing funds will continue to be subject to historical high watermark provisions, with Grosskopf noting the majority of fees will leave with the purchase group as well.

“In terms of 2016 performance fee generation, the bulk of that came from the private credit businesses, which are not being retained by Sprott, and the precious metal funds, which are going to be split,” he said. “So the performance fees [are] leaning toward the NewCo purchase group, and we’re maintaining a minority of those.” He adds that he sees potential new fee revenue from lending and resource funds.

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Sprott Private Wealth

Grosskopf said total AUA for Sprott Private Wealth is “in the range of $1 billion.” He added that between $350 million to $400 million of that was “self-owned and managed at Sprott Asset Management,” and those assets going with the purchase group. Grosskopf estimated that, in total, about $700 million would go with the purchase group.

“The accounts that we’re keeping are more resource-related accounts,” he said.

What’s next

The mutual funds arm, which executives referred to as “NewCo” and “the purchasing group,” will need to rebrand.

As for Sprott Inc., Grosskopf said it wants to become “one of the larger investors in the resource lending LPs” and that it’s “looking at different international iterations of our precious metal products to see where we could sponsor them in larger markets.”

Pending approvals, Sprott Inc. will also repurchase 5% of its outstanding shares. Grosskopf added the sale could positively impact dividend payments going forward.

Overall, the transaction isn’t expected to have any material impact on the business, operations or affairs of the affected funds, says Sprott in its release, which notes the first phase of the transaction is expected to be completed in Q3 2017 while the second phase should occur in Q4.

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TD Securities Inc. acted as exclusive financial advisor to Sprott while Baker McKenzie and Borden Ladner Gervais LLP acted as legal counsel. Norton Rose Fulbright Canada LLP is legal counsel to the buyer.

Melissa Shin

Melissa is the editorial director of Advisor.ca and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at mshin@newcom.ca. You may also call or text 416-847-8038 to provide a confidential tip.