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The Doctor Is in the House at Bank of Nova Scotia (TSX:BNS)

Doctor fees

Bank of Nova Scotia  (TSX:BNS)(NYSE:BNS) announced June 1 that it was paying $2.6 billion to acquire MD Financial, the wealth management company owned by the Canadian Medical Association (CMA).

Is it a good deal? A bad deal? What, if anything, does it mean for Scotiabank shareholders?

Bulking up wealth management

First, the bank announced in February that it was paying just less than $1 billion to acquire Montreal-based institutional investment manager Jarislowsky Fraser Ltd. (JFL); founder Stephen Jarislowsky continued to run it until stepping down in 2012 at the age of 87.

With a stellar reputation that’s never been tarnished, Jarislowsky wouldn’t have sold to Scotiabank if he thought the bank wouldn’t maintain the corporate culture built by Jarislowsky and the rest of its corporate managers over the past 63 years.   

It might not be the biggest asset manager in the country, but it is arguably the most respected. It was a smart play by the bank — I’ll give it that.

The second move comes with the acquisition of MD Wealth Management, which gives it direct access to some of the country’s most affluent individuals — doctors and their families.

Just as Scotiabank wants to be the “Bank of Hockey,” it now appears that it wants to be the “Bank of Doctors” as well. Only this deal comes at a much steeper price — it’s paying 2.5 times what it shelled out for Jarislowsky’s company — not the least of which is a bought deal to pay for the acquisition that will dilute shareholders by approximately 2%.

It’s not quite as dilutive as what cannabis investors are used to, but it’s significant, nonetheless.

The fact is, Scotiabank has stated that it wants to grow its wealth management business, which currently accounts for just 12% of its total earnings.

The addition of JFL and MD Management adds $89 billion in assets under management. Even at a conservative 0.25% management fee, it’s buying an additional $223 million in annual management fees with the potential to grow both organizations across the country.

For example, the CMA has 88,000 physician members out of a total of approximately 125,000 practicing doctors across Canada. MD Management serves a little less than half the CMA membership and just 35% of all doctors in this country.

If it persuaded another 43,750 doctors across the country to join the MD Management fold — at an average AUM of $1.1 million per doctor ($49 billion AUM divided by 43,750 current physician clients) — Scotiabank would add another $223 million in annual fees, probably more, given its other bank products it could add to the mix.

With the company delivering solid, if not spectacular, Q2 2018 earnings, there’s no question that the mortgage business is slowing down and is likely to remain soft in the future

New mortgages issued in the second quarter were $8.9 billion, $1.4 billion less than in the first quarter, which means wealth management must make a more significant contribution to overall earnings if its stock price is going to keep rising.

The bottom line for Scotiabank shareholders

To me, the acquisition of MD Management makes a lot of sense — far more than paying $800 million for the signage rights to the Air Canada Centre in Toronto.

In the case of MD Management, Scotiabank paid about 5.3% times AUM, while it paid about 2.4% AUM for Jarislowsky Fraser. While it’s a steep price, the clientele it’s gaining access to are some of the most affluent individuals in this country.

I think buying both JFL and MD Management will turn out to be excellent acquisitions three to five years from now, helping to keep Scotiabank one of the top banks in Canada.

If I didn’t like Canadian Imperial Bank of Commerce so much, I’d probably be all over recommending Scotiabank stock. Let’s say it’s a reliable second choice.

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Fool contributor Will Ashworth has no position in any stocks mentioned.

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