Janus Capital Group
seems to be followed by its own personal black cloud these days. What does all the bad news mean for the company's beaten-down stock price? Janus may be one of the market's most undervalued stocks.
The once-lauded Denver fund shop racked up three years of embarrassing underperformance during the brutal bear market, and it suffered a major brain drain of talent that has left it without a chief investment officer -- to name just two of its troubles. Going from bad to abyss, Janus in September had the misfortune of being one of the first firms slapped with the fund industry's version of the scarlet letter, getting fingered in the recent investigation of abusive-trading practices.
Industry analysts and investors in Janus' stock say the firm still has regulatory, operational and investor-trust hurdles to clear over the next few months. However, provided there are no more major revelations of abusive trading, the company's shares may be worth somewhere in the mid-$20s to $30s -- an impressive gain from its current level of $14 and change.
"We view this as a temporary issue that is likely to be resolved in quarters, not years," said Franklin Morton, senior vice president of portfolio management at Ariel Mutual Funds. The highly successful value-oriented Chicago shop first scooped up Janus shares in October 2002 when they tumbled to $10, and "we have added to our position by about 20% to take advantage of the current weakness," said Morton, who pegs the stock's fair value at about $24.
The Spitzer Story
In light of the Sept. 3 revelations about Janus by New York Attorney General Eliot Spitzer, it may be difficult for investors to grasp how the stock looks appealing. Janus gave New Jersey hedge fund Canary Partners permission to make improper trades in Janus funds in exchange for Canary's parking money in a money market fund, padding Janus' fee collection. Spitzer's complaint implicated Janus and three other firms --
Bank of America's
One Group and
Strong Capital Management
-- in the abusive-trading scandal. After that bombshell, the fund industry has been reeling as several other fund firms have been implicated in allowing abusive trading.
Bank of America, AllianceBernstein and a few others were subsequently alleged to have engaged in "late trading" -- an illegal practice that involves traders buying or selling the fund after the market's close but getting the preclose fund price. Spitzer compared this to betting today on yesterday's horse races. Janus, however, was implicated in a time-zone arbitrage trading strategy in which market-timers exploit inefficiencies in how a fund is priced. While not illegal, these forms of market-timing skim profits off the top of long-term fund investors, and the rapid-fire trading increases the fund's expenses -- plus, Janus and other firms claim to deter market-timing in their prospectuses.
Perhaps the most damning component of the Spitzer complaint was an email exchange between an employee and Janus International CEO Richard Garland about the effect of Canary's trading on individual investors. In response to the employee's concern that "we need to keep our funds clean," Garland replied, "I have no interest in building a business around market-timers, but at the same time I do not want to turn away $10-$20m!"
While Janus' initial response -- "We've long view market-timing as an industrywide problem," CEO Mark Whiston said on Sept. 5 -- was criticized in many circles as a rather craven way of saying, "Everybody does it," the events of recent weeks have borne out that defense as partially legitimate, if weak. The SEC recently canvassed the 80 largest fund firms in America and found that roughly half of them had allowed some form of market-timing in their funds.
And some investors in the company noted that Janus' transgressions are looking less egregious -- and more importantly, more easily resolvable -- than those of some of its peers. Janus has said the market-timing investments represented less than one-half of 1% of its $150 billion in assets under management -- less than $750 million -- and that it would make restitution to investors in the affected funds. While Janus initially looked especially vulnerable because it was the only publicly traded "pure play" fund firm on the scandal sheet -- Putnam is owned by financial-services giant
Marsh & McLennan
, AllianceBernstein by
and so on -- some Janus defenders say it looks less vulnerable now.
"In the range of things that have been done, what Janus has done is in the middle of the road," said Bill Jacobs, an analyst at the value-oriented fund firm Oakmark, one of the largest institutional investors in Janus. "They had the misfortune of being one of the first four named, even though what they did wasn't in the top four worst things to do," Jacobs said, adding, "I think the key question is, what is the damage to the Janus brand? That's an open question, but we feel that over time this will fade from memory. You'll be left with what was a very strong brand name."
Ariel's Morton agrees. "You had Putnam managers market-timing their own funds, some obstruction at Fred, and at Strong you had the founder engaging in their trades," he said. Morton believes the bad news is out there. "It's contained to timing only, the timers have been thrown out, and the direct costs have been largely quantified."
Janus is in talks with Spitzer's office about settling the case -- the upside of being first named is that it is likely to be the furthest along in the negotiations. While the amount is sure to be substantial, analysts and industry watchers view the settlement costs itself as a "one-off" that will be easily written off in an earnings statement. However, the more pressing issue to Janus is the potential that this will set off a deluge of institutional and individual money flying out the door.
The first wave of Janus fund selling, which most likely came from individual investors responding to the news, came in September. Janus stock funds lost $2.4 billion in outflows. Meanwhile, the slower-to-move institutions are undoubtedly meeting today and in the coming weeks to decide whether or not to drop Janus from their retirement plans. Last week, the Colorado Public Employees Retirement Association said it would drop Janus as an option in its retirement plans, effective in March.
"Over the next couple of months, you have to consider the possibility that you're going to lose money," said Matthew Snowling, a Friedman Billings Ramsey analyst who currently has a hold rating on the stock. "The big question here is, how much?"
Janus ended the quarter with $146.5 billion in assets -- down from $149.5 billion a quarter ago and far from the $300 billion it commanded at the market's peak in 2000. If you remove the $16 billion in money market funds, Janus has about $130 billion in long-term assets. Snowling, who notes that Janus saw $16 billion in redemptions in 2002 -- just over 9% of its long-term fund net assets. "That's coming off three years of awful returns, so let's use that as a gauge to say how bad this can get." If Janus loses $13 billion, or 10%, in the next year, and Janus' assets appreciate with the market about 7%, it's not that bad."
Snowling's model projects Janus will end next year with $149 billion in assets, thanks in part to a rising market. Those assets translate to about $1.30 in cash on the balance sheet, meaning Janus is trading at 11 times cash -- compared with mid to high teens for its peers. "A lot of the risk of losing assets is built into this price," said Snowling, who thinks the stock gets "really compelling" below $13.50 a share.
Oakmark's Jacobs agrees that the downside risk is more than priced into the stock. Janus' stock is trading at about six to seven times earnings before depreciation, income and taxes, or EBIT, he says, compared with multiples in the teens among other investment firms. You would have to cut outflows almost in half to justify the current price, said Jacobs, who thinks the stock's private market value -- the price someone would pay to acquire it -- is in the $30s. "Worst case scenario, you find another trading violation, and outflows bring assets down to $80 billion -- Janus would probably get acquired at a midteens price, where it is now."
To be sure, value skippers investing in Janus don't expect the Spitzer side of the story to improve overnight. The company still faces the settlement issue -- few Janus watchers expect this affair to end up in court. Also, while Janus has attempted to lay blame on three former Janus employees for most of its market-timing troubles -- a sales executive and two former fund managers, Warren Lammert and Sandy Rufenacht -- Garland's status has yet to be resolved.
Also, there is this question: Was Whiston, the recently installed chief executive, aware of the trading? In a recent conference call, Whiston expressed frustration at being unable to answer the question on his lawyer's advice. It seems unlikely that Whiston knew, individuals familiar with the matter say. Lastly, though the firm will certainly have a difficult time generating new sales while the regulatory overhang bedevils the firm, Jacobs says he's confident that "investors tend to have short-term memories -- the
recent surge tells you that."
The Fundamental Story
While the Spitzer story will take a while to play itself out, Janus' fans like the fundamental story of the company, even though the firm still is in the process of diversifying its offerings beyond the growth and tech-oriented funds that made its name in the 1990s, and even though the firm still lacks a chief investment officer since Helen Young Hayes stepped aside earlier this year.
"The fundamental story is unfolding exactly as expected," Morton said. The new management led by Whiston laid out its priorities -- cut costs, broaden its product line and restore the fund firms' credibility with investors. The latter one has suffered a major setback with the Spitzer case, but the first two have been largely successful. Janus has brought value shop Berger into its fold, as well as highly regarded quant firm InTech. While Janus' big holdings remain a bit tech-centric --
are big holdings -- the firm is no longer the growth-only shop it once was.
Improved performance by the firm's funds will go a long way toward healing the rift of the latest scandal. "When you're making money for them, nothing else is that important, as long as you're honest," Jacobs said.
Meantime, Janus plans to divest itself of its subsidiary DST Systems by year end, which will give the firm $1 billion in cash, which may help Janus seek new acquisitions.
Responding to the scandal has sidetracked the company's efforts to hire a new investment chief -- which suffered a blow after almost exclusively courting Morgan Stanley market strategist Steve Galbraith. "They're probably not going to get anyone this year," said Snowling, adding, "Who wants to step into this right now?" It may get easier to bring in someone after the Spitzer case is resolved, although Janus will likely have to pay a fat sum to lure top-shelf talent, according to executive-recruiting professionals.
"The year 2004 could hold a lot of good things for Janus -- resolution of the Spitzer issue, a new CIO, improving performance in the funds and whatever they decide to do with the $1 billion from the DST deal." Morton said. "We are very enthusiastic about Janus."