Can Janus Save Face?
By Amey Stone
For Janus Capital Group, the Denver-based mutual-fund company, being implicated in New York Attorney General Eliot Spitzer's probe of alleged trading abuses at mutual-fund companies couldn't have come at a worse time. The one-time darling of the growth-stock era was in the incipient phases of a turnaround after suffering catastrophic fund losses and major investor defections during the three-year bear market. Fund returns were perking up, and management was diversifying into new investment styles, cutting debt, and reducing expenses.
In recent months, some new cash was starting to trickle in, while the flood of assets out the door was abating. The parent company's stock price had responded smartly to the positive signs, rallying from $10 in March to $19 by mid-July.
The stock's run, and many investors' faith in that turnaround, came to an abrupt halt on Sept. 3, when Spitzer announced his probe. He named Janus (JNS ) as one of four major fund outfits that allegedly gave a hedge fund "special trading opportunities" that harmed returns for long-term shareholders while benefiting the parent company. In the two trading days after Spitzer's announcement, Janus' stock fell from $18 to $15.50 and, after rebounding, closed Sept. 8 at around $16.
In his complaint, illustrated with the help of damaging e-mail between executives, Spitzer alleges that Janus execs allowed hedge fund Canary Capital Partners LLC to trade in and out of its funds on a short-term basis to take advantage of stale prices, a process known as "timing" the fund. Janus' official stance had been that it didn't allow the practice, which dilutes profits to long-term shareholders and increases the fund's expenses, eating into returns (see BW Online, 9/4/03, "Scandal Finds the Funds' Sly Secrets").
SPREADING THE BLAME.
In return for allegedly getting the privilege of market timing, Canary made large deposits in other Janus funds, increasing asset-management fees to Janus. In one e-mail cited in the complaint, a top Janus executive wrote: "I have no interest in building a business around market timers, but at the same time I do not want to turn away $10 [million to $20 million]!"
Janus, which declined to make senior management available for interviews after Spitzer's remarks, admitted in a Sept. 5 press release that it had made some "discretionary market-timing arrangements." It promised to hire an independent auditor to evaluate whether shareholders in those funds were hurt and provide restitution if they were. Janus also promised to return to shareholders all management and advisory fees it received from any market-timing activities. Meantime, Janus says it will continue cooperating with Spitzer's investigation.
In a letter to shareholders posted on its Web site on Sept. 4, Janus Chief Executive Mark Whiston wrote, "I realize these allegations may be troubling and I want to assure you that we're committed to the highest ethical standards." He also pointed out that Janus, which manages $150 billion in assets, was not named as a defendant in Spitzer's claim and that it had not been linked with the more serious alleged abuse -- after-hours trading in its funds. He further noted that Spitzer said it was a "near certainty" that more fund companies would be named in the course of the investigation.
Still, even if other fund companies are implicated and Janus is never charged with any crimes, major damage to its reputation has already been done. And coming after a nasty bear market, Janus may not have much of a reservoir of good will with fund shareholders or owners of its own stock.
"This puts them many steps back," says Matthew Snowling, an analyst with Friedman, Billings, Ramsey, who rates the stock a hold. "Retail and institutional investors had gone through a pretty rough time with Janus. Now there is a real risk that a considerable amount will just give up."
Spitzer's probe also casts doubt on management's ethics and judgment. In a Sept. 5 note, Morningstar said the allegations "represent a serious breach of investor trust and fiduciary duty" and reduced its estimate of the stock's value from $18 to $16.
Janus is sure to face ongoing legal problems that will be a drain on management's focus even if the problems don't erode earnings. "This clearly raises the stakes from a risk standpoint," says Mark Foster, chief investment officer at Kirr, Marbach Partners, which owns Janus in its portfolios. "We're in uncharted territory in terms of what fines could ultimately be and what the repercussions are."
Meantime, Janus' other challenges remain. It still needs to hire a chief investment officer and rebuild the brand to show that it has more to offer than aggressive growth funds. It plans to launch a major advertising campaign, including TV spots, in the fourth quarter, to introduce its evolving brand.
Janus also has to start attracting more assets to its funds. Although overall net outflows recently stopped, it hasn't been able to attract new assets at close to the same rates other fund firms have achieved this year. Year-to-date through August, equity mutual funds have reported net inflows of more than $72 billion, while Janus has reported net outflows totaling $5 billion, according to fund asset tracking firm AMG Data Services. To Snowling, the net outflows this year are "a little strange" and suggest that investors are still looking to exit the funds on improving returns.
Janus' stock fundamentals were looking a little weak even before the scandal broke. Its price-earnings (p-e) ratio is 41, vs. the industry average of 23 and the Standard & Poor's 500's 22, according to data from Morningstar. The rally in the stock had already ebbed in August as bottom-fishers began to sell. Foster, for one, had sold half of his stake in Janus as it neared his price target of $20.
Still, earnings have improved so far this year, and Janus beat analysts' estimates in the second quarter, with net income of $47.5 million, or 21 cents a share, on revenues of $251 million. But that was still down substantially from the same quarter a year ago when profits were $74 million, or 33 cents a share, and revenues were $310 million.
Some analysts believe the recent sell-off in Janus is overblown. Prudential Financial reiterated its buy rating on Sept. 3 and suggested in a research note, "at this early stage of information, it appears that the economic damage for Janus could appear quite moderate." A note on the same day from Merrill Lynch maintained a buy rating and carried the headline, "JNS Permitting Some Market-Timing Doesn't Appear Illegal."
Even if that's the case, worries over the damage to Janus' reputation remain. Some investors were lucky enough to make money in the stock on early signs of a turnaround and a boost from the broader market rally. It might have proved difficult for Janus' stock to climb much higher this year even without its implication in scandal. But thanks in no small part to Eliot Spitzer, it just got a lot tougher.
Stone is a senior writer at BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column
Edited by Beth Belton