For Putnam's Parent, Limited Damage

My three favorite words (about Wall Street, anyway) are these: Trust no one. Imparted to me amid the Volcker-Reagan bull market, this little motto now rings true with vast legions of investors, thanks to the mutual fund industry and perhaps Putnam Investments (PEYAX ) most notably. Were I more trusting, I would say the Securities & Exchange Commission will make Putnam, which neither admitted nor denied fraud in its Nov. 13 settlement, pay big time. But remember, trust no one.

That's one reason why Putnam's low-profile parent, Marsh & McLennan (MMC ), strikes me now as an opportunity. Since Sept. 3, when the funds scandal erupted, M&M's shares have slid below $45 from above $51. They may go lower yet. Already, clients have taken fee-earning assets away from Putnam, its legal bills mount hourly, regulators remain on the case, and Putnam must make restitution to clients harmed by its employees' self-dealing. There's more pain to come. Yet cool-headed investors who examine M&M may see the trouble at Putnam as easily tolerable given its other strengths.

UNLIKE MANY OTHER FUND operators, Putnam's parent is well diversified. Beyond mutual fund and pension management, M&M operates principally as an insurance broker -- by far the world's largest -- and as a management consultant, via its Mercer group of firms. Together, these three business lines have proved a potent combination: Revenue this year is expected to grow 10%, to $11.5 billion, and net earnings 12%, to more than $1.5 billion. Cash flows are heavy and growing: Last year, M&M generated $1.3 billion in cash; this year through September, it had already produced $1.6 billion. It pays a $1.24 annual dividend, good for a 2.8% yield, and its balance sheet is strong, with net debt under one-third of total capital and earnings covering fixed charges more than eight times over.

Over this idyllic financial scene, of course, Putnam hovers like a dark cloud. How threatening does it remain? M&M Chief Executive Jeffrey Greenberg is not talking. So, to hazard an answer, I developed three scenarios for 2004. In the first and most dire, I imagined Putnam's reputation gets so trashed that its assets under management -- $256 billion on Nov. 14 -- are halved. Further, I figured legal fees, regulatory penalties, restitution, and other costs squeeze its operating margin, a rich 25% so far this year, to 12.5%. Next, in a best-case scenario, I assumed $250 billion in average assets under management and no change in operating margin. A middle case split the difference.

What did this tell me? That Putnam just isn't such a big deal for M&M. In the best case, M&M would still see $456 million in operating income from Putnam, which contributed $560 million last year and $364 million through Sept. 30 this year. In the most pessimistic scenario, Putnam's share of M&M's operating profit next year would plunge to $117 million. Even at that, assuming a modest 10% increase in M&M's insurance and consulting profits (so far this year, they have risen 18%), operating income in 2004 could approach $2.4 billion, down from perhaps $2.5 billion or so this year.

Watching profit growth shift into reverse is never an inspiring sight on Wall Street. But at under $45 a share, M&M already seems to reflect the probable damage to its earnings power. Its $24 billion stock market value comes to less than 10 times my middle-case view of 2004 operating income. Justice may demand that Putnam's parent keep writhing in pain; odds are it won't.

By Robert Barker

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