Janus Stockholders Foot the Bill

In January, Barron's speculated that  Janus Capital Group   shareholders could be in "fat city." Shares of the firm's publicly traded stock were close to an all-time low earlier in the year, and some have speculated that the firm could be a comeback kid if growth investing heats up again. Is it time to bring out the wheelbarrow and load up on Janus shares?

We don't think so.

The mutual fund manager is not just struggling with some dismal performance records for its growth funds. It's also saddled with a record of poor corporate governance, and we fear there's little hope for meaningful change. Given these risks, we would demand a substantial margin of safety before investing in Janus' stock. Even though the shares trade at a 24% discount to our fair value estimate, they're still not a buy.

Debt Dilemma
How did this former highflier find itself in such a pickle? The debt fiasco began when Janus founder Tom Bailey cashed out in 2001. His sweetheart deal allowed him to sell his remaining shares back to the company at 15 times the previous year's earnings, which meant that Bailey cashed out at 2000's inflated prices--the top of the market. The stock proceeded to shed 30.9% of its value in 2001, and dropped another 51.8% in 2002.

The company didn't have enough cash to pay the $1.6 billion it owed Bailey, so it was forced to borrow $1.1 billion. But an offering of low-interest convertible notes backfired the very next year when 95% of noteholders took advantage of the bonds' put option and forced Janus to buy them back.

So, Janus had to borrow again and is now stuck with $840 million of debt. Debt is now at 57% of shareholder equity--hefty compared with the debt levels of other asset managers--and operating income covers interest payments by only five times, significantly lower than its peers. Naturally, the credit-rating agencies have noticed. The only thing preventing the debt from sinking closer to junk-bond levels is Janus' large stake in mutual fund data processor  DST Systems  , which Janus has owned for years. Janus could sell its 33% stake in DST for around $1.2 billion and pay down its debt, but this would probably result in more than 40% of the proceeds going to Uncle Sam as taxes. That's a pretty big hit for shareholders to take.

The Question of Compensation
So, we have a firm that essentially wrote a blank check to its founder, with shareholders footing the bill. Unfortunately, the streak of lousy finance decisions is having little effect on the enormous salaries that Janus fund managers pull down.

Of course, we still can't know exactly what fund managers make because fund companies won't tell. But in the absence of good disclosure, we can make some savvy guesses. Compensation--including restricted stock grants--totaled $353 million in 2002. Because only 5% of employees are on the investment team, we can factor in average administrative and support salaries for the majority of the staff, and estimate that Janus portfolio managers are being paid far above their peers, who make an average of $400,000. Our ballpark estimate for average total compensation per fund manager is at least $4 million for 2002. With the departure of star manager Helen Young Hayes, this average may drop somewhat--but it's got a long way to fall.

Adding to that, Janus has decided to accelerate the vesting of a $300 million equity grant it gave to employees, mostly the investment professionals. That means more shareholder money will be going into fund managers' pockets at a faster rate.

Are they worth it? Many Janus funds have lost boatloads of money for their fundholders recently. Its three largest offerings-- Janus Fund ,  Janus Worldwide , and  Janus Twenty --all have trailing three-year performance records that are not only dismal, but worse than their average peers'. The three funds, respectively, have lost an average of 21.68%, 22.93%, and 25.88% per year for the three years ending April 21. 

Tough Choices
When Janus was in the market for a new CEO, we hoped for a strong outsider who would break some glass and turn things around. What we got was Mark Whiston, a former fund salesman and longtime Janus insider. To be fair, he has been at the helm only three months. But we are dubious about his ability to make the tough calls.

Many Chicagoans recall when the Lyric Opera’s own iron lady, Ardis Krainik, fired Luciano Pavarotti because he failed to show up for his role in Tosca. Although the star tenor had made a habit of canceling his appearances at the last minute, no one expected him to get the boot. People marveled that the Lyric's general director--a mere business manager--would have the guts to stand up to one of opera’s biggest stars. But stand up she did, and Chicago opera fans have continued to enjoy first-rate performances ever since.

Will Whiston stand up to the star managers of Janus? We wouldn't bet our opera tickets on it. Hayes' departure will leave him with one less to deal with (we believe she left of her own accord). But Whiston may need to make the kind of tough calls that Krainik did in the very near future, and it's not clear if he's up to the challenge. With a load of debt, a struggling fund lineup, sky-high compensation, and milquetoast management, we think it's the Janus managers--not the shareholders or fundholders--who are in fat city.