Federated Upgraded to Neutral

We have upgraded our recommendation on Federated Investors Inc. (FII - Analyst Report) to Neutral from Underperform based on the company's increasing global exposures. The company continues to look for more opportunities to crack profitable deals and is on track to expand globally.

During the nine months ended September 2011, Federated added $2 billion in new business from a large offshore client besides working on two new money market entry opportunities in the U.K. Federated launched a new sterling-denominated money fund in the third quarter of 2011 while adding the fund to a multiple of global portals, already offering other Ireland domicile products. The company expects to complete the addition of the product into two new portals any time soon.

Moreover, after the evaluation of Federated's expected continuing cash flow from operations, and its ability to obtain additional financing arrangements and issue debt or stock, we believe that the company will have sufficient liquidity to meet its present as well as reasonably foreseeable cash needs. For Federated, cash and marketable securities totaled $322 million as of September 30, 2011.

The third-quarter results were in line with the Zacks Consensus Estimate, but were below the prior-year quarter and prior-quarter earnings. In October, Federated's third-quarter 2011 earnings came in at 37 cents per share, in line with the Zacks Consensus Estimate, and below the year-ago quarter's earnings of 42 cents. Moreover, this compares unfavorably with the earnings of 41 cents recorded in the prior quarter.

As of September 30, 2011, total assets under management (AUM) for Federated were $351.7 billion, up 1% sequentially. However, the company's closest competitor-Franklin Resources Inc. (BEN - Analyst Report) reported total AUM of $659.9 billion over the same period, down 10% sequentially, attributable to market depreciation.

Results reflected decreased revenue, increase in voluntary fee waivers, and reduced equity assets. This was partly offset by a rise in fixed income and money market assets, higher AUM and a decline in total operating expenses.

During the latter half of 2008 and early 2009, disruptions in the financial markets severely dislocated the functioning of the credit markets and damaged the availability of liquidity in the short-term debt markets. In certain money market funds, the gross yield was not sufficient to cover all of the funds' normal operating expenses due to historically low short-term interest rates. Since the fourth quarter of 2008, Federated has voluntarily waived fees in order for certain funds for maintaining positive or zero net yields. During third-quarter 2011, interest rates for certain money market investments declined, leading to an increase in these fee waivers. We expect fee waivers and related reduction in distribution expenses, which is likely to be significant, to continue into 2013.

Moreover, weak AUM has resulted in a negative organic growth in the core business as investors are transferring cash from money market funds to higher yielding bank deposits or investments across the fixed income universe and equities.

We expect certain factors like regulatory backdrop, waning equity markets and sluggish global economic growth, to likely keep the earnings under pressure. However, Federated has the potential to grow in the long run on the back of its diversified asset and product mix along with a fairly healthy balance sheet.

Federated currently retains a Zacks #3 Rank, which translates into a short-term "Hold" rating.

Read the full analyst report on FII

Read the full analyst report on BEN