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Federated Investors Inc. (FII - Analyst Report) reported second-quarter 2012 earnings per share of 39 cents, falling short of the Zacks Consensus Estimate by a penny. Earnings were also lower than the prior-year quarter’s earnings by 2 cents.

Results were impacted by escalated operating expenses. Yet higher top-line growth and a rise in fixed income and equity assets were positives for the quarter. Moreover, increased assets under management (AUM) added fuel to the fire.

Net income in the quarter was $40.4 million, down from $42.4 million reported in the prior-year quarter.

Performance in Detail

Total revenue climbed 3% year over year to $232.1 million, driven by a decrease in voluntary fee waivers and enhanced fixed-income assets. This upside was partially offset by a fall in revenue related to changes in equity asset mix. Revenue reported was below the Zacks Consensus Estimate of $243 million.

During the reported quarter, Federated derived 47% of its revenue from money market assets, 52% from fluctuating assets (31% from equity assets and 21% from fixed-income assets) and the remaining 1% from other products and services.

Total operating expenses jumped 6% year over year to $163.1 million in the quarter. The rise in expenses primarily reflects higher distribution costs and increased compensation and related expense.

Assets Position

As of June 30, 2012, total AUM was $355.9 billion, up 2% from $349.4 billion as of June 30, 2011. Average managed assets were $360.6 billion, up 2% from $354.2 billion in the prior-year quarter.

At quarter end, fixed-income assets improved 16% year over year to $49 billion. Equity assets came in at $33.2 billion, rising 6% year over year. Money market mutual fund assets were $238.6 billion, up 1% year over year. However, money market assets in both funds and separate accounts were $265.5 billion, slightly down on a year-over-year basis.

As of June 30, 2012, cash and other investments were $327.1 million, up from $322.3 million at the end of December 2011. Total long-term debt was $411.5 million, down from $420.4 million as of December 31, 2011.

Capital Deployment Update

In the second quarter of 2012, Federated repurchased 69,443 shares of Federated class B common stock for $1.2 million.

Concurrent with the earnings release, the Board of Federated declared a quarterly dividend of 24 cents per share. The dividend will be paid on August 15, 2012 to shareholders of record as of August 8, 2012.

Developments During the Quarter

In June 2012, Federated and Trustmark Corporation (TRMK - Snapshot Report) entered into a deal under which, Federated will acquire assets worth $903 million from Performance Funds Trust, a wing of Trustmark. Increased assets under management give Federated various new fund offerings that would benefit its clients.

In April, Federated entered into an agreement with Cincinnati-based Fifth Third Bancorp (FITB - Analyst Report) to acquire money-market assets worth $5 billion from four Fifth Third money market funds. These assets will be merged by Federated into its existing four Federated money market funds with the same investment objectives.

Peer Performance

Among Federated’s peers, Janus Capital Group Inc. (JNS - Analyst Report) reported second-quarter 2012 earnings per share attributable to common shareholders of 13 cents, below the Zacks Consensus Estimate by a penny.  Moreover, results compare unfavorably with 15 cents earned in the prior quarter and 23 cents in the year-ago quarter.

Lower top-line growth and net outflows came in as dampeners for the quarter. However, decline in operating expenses reflect better expense management.

Our Viewpoint

We believe Federated has the potential for significant growth in the long run, given its fairly liquid balance sheet and a diversified asset as well as product mix. Moreover, investors increased demand for the company’s wide range of income-oriented products will help it to increase profitability.

However, persistent regulatory pressures, slow global economic growth and a low-interest rate environment will keep Federated’s earnings under pressure in the upcoming quarters.

Shares of Federated currently retain a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a Neutral recommendation on the stock.

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