We have reiterated our Neutral recommendation on Federated Investors Inc. (FII - Analyst Report) following a detailed analysis of the company’s fundamentals in light of the current economic environment. Also, the opportunistic expansion efforts by the company, and the fact that it is on track to expand globally, contributed to this stance.
In April 2012, Federated completed the acquisition of London-based Prime Rate Capital Management, LLP – a provider of institutional liquidity and fixed-income products – from Matrix Group Limited. The acquisition further increased the company's European presence with UK-domiciled UCITS (Undertakings for Collective Investment in Transferable Securities) products.
Federated came up with the plan of buying more mutual fund assets to enhance its business in strategically important segments to mitigate the effects of the lingering low interest rate environment and the increasing number of regulations. Hence, in September 2012, the company acquired money market assets worth $4.4 billion from FTAM - the asset management subsidiary of Fifth Third Bancorp (FITB - Analyst Report).
Moreover, in the same month, Federated acquired assets worth $929 million from Performance Funds Trust, a wing of Trustmark Corporation. Increased assets under management (AUM) furnished the company with various new fund offerings that would benefit its clients going forward.
Moreover, Federated boasts a strong liquidity position to meet its present as well as future financial needs. Cash and investments coupled with the cash flows from operations and available cash will help take advantage of acquisition opportunities and use these for other general corporate purposes. Further, the company’s varied business mix, which includes products that are functional under diverse market conditions, is beneficial for the company.
Federated remains an attractive pick for yield-seeking investors due to its extensive capital deployment activities. In the first half of 2012, Federated repurchased 0.1 million shares of Federated class B common stock for $2.3 million. The authorization of the new share buyback program, slated to expire on March 1, 2013, and stable dividend payments raise our hopes for an enhanced investor confidence in the company.
On the flip side, Federated was significantly impacted by the negative developments in the global financial markets over the past years. Volatile equity markets and sluggish economic environment are expected to keep AUM, flows and margins under pressure. Even though the situation is slowly easing, we do not expect stability in the near term.
Further, the uncertain regulatory environment is expected to significantly impact Federated’s financials. In January 2010, the Securities and Exchange Commission (SEC) adopted extensive amendments to Rule 2a-7 of the Investment Company Act of 1940 aimed at enhancing the resiliency of money market funds.
Further, the SEC is set to propose a new body of regulations for money market funds in the near future. When enacted, these are expected to be unfavorable to Federated's money market fund business and could significantly affect its financials.
In addition, the low-interest rate environment continues to adversely impact Federated’s money market funds. Over the last several quarters, the Federal Reserve left the near-zero federal funds rate unchanged and short-term interest rates continued to be at their all-time lows. We believe that the prevailing low interest rates will continue to negatively impact the company’s operations.
The risk-reward profile of Federated is currently balanced and hence, we have reiterated our Neutral recommendation on its shares.
Federated currently retains its Zacks #2 Rank, which translates into a short-term Buy rating.