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Tuesday, April 24, 2007

Shopping with Federated

Reported by Sean Hanna, Editor in Chief

For years the conventional wisdom in the fund industry has been that fund shops either need to build scale or focus on a niche. Playing tennis in the middle of the court, as it were, is a loser's strategy, or so says the CW. That advice may explain Federated Investors deal yesterday to pick up the Rochdale Atlas Portfolio from Rochdale Investment Management, a specialist in quantitative overseas investing. The deal marks the second time in less than a year that Federated has purchased a quantitative-focused investment manager.

Federated's Shopping Spree
  • May 2006 -- MDT Advisers, a Cambridge, MA-based quantitative equity management firm with about $6.7 billion in AUM.

  • March 2006 -- Mason Street Index 400 Fund's $218 million in AUM merged into the Federated Mid-Cap Index Fund.

  • March 2006 -- Wayne Hummer Growth Fund with $158 million in AUM merged into the Federated Kaufmann Fund

  • September 2005 -- AMCORE Financial's Vintage Funds with $142 million in AUM.

  • Source: The MutualFundWire.com
    One detail absent from yesterday's news release (and not yet part of the chatter that inevitably follows the completion of a deal), is the pricing of the transaction. Current sales run at 10 to 12 times EBITDA, say deal-makers, a little more than before the stock market recovered. Where this one fell on the pricing spectrum may become apparent in the coming months.

    Meanwhile, on a dollars-per-AUM basis the deal some seem pricier than many. Federated could pay up to $25.75 million and perhaps more -- which translates into 8.02 percent of AUM -- over five years if all of the conditions of the earn out are met. That includes an upfront payment of $5.75 million and payments three and five years after the deal closes that could reach as much as $20 million along with "Additional contingent payments" paid on a semi-annual basis over the next five years based on "certain revenue earned by Federated from the Federated InterContinental Fund," according to a 8-k filing made with the SEC. As with all earnouts, the payments are based on earnings and asset growth hurdles.

    Since Eliot Spitzer tied Pittsburgh-based Federated to the fund trading scandals roughly three years ago, the talk has been that Federated CEO J. Christopher Donohue should be on the lookout for deals -- either as a buyer or a seller. That talk reached a crescendo last year when some industry insiders were openly speculating that Federated was on the block and ready to serve a deal. Not only was Federated tainted by the fund scandals, went their thinking, but the firm was also limited by its reliance on money market funds in a new and seemingly permanent era of low interest rates. Also, as a public company Federated did not, and does not, have the option of trimming some of its 148 fund products and $237 billion in AUM to squeeze into a niche player's outfit.

    A year -- and a widening yield curve -- later, that there could be a sale in the cards is obviously not the case. Indeed, Federated appears to be leveraging the booming outlook for its core product line to smash a winner when the opportunity presents itself.

    Last May, Federated purchased MDT Advisers based in Cambridge, Massachusetts which claimed about $6.7 billion in AUM in eight funds at a cost of roughly $110 million in initial payments plus up to $130 million more in contingent payments over three years. That deal followed a number of others that were kicked off by Federated's purchase of the Kaufmann Fund in 2000.

    Indeed, Donahue in 2002 outlined the strategy to buy funds with strong track records that are struggling operationally that it could roll into its existing funds during a call with analysts.

    "Obviously they need a grand home like Federated Investors...so we're looking at a number of those opportunities," he at the time.

    While the Rochdale fund only brings $321 million in assets to its fund, it does broaden Federated's investment management skill set and further focus the firm as an asset manager, something that Donohue has sought to do (other moves related to this strategy were made last year and include the sale of the firm's advisor custody business to Matrix and the sale of its 401(k) recordkeeping software arm InvestLink in a management-led buyout).

    To use Donahue's own words to shareholders in explaining the deal's rationale: "The unique country-specific investment approach makes Rochdale Atlas Portfolio an ideal opportunity for Federated to expand our international equity product line."

    The deal brings an experienced stock-picking team led by Merrill Lynch veterans Audrey H. Kaplan and Geoffrey Pazzanese, who will continue to manage Rochdale Atlas Portfolio even as the fund is rebranded as the Federated InterContinental Fund.

    As with Federated earlier adoption of the Kaufman Fund, the deal holds out the promise of synergies for both parties: Federated is able to diversify its product line and further fill its distribution pipeline with proprietary product, while Rochdale is unentangled from the nitty-gritty, day-to-day details and headaches of running an operating business in the fund space and freed to focus on managing money for the sky-box set.

    The pick-up appears to be an especially savvy one as Rochdale has a relatively rare and valuable asset in the form of a five star rating from Morningstar. Funds with that peak rating continue to be the industry's most saleable and Rochdale lacked the marketing and distribution clout to fully take advantage of that asset on its own. And, while Lipper does not yet have the marketing clout of Morningstar, the fund also ranks in that firm's top decile for large-blend international products.

    Federated officials expect the sale to be complete in the third quarter. 

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