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Shares of Janus Capital Group (JNS) ended Friday's trading session with gains of 10%. The provider of investment funds announced that Japanese Dai-ichi Life Insurance will take a 20% stake in the business.

The Deal

Janus announced the strategic alliance on its website. Under the deal, Dai-ichi Life Insurance will buy a 20% stake in Janus and take a seat on its board of directors. Dai-ichi will acquire a 15-20% equity stake in Janus Capital through open market transactions or by options issued by Janus. Furthermore the Japanese insurance company will make an investment of $2 billion into Janus' funds.

Janus CEO Richard Weil has been talking to Dai-ichi since he became CEO in 2010. According to Weil, the deal will result in greater diversification in the firm's product line. A significant portion of the $2 billion investment will be steered towards fixed-income products. Janus aims to boost its fixed income funds, as it traditionally has been highly reliant on equity markets.

Weil commented on the deal, "We are honored to partner with one of Japan's financial services leaders and are very excited by this opportunity. Dai-ichi Life has a 110-year history of client service excellence, and our alliance represents a substantial leap forward in the development of our business in the Asia-Pacific region."

Janus which is known from its Janus, Intech and Perkin funds has been suffering amidst poor market conditions, bad performance and increased competition from ETFs. As a result, assets under management have been steadily falling in recent years. At the moment assets under management are still 25% below levels in 2007.

Second Quarter Results

On the 26th of July, Janus Capital reported its second quarter results. Revenues fell sharply from $264.0 million last year to $206.0 million in 2012. Assets under management fell from $171.6 billion to $155.0 billion. As such, the annual revenue rate fell to 53 basis points of assets under management. In comparison, many ETFs have expense ratios of a mere 10 to 30 basis points. Net income fell from $45.5 million to $23.4 million. Consequently, earnings per share fell from $0.23 to $0.13 in 2012.

Valuation

Janus Capital ended its second quarter with $304 million in cash and equivalents. Furthermore it holds roughly $331 million in seed investment and mutual fund share awards. The company operates with $540 million in short and long term debt.

For the full year of 2011 the company reported revenues of $982 million, on which it net earned $142.9 million. Earnings per share came in at $0.78. Given the first two quarters of 2012, the firm is on track to report annual revenues of $800-$850 million and earnings around $90 million, or $0.50 per share.

Based on Friday's closing price of $8.46, the market values the firm at $1.58 billion. This values Janus at 1.9 times annual revenues and 17 times annual earnings.

This valuation compares to a revenue multiple of 5.6 times for T. Rowe Price Group (TROW), 2.5 times for Eaton Vance (EV) and 2.1 times for Waddell & Reed (WDR). These competitors trade at 20,15 and 15 times earnings, respectively.

Currently, Janus Capital pays a quarterly dividend of $0.06 per share for an annual dividend yield of 2.8%

Investment Thesis

Shares of Janus Capital trade with year to date gains of 34%. Shares rose sharply in line with the wider equity markets in the first months of the year to peak at $9.50 in March. From there, shares fell back to the $7 mark in May when markets corrected on worries about a global economic slowdown. The latest equity market rally, and Friday's announcement propelled shares upwards to $8.50

Despite this year's returns, the long term picture is not that nice. In 2007 shares traded at $34, the peak of the last decade. The recession which resulted in a massive sell-off in equities, hurt the firm hard. Assets under management fell as the major indices took a dive, while performance was lackluster as well. At the same time, mutual funds got more competition from cheaper ETFs as investors try to save on investment costs amidst lower returns.

This latest deal is not addressing the real issues of Janus. Lackluster performance and increased competition from cheap ETFs and tailored hedge funds are cutting the grass away for traditional mutual fund holding companies. This latest deal does nothing to address these structural issues.

In the meantime, shareholders are left with an underperforming business. Fortunately for current investors, they still receive their annual dividend yield of 2.8%. The business remains profitable, also on a smaller scale, as many of Janus' costs are variable and linked to investment performance and assets under management.

Until the business can make steps to improve its long term competitiveness by offering ETFs or structurally improve fund performance, shares are simply a levered bet on the wider market performance. The business fundamentals are to shaky, and the valuation is not appealing enough to initiate a long position. On the other hand, I would be hesitant to short the stock with Dai-ichi Life Insurance on the bid. I remain on the sidelines.

Source: Janus Capital Group - Short-Term Infusion Does Not Address Long-Term Competitive Issues