DST Improves Corporate Governance, But Issues Linger

| About: DST Systems (DST)

News hit that DST Systems, Inc. (NYSE:DST)'s CEO Thomas A. McDonnell is retiring, and investors bought shares in the information processing and software services company. While DST has taken steps in recent months that could resolve some red flags about its corporate governance, McDonnell's successor, Stephen C. Hooley, is a company insider who will inherit ongoing issues.

DST said Hooley is CEO effective September 12. He had worked at State Street Corp. for eleven years before January 2004, when he became president and CEO of Boston Financial Data Services, Inc., a joint venture between State Street and DST. In 2009 Hooley became president and COO of DST.

He takes the reins during a time of high turnover. DST said McDonnell, who had formerly performed the duties of board chairman without having the official title, will serve as non-executive chairman "through his planned retirement" on December 31. He isn't the only one to go. Board directors Thomas A. McCullough and William C. Nelson said February 6 this year that they wouldn't stand for re-election at the next annual shareholders meeting. Audit committee chairperson M. Jeannine Strandjord told DST Systems, Inc. on April 2 this year that she would quit, explaining that she also served as a board director at another company whose policy limited her ability to continue to serve simultaneously at DST. As Strandjord and Nelson had both been with DST for 16 years and McCullough for 22 years, their familiarity with the management could easily have compromised their ability to supervise objectively, so their exit is positive for the company's balance of power.

In an indication that McDonnell's powers had few limits, his compensation in 2011 was 2.9 times above the median (more than $1.9 million) for the other named executive officers. DST's financial results gave it an AGR score of 8 a few months ago, when we had warned that DST has higher accounting and governance risk than 92% of comparable companies. With no full disclosure yet about how Hooley will be compensated as CEO, as well as some improvement in other areas, DST had an AGR score of 40 as of August.

Nonetheless, the new management faces lingering problems. For example, the board still includes 77-year-old A. Edward Allinson, who has served on DST's board since 1995 after taking a pause from an earlier stint between 1977 and 1990.

The decisions that DST managers have made in the past continue to have an impact. While the company managed to lower its debt burden by $145.9 million in the second quarter to more than $1.21 billion as of June 30, this debt continues to exceed DST's total equity. DST undertook a number of acquisitions in 2011, ranging from the retirement planning information firm Newkirk that May to the asset management solutions provider ALPS Holdings Inc. that October. The amount DST paid above book value for its acquisitions was $484.9 million as of June 30, or nearly 14% of total assets, compared to nearly 10% of assets as of September 30, 2011. If McDonnell and his team estimated those deal values incorrectly, the new management will have to announce painful revisions to DST's earnings later.

Even so, DST's stock price gained nearly 5.4% compared to Wednesday to trade at around $55.21 per share at Thursday's close of the market. In the coming years, those investors will see whether Hooley's long familiarity with DST and State Street will help or hinder his ability to instigate cultural changes.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by a financial reporter at GMI. The reporter has no business relationship with any company whose stock is mentioned in this article. Nobody paid GMI to write this article on his or her behalf.

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