Waddell & Reed Financial Inc., an asset management firm started by two World War I pilots, is winning its turnaround battle so far, but some observers say that the upshot ultimately will be to fix it or sell it.
BOSTON — Waddell & Reed Financial Inc., an asset management firm started by two World War I pilots, is winning its turnaround battle so far, but some observers say that the upshot ultimately will be to fix it or sell it.
Founded in 1937, Waddell — like Boston-based rivals MFS Investment Management Inc. and Putnam Investments — dates back to the early days of the now $10 trillion-plus U.S. mutual fund industry. With assets of $48.4 billion at yearend, however, it lags behind MFS’ $187 billion and Putnam’s $192 billion.
But things are looking up for the Overland Park, Kan.-based company. Its Ivy Funds, sold mainly through wirehouses, ranked among last year’s fastest-growing mutual fund groups. And Waddell shares, though down this year, gained 34% last year.
“I don’t think they are interested in selling the company at this point,” said Robert Lee, an analyst with New York-based investment bank Keefe Bruyette & Woods Inc. “They’ve been working hard to fix their business — put it on the right path — and I think that’s what they’re focused on.”
If Waddell, which has had regulatory issues in the past, were to consider a sale, “you [would] do it after you’re fixed,” said Mr. Lee, a managing director, who rates the stock “outperform.”
In July, Waddell announced that three of its units had settled with regulators after charges of market-timing in Waddell & Reed Advisors Funds. Without admitting or denying guilt, Waddell agreed to pay a total of $77 million.
Waddell’s chief marketing officer, Thomas Butch, declined to comment on the possibility of a sale. He also is president of Waddell & Reed Inc., which distributes Waddell’s proprietary funds, and Ivy Funds Distributor Inc., which distributes Ivy.
William Katz, an analyst at The Buckingham Research Group of New York, agrees with Mr. Lee that a near-term sale is unlikely. Still, if the Ivy channel’s growth stalls, management may have to seek a bigger partner with broader distribution to help Waddell “leverage an impressive manufacturing story,” he said in a recent report.
Waddell & Reed’s fourth-quarter earnings report states that 73% of its equity funds ranked in the top half of their Lipper categories on a three-year basis.
Waddell’s W&R Target Funds, available as investment options in variable annuity and variable life insurance contracts but not made available directly to the general public, have $6.3 billion in assets.
“We believe the key for investors to anticipate a possible sale will be how well the third-party-platform initiative plays out,” wrote Mr. Katz, who rates Waddell “strong buy.”
Waddell “screens too cheaply for a turnaround,” he said in a later report.
Waddell trades at about 16 times 2007 estimated earnings, Buckingham’s report said. That compares with about 20 times on average for its asset management peers.
Putnam Lovell NBF Securities Inc. data show that Waddell’s going-concern value is about 11.3 times its earnings before interest, taxes, depreciation and amortization. That compares with 14.3 times for the group overall.
‘Sticky’ assets?
Large-cap-growth managers such as Waddell are at the top of many shopping lists these days, said Ben Phillips, a managing director at New York-based Putnam Lovell NBF, though he declined to discuss Waddell specifically.
Strategic buyers aside, private-equity firms are sitting on about $250 billion of uncommitted capital and “need to start putting it somewhere,” he said.
Waddell is interesting because it has both proprietary funds — the $22 billion Waddell & Reed Advisors Funds — and Ivy, Mr. Lee said.
“The proprietary channel tends to be a higher margin, more profitable business, but it also tends to grow more slowly,” he said.
“You are somewhat limited by the size and productivity of your sales force.”
Although the third-party channel offers “more ability to drive sales through more people,” assets aren’t as “sticky,” Mr. Lee said. Waddell’s proprietary channel redemption rate is about 9% annually. The overall industry average is more than 20%, he said.
“If we, just for the sake of argument, assume that they are going to have an industry-average redemption rate in their third-party channel, you only have the assets half as long,” Mr. Lee said.
Ivy Funds, a $12.4 billion group, boosted assets by 68% last year, making it the fourth-fastest-
growing fund group among those with at least $5 billion in assets, according to Boston-based Financial Research Corp. Helping to drive the growth of Ivy, which Waddell bought from Mackenzie Financial Corp. of Toronto in 2002, was Ivy Global Natural Resources Fund, subadvised by Mackenzie.
Molding advisers
“It’s been a great growth story,” Mr. Butch said, adding that Ivy Asset Strategy Fund also has performed well. Waddell plans to increase the number of wholesalers selling Ivy funds to the mid-30s by yearend and low 40s in 2008, from 28 at the end of 2006, he said.
“We’ve been very careful to build into opportunity rather than ahead of opportunity,” Mr. Butch said. “Waddell & Reed has been around since [the] inception of the mutual fund industry and really grew up as an investment manager going to market arm in arm with a proprietary sales force.”
The proprietary model created loyal relationships, Mr. Butch said, citing Waddell & Reed Advisors Funds’ relatively low redemption rate.
“I don’t want to say it’s the lowest in the industry, but I certainly don’t know of one that’s lower,” he said.
Mr. Butch admits that the proprietary channel has limits: It can grow only as fast as the firm can add financial advisers. It had 2,255 at yearend. Waddell historically hasn’t recruited from rivals, focusing instead on career changers and new college graduates.
“We train and mold them into our culture, so that takes time,” Mr. Butch said.
Waddell likely will have to find a bigger partner if Ivy’s growth eventually stalls, said Kenneth Aulbach, investment strategist and senior vice president of financial products, sales and distribution at Investors Capital Corp., an independent
broker-dealer in Lynnfield, Mass. Investors Capital sells Ivy funds.
“In today’s marketplace, you really do need some type of scalability, and if you don’t have it, it’s really hard to make any money in the business,” Mr. Aulbach said.
