Power's bid to expand Putnam via Deutsche unit buy dims

Power Financial Corp. appears to be falling short in its bid to acquire DWS Americas, with that U.S. mutual fund family's parent, Deutsche Bank, focusing on bids that cover all but its European and Asian mutual fund businesses.

Investment bankers, who declined to be named, said as of Feb. 17, Guggenheim Partners and Macquarie Group were the leading bidders for that broader asset management business. Those units are Deutsche's real estate-dominated RREEF Alternatives affiliate, its DB Advisors institutional arm and its insurance asset management business, in addition to the U.S. piece of DWS Investments.

While Power might be down, it's too soon to say it's out, said one banker. The banker said it's unclear whether the all-in bids will satisfy Deutsche Bank, leaving open the possibility of Power getting a second bite of an ala carte apple.

Whatever the outcome of Deutsche Bank's auction, Power Financial's pursuit of DWS shows that executives at the Montreal-based firm are ready and willing to add more chips to a four-year bet on the U.S. asset management market — staked by its $3.9 billion, mid-2007 purchase of Putnam Investments, Boston — that has yet to contribute to the conglomerate's bottom line.

Adding DWS' $51 billion in mutual fund assets to Putnam's $125 billion in assets under management as of Jan. 31 would have lifted Putnam above the $150 billion mark its president and CEO, Robert L. Reynolds, cited in recent analyst calls as a threshold of profitability for the firm.

Fourth-quarter results reported on Feb. 9 by Power subsidiary Great West Lifeco showed Putnam — with assets of $116.7 billion as of Dec. 31 — delivering core earnings of less than $1 million for the period, on fee and net investment income of $182 million.

That amounts to an operating margin of 0.5%, better than Putnam's -10% margin when equity markets plunged in the third quarter, but still markedly low in an industry where competitors often boast margins of 30% to 40%.

One Toronto-based analyst who declined to be named said Putnam's infrastructure and cost structure, while slimmer now than when AUM peaked at more than $400 billion in early 2000, remains appropriate for a company with far greater assets, which accounts for much of the company's unusually low operating margins.

The markets Putnam is targeting, such as retail and 401(k), demand heavy spending on infrastructure just to come to the table, added a veteran money manager consultant, who likewise declined to be named. While that could be weighing on Putnam's operating margins at current AUM levels, it also could mean that any rebound in assets under management would provide a healthy boost for those margins, he said.

Thomas MacKinnon, a Toronto-based analyst with BMO Capital Markets, said officials at Putnam and Great West Lifeco have suggested that Putnam's margins could rebound to 10% or so as AUM rises toward $150 billion and improve further to between 15% and 20% as assets climb toward $220 billion.

On the fourth-quarter conference call, a healthy chunk of the analysts' questions focused on Putnam's prospects for becoming profitable and whether the money management firm was likely to get there organically or through acquisitions.

Mr. Reynolds expressed full confidence that Putnam could reach the goal through organic growth.

Asked separately about the prospects for an add-on acquisition, D. Allen Loney, Great West president and CEO, struck an agnostic tone, praising the “solid” foundation Mr. Reynolds had established and observing that “you can drive forward either organically or in acquisition mode.”

DWS isn't the first property Power has looked at in recent years. Investment bankers said the firm was kicking the tires at Boston-based Pioneer Investment Management Inc. when that firm's Milan-based parent, UniCredit Group, put its asset management properties in play between late 2010 and April 2011.

As a means of boosting Putnam's margins, a DWS acquisition would come with complications. For example, as much as $17 billion of the fund family's equity mutual funds are subadvised by firms such as QS Investors LLC and Dreman Value Management LLC, diluting the potential economic benefits for Putnam.

Analysts in Toronto remain convinced that the Desmarais family, which controls Power Financial, hasn't become flustered by Putnam's slow advance toward profitability.

It's a family-run company “playing the long game” in acquiring scale in the U.S. retirement market, noted Peter Routledge, an analyst with National Bank Financial. They're willing to make additional acquisitions, but in any case “they've made a strategic decision to maintain the quality and the stability of the platform,” he said.

Power's backing of Putnam through a difficult rebuilding process has drawn praise from some market veterans.

After buying Putnam “at the top of the market,” Power has acted “like the perfect long-term investor — professionalizing management, investing in quality portfolio talent and supporting acquisitions,” noted Donald H. Putnam, San Francisco-based manager partner with Grail Partners LLC. Power's example is in stark contrast to “other investors and owners whose actions during the crisis have been value-destroying,” he said. He declined to provide examples.

Whether the strong performance put up by many of Putnam's strategies in 2009 and 2010 has left investors and gatekeepers sufficiently impressed to overlook weaker numbers over the past year will help determine just how much Power's patience might be tested.

On the conference call, Mr. Reynolds conceded that a market spike in volatility in 2011 had dented performance for Putnam strategies, but he noted that, for the most part, three-year track records remain above median or top quartile.

The Putnam Voyager fund, a high-profile, $4 billion large-cap growth equity portfolio, is a prominent example. Despite ranking in the bottom 3% in Morningstar Inc.'s large-cap growth equity universe for the 12 months through Feb. 16, the fund remained among the top 11% on a three-year basis and the top 18% over five years.

For the first six weeks of 2012, meanwhile, Putnam Voyager's performance has been in the top 1%, in line with Mr. Reynolds' observation on the conference call that Putnam has gotten off to “a spectacular start” this year.

Net flows, meanwhile, were a positive $183 million for 2011, rebounding from outflows of $4.1 billion in 2010, more than $16 billion in 2009 and more than $18 billion in 2008.

However, with $3.4 billion in inflows for the first half of 2011 offset by more than $3.2 billion in second-half outflows, it remains to be seen whether the performance issues that arose during the past year could weigh on Putnam's prospects for 2012.