Did you hear that bloodcurdling scream?
It's coming from GAAP, which is being beaten beyond recognition by the folks at Janus (NYSE: JNS ) . In one fell swoop, the company has managed to come up with a transaction that will:
- Hide debt
- Create a tax-free transaction
- Create the appearance of cash
- Make an analysis of the company's financial position extremely difficult
From an investment standpoint, only one of these four elements is even slightly beneficial to investors, and even that may not stand. The others... well, some analysts may like them, but my humble estimation is that they reek of financial engineering, not fiscal prudence.
The long and winding road
Here's the deal. At present, Janus owns approximately 34% of DST (NYSE: DST ) , a Kansas City-based financial software provider. Janus is also saddled with more than $1.5 billion in long-term debt and liabilities, substantially higher than its assets once goodwill is removed.
Janus has been seeking ways to reduce its own debt levels and, in so doing, improve its credit ratings. Moody's (NYSE: MCO ) currently rates Janus debt at Baa2, which places it at the lower end of investment-grade. One of the ballasts Moody's has counted on to keep Janus' rating even at that level is its stake in DST. In such highly leveraged businesses as investment management, cheap debt is a real factor in profitability, so that debt rating is of more than passing interest to Janus and its shareholders.
Rather than opt for a simple asset sale that would raise cash, Janus elected to structure a highly convoluted transaction. The company will exchange 32 million DST shares (27% of the total float) for a subsidiary of DST, a printing and graphics design group. I guess Janus' T-shirt silkscreening costs will go down as a result.
DST will capitalize the subsidiary, to be named JCG Partners, with approximately $900 million in cash. JCG Partners will then buy some $450 million in Janus debt, taking that amount off the latter's balance sheet. This is despite the fact Janus will own 100% of JCG Partners, and will still be responsible for servicing the debt.
Break it down
So follow along while we recreate this. Janus buys a subsidiary and consolidates it for accounting purposes, which companies must do when they have controlling stakes in other entities. That subsidiary uses its own cash to buy hundreds of millions in Janus debt. By the rules of consolidation, Janus no longer needs to list this debt on its balance sheet. But it's not like the subsidiary just forgives the debt -- Janus must service all $450 million of the debt held by JCG, which is, essentially, itself. So Janus is both the debtor and grantor of the same notes -- they are still due. But, poof, they are no longer listed on its accounting statements.
By structuring it this way, Janus and DST create what amounts to a tax-free transaction. There's a catch for Janus, though. It cannot take a dividend or in any other way touch the money allocated to JCG without jeopardizing the tax-free status of the transaction.
Neither Moody's nor investors seem very impressed by the deal structure. Moody's, rather than looking more kindly at Janus, put the company's debt on watch for a potential downgrade. And though some analysts came out to defend Janus, saying that the move gives the company more flexibility, investors sent the stock downwards on the heels of the announcement.
Moody's clearly points out that Janus is in no way less encumbered by debt by virtue of this transaction, and that none of the capital that goes into JCG can be used by the parent company. Further, Janus still has more than $800 million in long-term obligations beyond that will be subsumed by JCG.
Confused yet? The transaction serves a few purposes for Janus: It allows it to cash in its stake in DST, it gets some debt off its balance sheet, and it cashes in an appreciated asset in a way that is tax-free. One analyst estimated the tax bite otherwise to be in the range of 40%. I assume that means of the appreciated value, and not total value.
Avoiding taxes is not a business
I hope that the tax avoidance is worth it for Janus. I think more wrong is done in investing for tax purposes than for nearly any other reason, even "diversity." One has to wonder what Janus' goals were in this transaction, and whether structuring the transaction this way achieves those goals.
First, the company wants to reduce its debt. While JCG will take a substantial amount of debt off the balance sheet, it does not reduce the amount owed at all. Janus will still have to make payments, some of them going to an entity it owns. And JCG assets are unavailable for uses in other parts of Janus' business.
Second, it wants to make bondholders and shareholders happy. How playing a shell game with your debt accomplishes this, I don't know -- except that bondholders know that there will be an existing, committed buyer for Janus' debt.
Third, it wanted to create liquidity from its DST holding. This could have been done by selling it on the open market or in closed transactions, but Janus instead elected to go this route, taking in a subsidiary business that has nothing to do with financial services, but which will be larded with cash. It has liquidity, but it has limited flexibility.
Fourth, Janus wants to improve its credit rating. Thus far, Moody's is decidedly unimpressed.
Fifth, Janus wanted to avoid taxes in completing the transaction. It will succeed in this regard as long as it stays away from the JCG capital.
But it seems that this fifth element has managed to trump all the others. Is "avoiding taxes" what Janus does for a living? For that matter, is Janus a graphics company, like JCG? No. Janus deploys capital. Further, it now has severely complicating elements on its balance sheet, which will be (a) hidden from less-sophisticated shareholders and (b) deeply confusing to the more savvy.
I can't count the number of companies I've bailed on simply because their footnotes convinced me that the analysis wasn't worth the trouble. Is this what Janus wants? The complicated transaction, the payments to entities that it owns, the tax avoidance, the gussied-up balance sheet... they all smell much like the biggest of scandals that have beset Wall Street in the last several years. That doesn't sit well at all.
When companies forget what it is that they're supposed to be doing, focusing instead on how things look, good rarely comes of it. In the long run, Janus may find itself not benefiting from this tangled web it's weaving.
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