More bad news for Fidelity Investments. On Friday, Moody's revised its outlook on the Boston-based investment behemoth from stable to negative. According to the ratings service, the outlook change reflects the "erosion of the company's market share in long-term mutual fund assets under management, the growing prominence of lower-margin businesses in its overall business profile and increasing risk from non-core investment activities."
Moody’s notes Fidelity is facing these pressures with higher leverage than that of its asset management peers.
"Today's outlook change reflects the relatively weak performance of Fidelity's equities funds, which has led to a loss of market share," Moody’s vice president Dagmar Silva said in a statement. "And while the company has leading market positions in retail brokerage and defined contribution plans, these businesses have lower margins than its asset management businesses."
A Fidelity representative took issue with Moody's report, and highlighted the company's successes during the past year.
"Our business continues to grow and our operating income in 2010 increased by 17%, from $2.5 billion in 2009 to more than $2.9 billion last year," Fidelity spokesman Vin Loporchio wrote in an e-mail. "2010 was one of the best years in our history. Our balance sheet is strong and we continue to invest significantly to further develop our businesses."
He claimed the release has absolutely no impact on the company's business strategy or the services it delivers.
"Fidelity is an industry leader that is healthy and well-positioned for the future; the firm is positioned exceptionally well with our unique and diverse business lines, strong brand and reputation, sound risk management practices, clear strategic direction, willingness to invest for the future, and commitment to financial strength," according to Lorporchio. "We hold a leadership position in the financial services industry and across multiple business lines.
A significant portion of Fidelity's revenues continues to depend on the vitality of the domestic equity markets, and last year the company saw net outflows from its higher-margin equity funds due to weak investment performance of several flagship funds.
This, in part, is shifting the company's revenue mix toward lower-margin businesses.
Moody's also believes that the company's non-core investments, which have grown over the past few years, have a significantly higher risk profile than Fidelity's core financial services businesses.
However, despite it’s outlook downgrade, Moody’s nonetheless reaffirmed Fidelity’s A2 senior debt rating, which it said reflects "Fidelity's strong market position in asset management and well-diversified sources of revenue. It is a leader in several investment-related sectors, including mutual funds, brokerage services, advice and retirement planning services, and human resources benefits administration."
Fidelity's profitability and debt-servicing metrics, while improving, are still low for the rating category and significant leverage and a relatively modest equity base limit its financial flexibility, Moody's said. Furthermore, the company's private ownership and involved capital structure add complexity to the credit profile, which the ratings agency characterized as 'incrementally negative.'
Through subsidiaries, Fidelity engages in private equity investments, real estate development, telecom, building supplies, and other activities that have pressured its overall earnings, Moody's said. These investments are not closely related to Fidelity's core financial services businesses and increase the company's earnings volatility and balance sheet risk. While these activities may provide some diversity to the income mix, their overall contribution in recent years have been limited and, in some cases, negative.
Fidelity's rating could be downgraded, Moody's warned, if the following trends do not stabilize or improve:
- persistent material net outflows,
- significant financial leverage as evidenced by Moody's adjusted total debt-to-EBITDA ratio above 2.5x and Moody's EBITDA to interest ratio below 4x,
- net income profit margins below 15%, and
- increasing exposure of the company's capital to non-core investments.
The company's outlook could return to stable if:
- pressure on the financial metrics identified above is reduced,
- Fidelity sustains its leadership positions across multiple business lines, particularly its long term mutual funds business, and maintains strong liquidity,
- the company's dependence on internal debt financing to support its long-term funding needs is reduced, and
- balance sheet risk from non-core investments is reduced.
The last rating action on Fidelity was on June 30, 2010, when the company's senior debt rating was affirmed at A2 with a stable outlook.