Friction between the two managements has KSU stock in a slide, but that could be a buying opportunity

What a mess. Kansas City Southern Industries (KSU), originally a railroad company, has long planned to spin off its financial businesses, which are dominated by its majority stake in Janus Capital. Now that spin-off, expected to be completed in the fourth quarter, may be veering dangerously off track. According to analysts and investors, Janus and Kansas City Southern are locked in a test of wills over how the spin-off will be executed and who will be in control when -- and if -- it's completed.

One of this year's early winners, KSU more than doubled since last fall to reach a high of 66 7/16 on Apr. 9, largely on hopes for the spin-off. But since word of the friction between the two managements has spread, the stock has fallen nearly 30%. It dropped 2 5/16 points, or 5%, on Aug. 30 to close at 47 7/8. With the bulk of its earnings coming from the mutual-fund business, KSU is also tied to the overall health of the market, which had a sick day on Aug. 30, tumbling 176 points. This leaves investors with a tough question: Is the beating KSU has taken creating a buying opportunity -- or is it a big yellow caution flag?

LUMPED WITH LESSER NAMES. Kansas City Southern, which began diversifying into financial companies in the 1960s and eventually acquired an 82% stake in Janus, wants to consolidate its financial holdings into one company, Stilwell Financial. That would combine Janus, one of today's marquee mutual-fund names, with Berger Associates, which manages the far smaller and less successful Berger fund group; Nelson Money Manager, a British asset-management firm; and a 32% interest in DST Systems, which does accounting and record-keeping for financial firms.

Janus' top executives, none of whom were available for comment before deadline, are none too happy about being lumped in with the lesser financial names and managed as part of the Stilwell group, say analysts. At Kansas City Southern's board of directors meeting in June, analysts say they asked for Janus to be spun out separately, since it is by far the most valuable of Kansas City Southern's financial assets. Janus execs are also concerned that its cash flow would go to acquiring other financial firms, perhaps at inflated prices and diluting Janus' value, according to analysts.

KSU says it'll continue with its plans for Stilwell (named after one of the railroad's founders), citing the "late date" for changing the plan -- particularly after it won IRS approval to make the transaction tax-free to shareholders. "While we recognize that some at Janus may be disappointed, we have full faith that Janus management is committed to continuing the tremendous success and outstanding results achieved for the Janus clients and shareholders," Kansas City Southern Chairman Landon H. Rowland said in the company's second-quarter earnings release dated Aug. 2.

"PHANTOM" STOCK. Some investors aren't so sure. What really has shareholders wringing their hands lately is fear that Janus may not take no for an answer. On Aug. 16, CIBC World Markets analysts took the drastic step of downgrading the stock from strong buy to hold because "a war for control of the company is brewing." The report says Janus might issue so much "phantom" stock (a form of profit-sharing) to employees that it would have the effect of cutting Janus' pretax profit margins in half.

That would crush Kansas City Southern's margins as well as Stilwell's. After all, the bulk of KSU's earnings come from asset management ($71 million, or 61 cents per share, out of a total of $76 million, or 66 cents per share earned in the second quarter). And the vast majority of financial-services earnings come from Janus. KSU dropped 9% the day the CIBC report came out.

Another danger, even if the deal does go through as planned, is that Janus managers will leave the firm -- an implicit threat in Janus' executives comments, says Joe Cornell, of Spin-off Advisors in Chicago, which publishes research for institutions.

Undaunted, some investors see the controversy and accompanying stock slide as an opportunity -- figuring a compromise will be reached between KSU and Janus. The easiest resolution could be to let Janus play a large role in managing Stilwell. "My thought is that this is just posturing by Janus," says Cornell. "They generate 85% of the operating income for financial services. They want a corresponding say in what is going on." He thinks investors should buy the stock, since the sum of the parts, post spin-off, is worth more than $75 a share, he estimates.

"A LITTLE BIT EXTREME." Marc Halperin, portfolio manager of Federated Global Financial Services, says he's holding onto his shares. "It is hard to believe they would destroy the relationship and undo everything," he says. Stephen Klein, an analyst with Standard & Poor's equity research group recently upgraded Kansas City Southern from sell to hold because he, too, believes the spin-off will eventually go through. Says Klein: "I felt the scenario being tossed around that Janus would sabotage the deal was a little bit extreme."

This confusion can't continue for long, since the spin-off is planned for October or November. If investors are assured that the Stilwell plan will go through and that Janus won't dilute earnings by issuing phantom stock, KSU would suddenly look pretty cheap. CIBC estimates that its p-e on 2000 earnings is only 15.5.

But KSU will still be riding on the overall fortunes of a currently choppy market. And with so much uncertainty and a battle of wills apparently still going on, most investors will want to watch this stock from the sidelines