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Some parts of Fidelity’s empire are still struggling

By Todd Wallack
Globe Staff / June 27, 2010

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To hear Fidelity Investments executives tell it, the Boston financial services giant is firing on all cylinders.

Its mutual fund business remains solid, with its stock funds bouncing back after a poor 2008. Its discount brokerage and employee benefits business are growing. And Fidelity reported increased profits last year, because of the stock market rebound and expense cuts.

But analysts point out that other parts of the Fidelity empire — outside of its core financial services unit — have hit some speed bumps. For instance, Fidelity’s parent company, FMR LLC, also owns a major supplier of home building materials that has been slammed by the real estate bust, costing the company hundreds of millions of dollars.

FMR’s “noncore businesses have been a drag on the company’s consolidated profitability,’’ Standard & Poor’s analyst Charles D. Rauch wrote in a report last month.

S&P singled out losses at ProBuild Holdings, one of the nation’s largest suppliers of building materials. Fidelity’s parent company spent $345 million over six months in 2009 to cover losses at ProBuild and could be on the hook for another $105 million through this year under a recapitalization plan for the firm, according to a recent story from the Reuters news agency, which cited a confidential prospectus for a Fidelity debt offering. Rauch predicted ProBuild will again lose money this year, though not nearly as much as it did in 2009.

Fidelity spokeswoman Anne Crowley declined to comment on the reported losses for ProBuild, but acknowledged the company has not been immune from the slowdown in the housing market. Nevertheless, she said, the firm is continuing to add key sales people and facilities throughout the country, putting it in a position to profit when the housing market recovers.

“Despite market fundamentals that continue to plague the industry with the worst housing market on record,’’ Crowley said, “ProBuild’s experienced management team has remained focused on strengthening and expanding our reach within major metropolitan marketplaces.’’

ProBuild is one of a dozen companies owned by Fidelity’s private investment arm, Devonshire Investors, which built the supplier through acquisitions and internal growth into a chain of 470 stores and 11,700 employees. ProBuild is more than double the size of its nearest competitor, ABC Supply.

Fidelity’s parent was also forced to take an impairment charge of $410 million early last year to reflect the reduced value of a European telecommunications firm it owns, Colt Technology Group of London. The company’s stock price, however, wound up doubling last year. And Crowley said the charge was not related to Colt’s actual operations, which were cash-flow positive last year.

The Devonshire affiliate owns a range of other companies, from Veritude, a temporary staffing firm, to Backyard Farms, a 42-acre tomato farm in Maine, that combined employ 23,000 workers across the United States, Europe, and Asia. Other significant holdings include Pembroke Real Estate, which manages more than 6.4 million square feet of real estate; Boston Coach, a limousine service; J. Robert Scott, an executive search firm, Seaport Cos., which manages the Seaport Hotel and Seaport World Trade Center; KVH, an Asian-Pacific communications service provider; and HR Access, a human resources software provider. Devonshire is also in the process of selling Sebastians, a small Boston restaurant and catering chain, to LPM Holding Co. of Maynard.

The investments aren’t new. For decades, Fidelity executives have built or acquired companies outside of their core financial empire, giving Fidelity chief executive Edward C. “Ned’’ Johnson III and his partners another outlet for their creativity.

The parent company said it is just following the same advice it gives to its investment clients: diversify. Owning a mix of businesses helps the company to weather tough periods in any one industry.

Moreover, Crowley said, the firm has the financial strength and foresight to focus on the firms’ long-term potential and isn’t worried about temporary losses because of the economic downturn.

“As a private company,’’ said Crowley, “Fidelity is able to view these diverse businesses from a long-term perspective.’’

In addition, the cornerstone of the company’s business, financial services, remains solidly in the black. Fidelity reported operating income of $2.5 billion last year, up from $2.4 billion in 2008, even though its revenue fell 11 percent to $12.9 billion. Standard & Poor’s noted that Fidelity’s operating margins were higher because of both the stock market rebound and significant reductions in headcount. Fidelity cut its worldwide payroll from 46,500 employees at the end of 2007 to about 37,000 today.

Dagmar Silva, a senior analyst at Moody’s Global Managed Investments Group, said FMR has had some challenges from time to time with some of its outside investments, such as ProBuild, “and they do increase the risk profile of the company.’’

Still, Silva said, the losses may not be as significant as they seem on the surface because the Fidelity parent is required under accounting rules to report the firms’ entire losses in its financials, even when FMR only owns a portion of the companies, such as with Colt Technology. She also noted the Devonshire holdings are considerably smaller than the size of Fidelity Investments and its other core financial operations.

“It doesn’t represent a significant portion of the balance sheet for FMR at this point,’’ she said. And overall, Moody’s gave the company a solid credit rating. “They have a strong financial position.’’

Todd Wallack can be reached at twallack@globe.com.