Once you reach the last room of the level you want to head upwards and jump out of the water. There will be a portal that you need to go through and you will be greeted by a seal with some sort of rocket boat.
Accept the challenge and jump in the boat. Just drive it forward, navigate the rocks and you will come to an open area where Bluto is waiting for you. The direction controls here can be quite annoying as the camera always wants to face Bluto. Try and keep the camera looking the way your boat is facing.
I have attached a video below of me beating him.