By Dylan Litt, Michael Lipsky, and Kyle Amelio (New York University), Ilya Korzinkin, Siddharth Sharma, Mihir Gupta, and Hugo Tay (University College London) | 20/04/2020
Overview of the Deal
Acquirer: Franklin Templeton
Target: Legg Mason
Estimated Value: USD $6.5bn
Announcement Date: 18/02/2020
Acquirer Advisors: Broadhaven Capital Partners, LLC and Morgan Stanley & Co LLC
Target Advisors: PJT Partners, J.P. Morgan Securities LLC
In February, Franklin Templeton announced a deal to acquire Legg Mason for $50.00 per share of common stock in an all cash transaction. The merged entity will assume approximately $2 billion of Legg Mason’s outstanding debt, creating a global investment manager with $1.5 trillion in assets under management.
This acquisition comes following recent trends of midsize firms suffering investor outflows due to the competition of lower fee passive funds and larger firms that could lower costs due to economies of scale. Legg Mason had come under pressure to cut costs and boost profits from key stakeholders, such as hedge fund Train Partners, who have a 4.5% holding. Franklin Templeton has also experienced a difficult period due to heavy outflows from their funds, such as the Tempelton Global Bond Fund, which saw $6.3bn in net redemptions in 2019.
This acquisition aims to create an expansive investment platform with complementary investment strategies for both institutional and retail clients across various key geographies. Franklin Templeton’s broadened product offering exposes them to new asset classes such as infrastructure, real estate and quantitative multi-asset solutions.
"This acquisition will add differentiated capabilities to our existing investment strategies with modest overlap across multiple world-class affiliates, investment teams and distribution channels, bringing notable added leadership and strength in core fixed income, active equities and alternatives." - Jennifer Johnson, president and CEO of Franklin Templeton
Company details (Legg Mason)
Legg Mason helps investors globally achieve better financial outcomes by expanding choice across investment strategies, vehicles and investor access through independent investment managers with diverse expertise in equity, fixed income, alternative and liquidity investments. Legg Mason’s investment affiliates operate with investment independence and have specialized expertise across asset classes and markets around the globe. The firm’s affiliates include: Brandywine Global, Clarion Partners, ClearBridge Investments, Martin Currie, QS Investors, Royce Investment Partners, and Western Asset. Legg Mason’s assets under management are $806 billion as of January 31, 2020.
Founded in 1899, headquartered in Baltimore, Maryland, United States
President and CEO: Joseph A. Sullivan
Number of employees: 3,300
Market Cap: $4.3bn
LTM Revenue: $2.9bn
LTM EBITDA: $0.6bn
LTM EV/Revenue: 1.82x
LTM EV/EBITDA: 8.81x
Company details (Franklin Templeton)
Franklin Resources, Inc. is a global investment management organization operating, together with its subsidiaries, as Franklin Templeton. Franklin Templeton’s goal is to deliver better outcomes by providing global and domestic investment management to retail, institutional and sovereign wealth clients in over 170 countries. Through specialized teams, the Company has expertise across all asset classes, including equity, fixed income, alternatives and custom multi-asset solutions. The California-based company has more than 70 years of investment experience and approximately $688 billion in assets under management as of January 31, 2020.
Founded in 1947, headquartered in San Mateo, California, United States
President and CEO: Jennifer M. Johnson
Number of employees: 9,700
Market Cap: $8.1bn
LTM Revenue: $5.8bn
LTM EBITDA: $1.6bn
LTM EV/Revenue: 0.64x
LTM EV/EBITDA: 2.31x
Projections and assumptions
The deal is expected to generate $200M in annual cost savings with the majority being realized in the first year. These savings will be in addition to the $100M cost cutting initiative announced in 2019 by Legg Mason Chairman and CEO, Joseph Sullivan. While cost synergies were not a driving factor in the merger, they are critical for the two companies that have repeatedly seen their pricing undercut by their competition which specializes in passively managed investment vehicles, such as ETFs.
A critical feature of the deal has been finding a way to balance the independence Legg Mason affiliates have enjoyed while leveraging the scale of the company post-merger. It’s because of the trepidation on the part of the affiliates that Franklin Templeton dedicated significant time and effort towards assuring them that they will retain their autonomy and investment independence and won’t be swallowed up by the larger company.
The deal will also mark the end of the hedge fund Trian Fund Management’s involvement at Legg Mason. The fund’s investment, which was initiated in the second quarter of 2019, was seen as significant because Trian’s founder and CEO, Nelson Peltz, had previously served on the board from 2009 to 2014 and sold the fund’s remaining position in 2016. Trian’s renewed activist effort in 2019 resulted in Legg Mason ceding two board seats to Trian’s CEO Nelson Peltz and its CIO Ed Garden. As a result, it served as an important seal of approval when Peltz came out in support of the two companies merging following the announcement.
“In our view, it offers an attractive valuation for Legg Mason’s shareholders. I believe it will also enable Legg Mason’s investment affiliates to remain at the forefront of an industry where scale is increasingly vital to success and to join Franklin Templeton, an organization that I have deep respect for and confidence in.” - Nelson Peltz, Nelson Peltz, CEO and Founding Partner of Trian Fund Management
While active asset management is faltering, Franklin Templton acquiring Legg Mason looks to leverage $1.5 Trillion in AUM for more growth opportunities. While Legg Mason’s affiliates are operating autonomously Franklin looks to integrate the global distribution operations of Legg Mason to continue the company’s growth. Franklin will leverage Legg Mason’s specialization in equity, fixed income, alternative, and liquid investments to diversify its investments to create greater scale and balance for its clients.
Through this acquisition Franklin looks to continue their push into ETFs with $6.4B in combined ETF assets. With the uncertainty of the economy and more American’s looking for safer investments the demand for ETFs have grown significantly over the past decade. While both companies have struggled growing their ETF businesses, with a diverse mix in ETF products in investment this synergy puts Franklin in better standing as the demand for ETFs grow. Legg Mason has investments in factor-based and active ETFs, which can be managed with Franklin’s smaller asset managers. Franklin is preserving Legg Mason’s investment independence which allows Legg Mason’s active ETFs and asset management products to incorporate their active managers strategy to further Franklin’s investment product offerings. Franklin on the other hand is focused on cheap core products and single country ETFs. The acquisition of Legg Mason provides clients with a wider range of investment opportunities allowing both companies to combat the recent transition from active funds to passive funds.
The recent effects of Covid-19 have given these active managers the opportunity to prove their value. With such a volatile market active managers look to take advantage of favorable valuations and market inefficiencies.Active funds look towards companies with smaller market caps while most passive funds don’t target them. These companies may present more opportunities due to corporate governance issues and price mismatches, which could have caused their valuations to fall below their industry for little reason in the current market conditions.
Risks and uncertainties
In August of 2019, passively managed funds grew to $4.27 Trillion in assets, marking a significant turn around as they surpassed the $4.25 Trillion in assets under management of actively managed funds for the first time in history. These funds that track broad U.S. equities own nearly 14% of the U.S. stock market. This transformation of the asset management industry has been led by the likes of Vanguard and Blackrock whose ETF businesses each manage over $1 Trillion as investors desire low cost funds whose performance net of fees has been comparable to that of actively managed funds in the last decade.
Despite a massive $1.5 Trillion combined AUM, Franklin Templeton and Legg Mason will have a relatively small ETF business with only $6.4 Billion in ETF assets. Although their ETF business is growing rapidly with $4.9 billion in net inflows since 2016 they have a long way to go towards competing with the industry giants. The synergies from the different types of ETF products the two companies offer should help prime them for future growth in the business. The biggest challenge the combined companies face in the ETF business is that because of their long histories in active management, they will need to transform their fund structure to lower costs. Cost cutting is critical in order to slash fees to be competitive with the existing players like Vanguard and Blackrock, who together control more than 50% of the ETF industry.
“I am telling the world that in the coming era there will be mass mutualization for the larger firms in the business. There are a whole lot of reasons. One is there’s a competitor out there eating their lunch and they know perfectly well why. They’d have to slash their fees but they could never slash them enough to get down to what mutuals can do ” - John Bogle, Founder Vanguard