Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 4Q13 and FY13 Earnings Update
Previous Edition: News Update, Apr 11, 2013
Brokers’ Recommendations: Neutral: 53.8% (7 firms); Positive: 23.1% (3); Negative: 23.1% (3) Prev. Ed.: 7; 3; 4
Brokers’ Target Price: $30.18 (↑ $1.45 from the last edition; 11 firms) Brokers’ Avg. Expected Return: -16.5%
Note: A flash update on 4Q13 and FY13 Earnings was done on Apr 30, 2013.
Note: We don’t have access to the reports from the brokers having the sell recommendation on the stock.
Portfolio Manager Executive Summary
Legg Mason Inc., a global asset management company, provides investment management and related services to institutional and individual clients, company-sponsored mutual funds, and other investment vehicles worldwide. It offers its products and services directly and through various financial intermediaries.
Trend of Broker Opinions: Broker sentiment on the stock remains skewed toward the neutral side with 53.8% of the firms in the Digest group rating the stock neutral, 23.1% rated it positive and the remaining 23.1% rendered a negative rating. Target prices provided by the firms range from a low of $19.00 to a high of $41.00 per share. The average came in at $30.18, implying a negative return of 16.5%.
Chief Investment Considerations:
§ Seasonality affecting flows
§ Strong balance sheet and ample liquidity
§ Expense reduction initiatives
§ Diversified footprints
§ Ability to return capital to its shareholders
§ Sustainable improvement in flow trends
§ Current market volatility
§ Weak equity markets
Neutral or equivalent outlook (Seven firms or 53.8%) – According to these firms, Legg Mason is diversifying its products by upgrading them as well as making them customer-friendly. It is striving to aggressively build on its assets under management (AUM) through organic growth and acquisitions. Therefore, over the long term, these efforts are expected to result in improved margins and inflows. However, there are challenges with persistent negative flows, equity exposure only in domestic periphery and unsatisfactory performance of Royce (Legg Mason’s largest equity manager). The Western compensation is on rise, wherein Japan emerges as a cause of concern. Notably, aggressive mergers and acquisitions will definitely boost AUM but it will also increase the cost burden for the company to a certain extent. Further, some firms believe that the company’s scope for organic growth is limited. Therefore, currently the firms maintain a neutral outlook over the stock.
Buy or equivalent outlook (Three firms or 23.1%) – According to these firms, Legg Mason is focusing on growth rather than cost cutting motive prevelant in the preceding quarters. The investment performance of the company shows improvement marked by recent acquisition of Fauchier Partners. Management believes that improved investment performance will eventually lead to positive organic growth rate. Moreover, the company’s outflows have been decreasing compared to prior periods, and reflects an improvement in the overall environment and portrays a favorable senario of better flows and performance in the near future. The recent capital deployment activities of the company also instill investors’ confidence in the stock. However, these firms opine that in the short term, the company could face weakness in flows. They believe that the challenges faced by Legg Mason in generating net inflows are severely testing investors’ patience. Until flow trends show a sustained improvement, it is likely to limit stock price performance.
May 17, 2013
Overview
Headquartered in Baltimore, Md., Legg Mason Inc. (LM) is a global asset management firm focused on the growth and preservation of its clients' capital through its proprietary mutual funds and separately-managed accounts (SMAs). It was founded in 1899 and incorporated in 1981. As a holding company, Legg Mason provides asset management, securities brokerage, investment banking and related financial services through its various subsidiaries. The company conducts its business primarily through 16 asset managers. The company has operations principally in the United States of America and the United Kingdom, but also has offices in Australia, the Bahamas, Brazil, Canada, Chile, China, Dubai, France, Germany, Italy, Japan, Luxembourg, Poland, Singapore, Spain and Taiwan.
In Dec 2005, Legg Mason changed its business model to focus solely on asset management through an asset-swap transaction with an investment banking firm. In this transaction, Legg Mason sold its capital markets, as well as private client businesses, and acquired the asset management arm of the firm. Legg Mason and its subsidiaries operate through 3 primary divisions: Managed Investments, Institutional, and Wealth Management. The company markets its services to individuals and institutions through brokerage houses, insurance companies, and other third-party distributors.
Legg Mason is organized around 2 principal revenue segments:
§ The Investment advisory Services segment (accounting for 87% of total revenue in fiscal 2013) includes discretionary and non-discretionary management of separate investment accounts in numerous investment styles for institutional and individual investors. The investment products include proprietary mutual funds ranging from money market and other liquidity products to fixed income, equity funds managed in a wide variety of investment styles, other domestic and offshore funds offered to both retail as well as institutional investors, and funds-of-hedge funds.
§ The Distribution and Service Fees segment (13%) includes fees received for distributing investment products and services or for providing other support services to investment portfolios, and are generally calculated as a percentage of assets in an investment portfolio or as a percentage of new assets added to an investment portfolio.
Legg Mason’s AUM is split between fixed income, equity and liquidity investments. The company’s principal fixed income and liquidity manager is Western Asset Management. Legg Mason equity managers primarily include Legg Mason Funds, Legg Mason Capital Management (LMCM), Private Capital Management (PCM), Royce & Associates, Brandywine Asset Management, and Batterymarch Financial Management.
As of Mar 31, 2013, Legg Mason’s AUM was $664.6 billion. Fixed income represented 55.0% of AUM, while equity represented 24.0% and liquidity represented 21.0% of AUM. Fixed income constituted 55.0%, equity constituted 24.0%, and liquidity comprised 21.0% of AUM.
Further information on the company is available at www.leggmason.com.
The analysts identified the following factors for evaluating the investment merits of Legg Mason:
Key Positives / Key Negatives§ Legg Mason continues to actively build the asset management business. A strong operating and AUM leverage follows its diversified product mix and leading investment performance in both equity and fixed income markets.
§ Strong growth is expected in AUM in future with the recovery of capital markets.
§ Improving operating efficiencies through key initiatives with focus on enhancing business mix and cost reductions.
§ Committed to increasing shareholder wealth with effective deployment of capital through share repurchase and dividend payments. / § Intense competition among the industry participants.
§ Weakness in the equity markets can adversely impact revenue.
§ Considerable decline in global asset values can result in the reduction of AUM. substantially.
§ Regulatory environment remains intense for the asset management industry.
§ Sensitivity to interest rates.
NOTE: The company’s fiscal year ends on Mar 31.
May 17, 2013
Long-Term Growth
Legg Mason has a long tradition as a leader within the global asset management industry. The storied successes of several mutual funds and an expanding international business have been the foundation for strong AUM growth for several years. Management's strategic priorities remain focused on debt reduction, potential lift-out/bolt-on acquisitions, and share repurchase.
Management’s ability to finalize an attractive deal will likely go a long way in helping the company achieve its margin expansion goals and in boosting EPS. At the top of the company’s priority list, there would be an affiliate (or team) with expertise in international equity, U.S. growth equities, or potential real estate.
According to the firms, sluggish economic growth and large balance sheet exposure to residential and commercial mortgages indicate a lackluster, low-visibility environment for large investment banks. Legg Mason, despite its short-term woes, has a strong long-term business that is expected to generate strong cash flow relative to the price of the business.
Additionally, the firms believe that the initiatives to streamline the business model will position the company for future growth as well as increase operating efficiency and overall profitability. Affiliates will also be positioned to continue providing incomparable service to their clients. The corporate management team will work intimately with the affiliates to transfer these responsibilities going forward, as and when needed.
May 17, 2013
Target Price/Valuation
Provided below is a summary of valuations and ratings as compiled by Zacks Research Digest:
Rating DistributionPositive / 23.1% ↑
Neutral / 53.8% ↑
Negative / 23.1% ↓
Average Target Price / $30.18 ↑
Maximum Upside from Current Price / 13.5%
Minimum Upside from Current Price / -47.4%
Upside from Current Price / -16.5%
Digest High / $41.00↑
Digest Low / $19.00
Number of Analysts with Target Price/ Total / 11/13
Risks to the target price include a general fall in the overall value of the major equity and fixed income indices, any reluctance on the part of the retail investors to invest in stocks and bonds, the possibility of higher interest rates, and the associated market value declines and possible outflows as well as any deterioration in investment performance.
Recent Events
On May 10, 2013, Legg Mason reported its preliminary month-end AUM for Apr 2013. AUM for the month was $655.4 billion, down 1.4% from the prior month. Notably, liquidity redemption from a sovereign wealth client was the cause for this decline.
On Apr 30, 2013, Legg Mason reported its fiscal 4Q13 and FY13 earnings results. Earnings for fiscal 4Q13 adjusted earnings came in at $0.52 per share, missing the Zacks Consensus Estimate by $0.06. Moreover, this came well below the year-ago figure of $0.88 per share.
Lower-than-expected results reflect higher operating expenses. Moreover, net client outflows in the quarter were negative. However, growth in top line, aided primarily by improved investment advisory fees and other revenues was a tailwind.
Adjusted net income came in at $66.7 million compared with $123.6 million in 4Q12. Including one-time items, Legg Mason reported net income of $29.2 million or $0.23 per share as compared with $76.1 million or $0.54 in 4Q12.
For fiscal 2013, adjusted net income came in at $347.2 million or $2.61 per share compared with $397.0 million or $2.77 per share in the prior year. This also missed the Zacks Consensus Estimate by $0.12.
Including one-time items, Legg Mason reported net loss of $353.3 million or $2.65 per share versus net income of $220.8 million or $1.54 per share in the prior year.
Revenue
Total revenue was $667.8 million in fiscal 4Q13, down 1.0% sequentially and up 3.0% year over year (y/y). The quarter-over-quarter (q/q) dip was due to a reduction in performance fees. Notably, 3Q13 results included $32.0 million fees inflow from Western Asset due to winding down of the company’s participation in the U.S. Treasury’s Public-Private Investment Program (PPIP). On the contrary, the y/y increase reflects an increase in performance fees.
Total revenue for fiscal 2013 was $2.6 billion, down 2.0% from $2.7 billion for fiscal 2012 due to less favorable AUM mix.
Investment Advisory Fees were $581.9 million in fiscal 4Q13, down 1.2% from $589.0 million in 3Q13 and up 3.0% from $564.7 million in 4Q12. For FY13, fees were 2.3 billion, down 1.8% y/y.
Investment Advisory Fees consist of three businesses:
§ Separate Accounts: In 4Q13, fees were $182.7 million, up 0.5% from $181.8 million in 3Q13 and down 2.4% from $187.2 million in 4Q12. For FY13, fees were $730.3 million down 5.8% from $775.5 million in FY12.
§ Funds: In 4Q13, fees were $365.9 million, up 1.4% from $360.8 million in 3Q13 and 0.9% from $362.7 million in 4Q12. For FY13, it was $1.45 billion, down 2.7% from $1.49 billion in FY12.
§ Performance Fees: In 4Q13, fees were $33.3 million, down 28.0% from $46.4 million in 3Q13 but increased significantly from $14.8 million in 4Q12. Performance fees surged significantly in FY13 to $98.6 million from $49.5 million in FY12.
Distribution and Service Fees were $83.9 million in 4Q13, up 1.0% from $83.1 million in 3Q13 and 1.8% from $82.4 million in 4Q12. Distribution and Service Fees reduced by 3.0% in FY13 to $330.5 million from $341.0 billion in FY12.
Other revenue was $2.0 million in 4Q13, up 9.2% from 3Q13 and 38.6% from 2Q12. It was $7.2 million for FY13 up 36.0% from $5.3 million in FY12.
Outlook
Management looks forward to continue improving productivity and expanding market share related to sales. Development of new products, improvement of sales productivity and gains in market share will be important drivers of growth in retail. Additionally, the forthcoming quarters are expected to witness more of investor oriented marketing campaigns wherein the company’s global income focus remains unperturbed.
Management anticipates performance fees to be in the range of $10.0–20.0 million in fiscal 1Q14.
Some firms believe that if the equity products of the company continue to record outflows, fee income and margins will be under pressure.
Margins
In fiscal 4Q13, operating expenses were $624.8 million, down 52.0% from $1.3 billion in 3Q13. Notably, 3Q13 expenses included non-cash impairment charges related to intangible assets worth $734.0 million.