Franklin to Acquire Legg Mason

We've been big proponents of consolidation among the U.S.-based asset managers the past several years, with firms expected to pursue scale as a means of offsetting the impact of fee and margin compression driven by the growth of low-cost passively managed products. However, a combination of narrow-moat-rated Franklin Resources BEN with no-moat Legg Mason LM was not even on our radar; we believed both firms were likely to be acquirers of smaller asset managers as opposed to either one being an acquisition target.

The combined firm is expected to have $1.5 trillion in assets under management once the deal is completed, with a much heavier focus on fixed income (expected to account for 46% of managed assets) as opposed to equities (33%), with alternatives (7%), multiasset strategies (9%), and money market funds (5%) accounting for the remainder. While Franklin looks to be willing to retain Legg Mason's affiliate structure, which has proved problematic in the past, we think the strength of the deal resides in Western Asset Management, which accounted for 57% of Legg Mason's $792 billion in AUM at the end of December 2019. This will not only expand Franklin's bond operations, making it far less reliant on the Michael Hasenstab-driven global/international fixed-income platform, but also benefit from Franklin's registered investment advisor distribution network.

At $4.5 billion, or $50 per share of Legg Mason common stock, we think the deal (which represents a more than 25% premium to our fair value estimate for Legg Mason) represents a fair bit of business at an estimated 10.8 times Legg Mason's trailing 12-month EBITDA--around the median run-rate EBITDA transaction multiple of 10 times EBITDA we've seen for asset managers the past decade. Although we expect to lift our fair value estimate for Legg Mason to $50 per share, as we see little that would stand in the way of the deal getting done, we are placing both firms under review while we work things through our models.

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