2023-03-06 16:04:03 ET
Summary
- Franklin Resources has been aggressively pursuing dealmaking to attempt to halt asset outflows.
- This has worked to some extent, but the soft competitive position is a real concern and continued expense.
- Continued M&A efforts and associated acquisition costs have depleted net cash holdings.
- An unleveraged 10 times earnings multiple looks cheap but is cheap for very good reasons.
In February 2020, when the outbreak of the pandemic was just surfacing on the radar of investors, I last looked at shares of Franklin Resources, Inc. ( BEN ) as it announced the purchase of Legg Mason in order to grow scale and realize synergies. While expectations were low, reflected in a low earnings multiple and strong balance sheet , real execution was required to turn the ship with more pressure anticipated ahead.
The Deal
Franklin Resources, Inc., better known as Franklin Templeton to many, joined industry consolidation as it announced a $5.7 billion deal to acquire Legg Mason in 2019, offering an $800 million premium for its then-publicly listed peer.
The deal was driven by a desire to obtain more diversification and scale, badly needed as fees were under constant pressure amidst the relentless rise of ETF structures and digitalization of investment possibilities.
Irony will it that Franklin was a bit smaller with nearly $700 billion in assets under management, with Legg Mason having nearly a hundred billion in assets more. The combined $1.5 billion assets under management count would make it the 6th largest asset manager, still trailing leader BlackRock, Inc. ( BLK ), which at the time reported $7.5 trillion in assets, as well as the likes of Vanguard and Fidelity. The reason for the deal was $200 million in projected synergies, albeit that they came at an upfront cost of $350 million.
The fact that Franklin was able to acquire Legg Mason had to do with the fact that Franklin was more profitable. It generated $5.8 billion in sales on $698 billion in assets under management, with revenues equal to 83 basis points on assets under management, posting EBITDA of $1.6 billion in the process.
Legg Mason generated just $2.9 billion in revenues on $804 billion in assets under management, for a 36 basis point revenue take. Its EBITDA number of $0.6 billion worked down to margins of 21%, compared to 28% for Franklin.
Combined, both businesses should generate $8.5 billion in sales, $2.4 billion in EBITDA (assuming realization of synergies) as the company should still operate with a net cash position. Shares of Franklin hovered around the $25 mark at the time of the deal announcement while the business generated earnings of $2.35 per share.
The resulting dirt cheap valuation came as assets under management ("AUM") fell 3% in a boom market, as an 83 basis point cut was simply too high, resulting in cash outflows. Similar trends were reported by Legg Mason, but its revenue take was much lower already, while leader BlackRock was already down to reported sales equal to 20 basis points of assets under management.
With accretion seen from the deal, earnings might top the $3 per share mark, but this did not factor in the secular headwinds, and the underlying of asset outflows, something which seemingly only can be achieved by cutting revenues and "investing" money in reducing fees and moving more towards exchange-traded fund ("ETF") alike structures.
Stuck Along
Fast forwarding three years in time, we see shares now trade at $30 per share, as shares have generally traded in a $25-$35 range ever since (with exception to a brief move lower during the outbreak of the pandemic). This is largely in line with markets at large as the S&P 500 (SP500) has risen some 20% as well over this period of time.
After acquiring Legg Mason, the company continued to pursue acquisitions. Last year, the company acquired O'Shaughnessy Asset Management, a leading quantitative asset manager. With this deal, Franklin adds $130 billion in separately managed accounts. In April, the company acquired Lexington Partners, adding $57 billion in alternative assets under management.
In May, Legg Mason bought Alcentra, adding another $38 billion in assets under management, to further strengthen the alternative assets line-up. This is needed as pro forma sales for the Legg Mason deal came in at $8.7 billion, while multiple deals have been announced ever since. Despite the above and rising equity markets, the results show continued pressure on the business.
In the fall, the company posted its 2022 results, for the twelve-month period which ended in September 2022, with reported revenues down 2% to $8.3 billion, as the fourth quarter run rate fell to $7.7 billion. Average assets under management for the year fell to $1.47 trillion, but they ended at $1.30 trillion, not boding well for 2023.
Adjusted earnings rose to $2.3 billion despite the decline in sales, as the company has been focusing on profit maximization instead of passing on price advantages to its customers, to thereby become more competitive. Adjusted earnings fell 2% to $2.3 billion, with adjusted earnings posted at $3.63 per share.
The problem remains with the fundamentals, in this case, outflows. Total outflows for 2021 amounted to $40 billion and change and improved to $29 billion in 2022, still marking huge outflows. Despite the headwind, the company hiked the dividend by a penny to $0.30 per share, for a solid $1.20 per share annual payout.
A Bit Of Momentum - Short-Lived
Since the release of the annual results, markets at large have seen somewhat of a recovery. Total assets under management of $1.30 trillion by the 30th of September have risen to $1.45 trillion by the end of January, mostly because of market appreciation and in part by closing of the Alcentra deal.
In January, the company posted its first quarter results for 2023 as well. Revenues of $1.97 billion rose 1% on a sequential basis but were down 12% on an annual basis. Average assets under management were reported at $1.35 trillion, indicating that average revenues in relation to revenues amount to 57 basis points. Other news was not as good as the company saw nearly $11 billion in outflows as adjusted earnings fell to $262 million, or $0.51 per share. This is down from $0.78 per share in the previous quarter and down from $1.08 per share in the same quarter last year.
This is all quite troubling, as the historical net cash position has been evaporated since the dealmaking strategy. The net cash and equivalents position has fallen to just around $200 million, less than half a dollar per share.
Concluding Thoughts
So amidst this, the Franklin Resources, Inc. situation remains quite the same as was the case in 2019. Over the past three years, the company has seen pro forma revenues fall by nearly a billion dollars, despite deals being pursued in the meantime, which have depleted net cash positions. Hence, we see an unleveraged business which reports continued asset outflows amidst competitive concerns, as outlined before.
Hence, we see $3.50 per share in earnings power to fall rapidly towards the $3 mark here, and shares of Franklin Resources, Inc. continue to trade around 10 times earnings, a non-demanding multiple. Contrary to past episodes is that net cash balances have been depleted as the competitive issues remain, with dealmaking more focused on asset growth and branching out, instead of really trying to tackle improvement in the competitive positioning.
With Franklin Resources, Inc. still trading at 10 times earnings, as was the case in 2019, I am more cautious now. The competitive position has not improved on the back of the dealmaking, as the net cash balances have been depleted. All this makes me very cautious here about Franklin Resources, Inc. despite the cheap optics, as the fundamental issue is by no means solved here.
For further details see:
Franklin Resources: Cheap For A Reason