A dispute between executives at Western Asset Management Co. and parent Legg Mason (LM) Inc. (LM) over who should handle distribution in the defined contribution and retail markets is fueling the firms' possible split.
If not resolved, sources warn of a staff exodus at WAMCO.
The conflict comes as the very future of Baltimore-based Legg Mason is at stake.
Some analysts view publicly traded Legg — a holding and distribution company for its nine principal investment affiliates — as a potential candidate for a breakup. The firm has struggled, without much luck, to regain its footing following the financial crisis. Plus, Legg Mason CEO Mark Fetting resigned Oct. 1 after failing during his almost five-year tenure to stem net investment outflows or increase the company's stock price, which trades for around a quarter of what it did before Mr. Fetting joined in January 2008.
On an Oct. 26, conference call with analysts, interim CEO Joseph Sullivan said that Legg Mason was committed to its affiliate model but noted the company in previous years has sold or merged affiliates
“These are things that we have done in the past and we're going to be open to doing in the future,” he said.
For officials at WAMCO, Legg Mason's largest affiliate with $460 billion in assets as of Sept. 30, some type of change is necessary.
A steady stream of investment bankers from key firms including Goldman Sachs & Co. and Morgan Stanley (MS) have had discussions with Western Asset CEO James Hirschmann over the past few months, seeking to structure a deal that would allow the fixed-income manager to break away from its parent and operate as a stand-alone company, informed sources say.
The sources say a whole host of investment banking firms have had discussions with Mr. Hirschmann. “Pretty much all of them,” said one source. Two separate sources said the meetings are preliminary, and that WAMCO's senior management is still in the “fact-finding phase” as to whether a management buyout aided by a private equity partner, or an outright sale to another money manager, could be possible.
A third source said Mr. Hirschmann has forwarded all information from these discussions to Legg Mason officials and the company board. Any deal, the sources noted, would ultimately have to be approved by the board.
Mr. Hirschmann did not return phone calls seeking comment; Legg Mason spokeswoman Mary Athridge said firm officials would have no comment.
Sale prompts more talks
Discussions between Mr. Hirschmann and investment bankers increased following the Aug. 9 announcement that Societe Generale SA had sold money manager TCW Group to TCW management and Carlyle Group, a private equity giant. The sale encouraged investment bankers to think that other major deals involving money managers and private equity firms were possible despite the difficult economic climate.
Sources said WAMCO executives contend the sales force can't adequately represent their firm while also working for other Legg Mason affiliates such as Batterymarch Financial Management Inc., ClearBridge Advisors LLC, Royce & Associates LLC and The Permal Group.
“It's not sustainable and it's not fair to Western (Asset Management),” said one of the sources.
WAMCO management has been pushing senior Legg Mason officials for at least two years without success to launch its own sales force to target defined contribution plans, financial advisers and wirehouses, the sources say.
Western Asset's internal sales staff markets to pension plans, foundations, endowments and other institutional investors, which account for 80% of WAMCO's assets under management. It also has a small group that sometimes accompanies the central staff on key presentations to retail clients, but mostly the central Legg Mason sales staff visits alone.
WAMCO officials believe a dedicated retail and defined contribution sales and marketing staff could boost their firm's assets under management in those areas to 50% of total assets, from 20% now, the sources said.
Both WAMCO and Legg Mason officials have declined to comment on the issue.
“I am not saying that the (sales) people at Legg Mason are not very good at their jobs,” said one of the sources. “It's a tough job to represent all those managers that are under the Legg Mason umbrella.”
The source said under that type of arrangement, it's impossible for the sales representatives to have intimate knowledge of all of WAMCO's offerings. “How granular can you actually get?” he asked, adding that the result is lost opportunities.
Legg Mason does not publicly disclose the revenue-sharing agreements it has with affiliates. But sources at WAMCO and analysts who asked not to be identified say WAMCO keeps about 60% to 65% of the money it collects in fees from clients. The remainder is returned to Legg Mason. Such an arrangement is fairly typical for money management parent/affiliate structures.
The departure of Mr. Fetting earlier this month could put more focus on a possible breakup of Legg Mason, said analyst Jeffrey Hopson with Stifel Nicolaus & Co. in St. Louis.
“Because of the CEO departure, it would be a natural time for the board to at least think about their options for various corporate transactions,” he said. “Thus, the odds of something happening have increased.”
But a breakup of Legg Mason units could have negative tax consequences for the parent company, Mr. Hopson said. He believes the odds still favor the “status quo” of keeping Legg Mason's existing affiliate structure in place. Robert Lee, analyst with Keefe, Bruyette & Woods Inc., New York, said he doubts a wholesale breakup of Legg Mason or the selling of key affiliates will occur, but he said the company could sell smaller, non-core units.
Mr. Lee said there is substantial value in the tax benefits Legg Mason receives from its current structure, and that deferred and net operating loss tax benefits combined amount to about $7 of the approximate $25 value of Legg Mason stock. Mr. Lee said one way for the company to generate greater earnings is through acquisitions. He acknowledged, however, that such a move is unlikely in the foreseeable future because the company has no permanent CEO.
In his conference call, Mr. Sullivan said Legg Mason has a gap in providing international and global mandates to clients, and it needs to fill that through acquisitions. He did not go into detail. If Legg Mason were to sell an affiliate, consultants would have to be assured the change would not affect the firm's investment performance, said one analyst, who asked not to be identified. The affiliate could be placed on watch or be terminated following a sale, he said.
A transaction, however, that would allow WAMCO officials to take control of the firm in a management buyout and become even more autonomous would be a favorable thing, said consultant Michael Rosen, principal and chief investment officer of Angeles Investment Advisors, Los Angeles.
Mr. Rosen said he is comfortable with the current WAMCO/Legg Mason structure, noting Western officials make all investment decisions. But he said a transaction that would give even more autonomy to Western investment personnel and allow them to operate even more independently would only enhance the firm. “It helps to align interests,” he said. Mr. Rosen said he would be more concerned if another investment firm took over WAMCO.
If Western Asset were the only affiliate to leave, Legg Mason (LM) would have less than $200 billion under management. Mr. Hopson said, however, that while WAMCO is the biggest affiliate, it accounts for only around 50% of Legg Mason's revenue because its fixed-income mandates produce smaller fee revenue than some of Legg's equity-focused affiliates.
An unknown in whether Western could be split off is the view of activist investor Nelson Peltz, who owns more than 9% of Legg Mason's shares. Mr. Peltz was given a seat on the Legg Mason board in October 2009 in exchange for signing an agreement in which he promised not to attempt to break up the company. That agreement expires next month.
Anne Tarbell, a spokesman for Mr. Peltz's Trian Fund Asset Management LP, said Mr. Peltz would have no comment.
WAMCO went through tough times during the financial crisis, underestimating its risk in issues such as mortgage-backed securities and high-yield debt while failing to pursue better yielding opportunities in Treasury securities.
The company also was hurt by the decision by Legg Mason founder and former CEO Raymond “Chip” Mason in 2005 to acquire Citigroup's $460 billion money management unit. Western Asset took over the management of the group's money market funds, which had $10 billion in vehicles containing mortgage-related debt. The funds later had to be bailed out in a $2 billion cash infusion funded by both Legg Mason and WAMCO.
Western Asset's investment performance since has come back.
WAMCO's largest strategy, its $67.8 billion core bond approach, had three- and five-year annualized returns of 10.53% and 8.53%, respectively, for the periods ended Sept. 30, compared with the benchmark Barclays Capital U.S. Aggregate Bond index returns of 6.19% and 6.53% for the respective periods, according to data from the company.
One source said retaining key investment staffers will be a challenge if the non-institutional sales force isn't decentralized. If people leave, they will go to boutique firms where they feel they can make a difference, not to archrival Pacific Investment Management Co. LLC.
PIMCO would not be a good fit for WAMCO employees because of its top-down hierarchy run by co-chief investment officers William Gross and Mohamed El-Erian, one source said. “It's a very tight ship. If you don't like it, get off,” said the source. “Western is a more collegial place.” n
This article originally appeared in the October 29, 2012 print issue as, "WAMCO-Legg Mason spat could cause split".