Franklin deal for Legg Mason turning heads

As the ink dries on Franklin Resources Inc.'s acquisition of rival Legg Mason Inc., industry sources are sifting through the details to figure out what the acquisition means for the merged firm, its clients, and in particular, its affiliate companies.

For the CEOs, the rationale and benefits are clear: They gain scale, plug gaps in investment capabilities and now have a significant distribution platform to leverage.

"This dramatically enhances (Franklin's) global distribution and presence across geographies, vehicles and channels," said Steven M. Levitt, managing director and founder of the New York-based investment bank Park Sutton Advisors LLC. "There's also some complementary strategies at play, such as real estate and fixed income."

The $4.5 billion deal, announced Feb. 18, creates a $1.5 trillion money manager, to be known as Franklin Templeton. It comes at a time of continued outflows for Franklin and brings together businesses that, between them, run strategies across equity, fixed income and alternatives; as well as institutional, retail and high-net-worth clients. The transaction will also see Franklin take on $2 billion of Legg Mason's outstanding debt.

The share prices of each firm rose following announcement of the deal. Franklin Resources share price was up 3.45% to $25.20 as of Feb. 21, and Legg Mason's was $50.35, a 23.65% jump vs. the share price Feb. 14.

But industry insiders — while appreciative of synergies and the complementary nature of the deal — can't help but wonder how Legg Mason's nine affiliate businesses will be affected.

"What do you do with Franklin's fixed-income business? Do you fold it in with (Western Asset Management Co.)? Do you merge Clearbridge (Investments) with Franklin's global equity platform? I don't know," said one investment banker source, who spoke on condition of anonymity.

Jennifer M. Johnson, president and CEO at Franklin Resources and Joseph A. Sullivan, chairman and CEO at Legg Mason, reiterated in an interview that there will be no changes to teams and processes, which will retain their independence.

"Franklin has a history of acquiring asset managers and leaving the integrity of the investment team and process. … In the case of Legg Mason, you have the affiliates and key to us was saying we are comfortable with keeping the independent investment teams to ensure a seamless experience for the clients," Ms. Johnson said. "We know that any transaction can be concerning and you'll often get on the institutional side people wanting to see how is this going to go, what's going to be the impact." So for that reason, executives "made it clear that those are all going to remain completely independent, and so … the integration really comes at the parent company and the global distribution platform."

The expansion of investment capability, giving Franklin Templeton an "all-weather lineup of products" as well as creating a "massive global distribution platform, ensures that you have opportunity ... at any time," Ms. Johnson said.

Legg Mason affiliate Western Asset Management Co. sees a chance to grow. James W. Hirschmann III, president and CEO of the Pasadena, Calif.-based manager, said in an email that executives see a number of opportunities afforded by the deal. "We will benefit from Franklin Templeton's strong balance sheet, gaining access to seed capital and other opportunities to meaningfully grow our business globally. We are eager to access Franklin Templeton's expansive retail distribution platform and presence in key growth markets, including Canada, India and Latin America. And we are eagerly anticipating the opportunity to begin actively investing in financial technology initiatives."

The move to increase global distribution and investment capabilities comes at a time when Franklin is experiencing continued net outflows. For the calendar year 2019, net outflows totaled $36.8 billion, and net outflows in the calendar year 2018 were $43 billion.

Legg Mason recorded net outflows for the calendar year 2019 of $700 million after net outflows of $9.2 billion in 2018.

But it is exactly the expansion of existing investment capabilities that has sources questioning whether Franklin Templeton can continue to operate a multiboutique structure.

"I would expect more consolidation between these affiliates," said Jim Tennies, president of investment bank InCap Group Inc., Baltimore. Mr. Tennies — a former executive at Legg Mason — noted that Legg Mason's affiliates aren't being "run with a whole lot of synergies between them."

Any consolidation could include not just combining Legg Mason's affiliates, but consolidating them with some of Franklin's comparable businesses.

Donald H. Putnam, managing partner at Grail Partners LLC, San Francisco, likened Legg Mason's multiboutique structure to a "solar system" model. He said founder and former CEO Raymond A. "Chip" Mason bought firms and left them alone, "each on its own planet, orbiting around a central 'sun' of Legg Mason mutual funds." But following Mr. Mason's retirement, "successive waves of management … and institutional investors have sought to pivot to the 'one firm' model."

Switching to a "one firm" model like Franklin's "cannot be done gently," said Mr. Putnam.

"The planets will not align voluntarily, and forcing the point risks visible losses of talent, disruption of institutional mandates and public shaming in the mutual fund world," Mr. Putnam added.

One change at the affiliate level has already been announced alongside the transaction: Legg Mason's EnTrust Global, an alternatives player, will be repurchased by its management at the close of the deal and will not be affiliated with Franklin Templeton. EnTrust reported total assets of $21.2 billion as of Dec. 31.

Regardless of how the deal plays out, it will take a considerable amount of time and effort.

"Dealing with affiliate culture at Legg is a major corporate responsibility for Franklin. How to get the two companies to be one, but without upsetting the key employees or clients at the Legg enterprises...(is) no easy task," Mr. Tennies said.

Mr. Putnam agreed that although "change is coming, big time," it won't be easy.

Domonkos Koltai, partner and co-founder at money management and financial services M&A advisory firm PL Advisors, New York, noted in an email that Legg Mason "has struggled to rationalize their multiboutique structure."

"Whether Franklin can do that will be the key to this deal's success," Mr. Koltai added.

Whatever the impact on affiliate companies, the deal makes Franklin Templeton a serious competitor in a number of areas.

The transaction catapults the $1.5 trillion combined firm up the rankings of the world's largest money managers. Combining assets under management as of Dec. 31, 2018, would have put the merged business into 12th place in the annual manager ranking by Pensions & Investments and Willis Towers Watson's Thinking Ahead Institute. Legg Mason sat in 30th place as of that date, with $727 billion in assets under management, and Franklin's $650 billion in assets put it at 36th. They reported a combined $309.5 billion in U.S. institutional tax-exempt AUM as of Dec. 31, with Legg Mason accounting for about $254 billion, according to P&I data.

"We are taking the two of us and going from both being kind of in the middle … of scale to being one of the biggest players," Mr. Sullivan said. "We are both expanding our capabilities from an investment capability standpoint, a vehicle capability standpoint, and really from an access standpoint meaning different countries, different channels. … And we are diversifying ... and doing it with an incredibly strong balance sheet that Franklin brings. We are just a better company for clients — we are going to be more relevant in a world where the larger you are, the better."

The deal brings balance in terms of institutional and retail business, with $757 billion or 51% institutional assets under management for the new Franklin Templeton. Franklin today is heavily weighted toward retail assets, with 72% or $502 billion of a total $698 billion in assets as of Dec. 31. Legg Mason is 75% institutional business.