Given the continuing exodus of its sales executives, struggles with fund outflows and an unexpected $74 million in compensation-related expenses disclosed this month, Legg Mason Inc. has many doubting that it will hit its goal of increasing operating margins to 30% by early next year
Given the continuing exodus of its sales executives, struggles with fund outflows and an unexpected $74 million in compensation-related expenses disclosed this month, Legg Mason Inc. has many doubting that it will hit its goal of increasing operating margins to 30% by early next year.
If the firm is unable to meet its March target, analysts wonder whether Mr. Peltz, whose Trian Fund Management LP is Legg Mason's biggest shareholder, will move to break up the company when his hands-off deal with Legg ends at the end of next year.
Legg Mason has struggled since the market crash. The firm had $672 billion in assets under management as of the end of last month, down from $1 trillion at the end of 2007.
The situation looked dire for Legg Mason in 2009 when Mr. Peltz — who is renowned for pushing Cadbury Schweppes PLC to spin off its American beverage division, Dr Pepper Snapple Group Inc. — started buying shares of the asset management firm, prompting rumors that he planned to break it up, as he has done with other companies.
But Legg Mason was able to stave off a proxy fight by reaching a deal with him in which he joined the board and agreed to keep his stake below 9.9%. That agreement, however, is due to expire at the end of 2012.
“If things haven't improved by March, I would expect him to start writing papers,” said Gregory Warren, an analyst at Morningstar Inc.
A spokeswoman for Mr. Peltz hadn't returned calls by press time.
Last year, Legg Mason chief executive Mark Fetting implemented a restructuring plan, cutting 350 jobs in a move that is expected to save the firm between $130 million and $150 million a year. He has said that he expects to expand operating margins to 30%, from 23%, by March.
Mr. Fetting declined to comment.
SMALLER OUTFLOWS
Legg Mason has made some progress.
Fixed-income net outflows were $6.7 billion in the first quarter, the smallest amount since December 2007. Equity outflows were $1.3 billion, the smallest since June 2006.
The performance of the firm's funds has started to improve, with 80% of its U.S. funds beating their Lipper categories over the past 10-year period.
Nevertheless, stemming outflows takes time, analysts said.
“Convincing institutional investors to come back is a challenge,” Mr. Warren said.
One hurdle is that Legg Mason's biggest asset management affiliate — $455.2 billion Western Asset Management Co. — is a fixed-income player, and bonds are out of favor, he said.
“Once interest rates go up, retail investors are going to start fleeing fixed income,” Mr. Warren said.
In addition, Legg Mason during its May 3 earnings call surprised analysts by saying that its expenses would rise by $74 million this year because it is reinstituting a revenue-sharing agreement with Western.
“For the past year, they have been telling people about cost savings, and then this,” said Douglas Sipkin, an analyst at Ticonderoga Securities LLC. “That was shocking to a lot of people, and I think it created a little bit of a credibility crisis for the firm.”
After the financial crisis, Western agreed to a reduction in its revenue share with Legg Mason as a way of paying back the parent company for bailing out its money funds.
Legg Mason decided to bring back the previous share levels now, “given the progress Western has made in delivering investment results for its clients and financial results for Legg Mason's shareholders,” said spokeswoman Mary Athridge.
Analysts aren't the only ones unhappy about the surprise announcement.
According to a Bloomberg report last week, Mr. Peltz and another board member, KKR & Co.'s Scott Nutall, said that they are disappointed that Mr. Fetting hadn't disclosed the expense previously.
“It was a bad move in terms of how they disclosed it,” Mr. Warren said. “They were giving forward-looking guidance on profitability and then said, "Oh, by the way.' It wasn't thought out all the way through.”
BIDING HIS TIME?
Mr. Fetting still has 10 months to reach his goal, but many analysts wonder whether Mr. Peltz is just biding his time.
“My sense would be that [Mr. Peltz] would be inclined to break it up,” said Geoff Bobroff, a mutual fund analyst. “He needs to think about whether Permal [Asset Management Inc., the firm's alternatives affiliate] and some of Legg's other businesses may be worth more separately than being part of a total.”
Given the decentralized nature of Legg Mason today, the firm could buy out the management of some of its affiliates, Mr. Bobroff said.
“I would assume that the principals at [The Royce Funds unit] and the principals at Permal would be interested in doing some kind of buyout for their companies at Legg Mason,” he said.
Ms. Athridge declined to comment on any speculation.
Meanwhile, Legg Mason's sales and marketing executives are leaving in droves. Just last week, the firm said that Joe Lohrer, head of U.S. national broker-dealer sales, and Benji Baer, head of U.S. intermediary marketing, are departing.
Last month, Laura Zimmerman, head of marketing and product, left after less than a year. In December, David Odenath, head of operations for the Americas, left after just two years at the company.
In the fall, Joel Sauber, U.S. product head, left the firm. And last August, Kim Mustin, co-head of distribution for the retail, subadvisory and institutional business, departed.
“For [a firm such as Legg], which has to build trust after the credit crisis, you want the same people going out and meeting with clients,” Mr. Sipkin said. “It's only when clients start seeing the same people over and over again that the trust will return.”
But turnover always occurs during a restructuring effort, said Joe Sullivan, head of global distribution at Legg Mason.
“We don't relish it, but we understand it's a natural outcome of change,” he said. Mr. Sullivan declined to say how many of the departures were voluntary.
Legg Mason was able to fill almost all the positions immediately, he said. For example, Bryan Ward, head of internal sales, was promoted to replace Mr. Lohrer.
PLAN ON HORIZON
And the firm has a sales plan, which it will announce this summer, to help increase flows, Mr. Sullivan said. He declined to comment on the specifics of the plan other than to say that it will entail adding employees and focusing more on registered investment advisers.
Still, some analysts, including Mr. Sipkin, who last month upgraded Legg Mason's stock to “neutral,” from “sell,” have doubts.
“I still have questions about their ability to drive home their consolidated cost savings,” he said. “I'm pretty skeptical about the business model to drive higher margins.”
E-mail Jessica Toonkel at jtoonkel@investmentnews.com.
