Last week, Legg Mason
Management attributes the current earnings miss to two factors. First, revenues will be lower by 1% from the June quarter, because of a shift in assets toward more fixed-income securities, which generate lower revenues. Secondly, there were unanticipated charges related to the newly acquired mutual fund business from Citigroup
Shares are now off over 35% from their 52-week high set earlier this year. With the current drop in share value, I thought it was time to take a closer look. Fellow Fool Stephen Ellis had some favorable comments earlier this month about Legg Mason's value. Fellow Fool Alex Dumortier also had a follow-up take last Thursday. With such positive views, I decided to play devil's advocate in order to better understand the market's more negative perception of Legg Mason's current business situation. In other words, what do I, as a potential investor, want to consider before investing in Legg Mason?
At first glance, it seems like a pretty straightforward investment story -- a short-term hiccup on an otherwise stellar business's march to new highs. But Legg Mason's morph into a pure asset manager business, although attractive, doesn't guarantee continued success. I think that the growth in assets and global reach of the firm is putting Legg Mason squarely into a new value network that it's going to have to adjust to before it can continue that march to new highs.
Consider that Legg Mason is now the fifth-largest asset management firm in the U.S., a move up from its previously-held 19th spot. The company is now the 11th-largest asset manager in the world. Legg Mason leapfrogged such asset management firms as Vanguard and Franklin Resources
I believe part of the additional competitive pressures is centered on Legg Mason's existing organizational structure. Will management be able to continue to increase assets under management by utilizing its large group of subsidiaries? In order to maintain growth, I believe the company will need to gain economies of scale by rebranding the different subsidiaries into a unified effort. Consider the successful moves to strengthen the brand names at both UBS AG and Credit Suisse with the "one bank/one brand" strategy. The Legg Mason brand needs to be strengthened. If I'm right (which happens on that rare occasion), it will take Legg Mason some time to implement such a strategy and harness the potential scale of the firm and ultimately grow its earnings.
And growing earnings brings me to my next concern. Regardless of branding strategy, I believe Legg Mason's top-line growth will be hampered by its size and existing product offerings. Admittedly, if UBSAG can manage over $2 trillion in assets, there's room for Legg Mason to grow its own asset base. However, with so many assets managed between these top global asset managers, it's by necessity that they're more influenced by the sways of the market than their smaller competitors. Outperformance becomes less of a potential competitive advantage for the top firms, and generating new customer business will be driven by other valued attributes. Look at the success of Barclay's and State Street's ETF business and Fidelity's sector fund business. These are products that are passive in nature and generate less revenue benefit from economies of scale. It will take time for Legg Mason to evolve an effective product mix that matches its increased size.
Lastly, the tailwinds Legg Mason has enjoyed in the mutual fund industry are winding down. I doubt that the mutual fund industry will continue its tremendous success in accumulating assets that it's had over the past 25 years. I believe that the driving forces such as the creation of ERISA and the defined contribution plan such as the 401(k), which have created the enormous success for mutual fund companies, have run their course. The fact that Legg Mason purchased Permal, a large fund-of-hedge-funds outfit, gives some evidence that the mutual fund business isn't satisfying Legg Mason's growth needs regardless of the diversification argument. This just marks one more reason that Legg Mason's future earnings could come under pressure.
These concerns have left me wondering about Legg Mason's future. I'm confident that Legg Mason can achieve continued success. However, I see a scenario where optimistic extrapolations of future growth will not materialize as soon as hoped for. In that case, there's a good chance that Legg Mason is fairly priced. Consider this Fool on the sidelines -- for now.
Catch up on Legg Mason:
- Legg Mason: Good Buy or Goodbye?
- The New Legg Mason Stumbles
- A Value Opportunity at a Value Manager
- Legg Mason's Big Swap
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