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Shares of asset manager may deserve another look

Feb 17, 2013 @ 12:01 am

By Jeff Benjamin

As investments go, Legg Mason Inc. (LM) has been a bit of a bust for much of the past decade.

The stock is up about 6% this year, which is in stride with the S&P 500, but it lags way behind the asset management industry's 12% average performance.

On a 10-year annualized basis, the stock is up just 48 basis points, which compares with 8.6% for the S&P 500 and 9.2% for the asset manager category.

However, the shifting landscape at the asset management firm could be a reason to take a fresh look at the stock.

Clearly, there still is plenty of uncertainty at this point, just days after interim chief executive Joseph Sullivan was appointed to the permanent role of president, CEO and director. But at the very least, his hiring shifts the focus from the five-month executive search toward what some are describing as attractive balance sheet fundamentals.

“I see it as a cheap asset with good cash flow that could be poised for a turnaround,” said Mac Sykes, a sell-side analyst at Gabelli & Co.

Legg Mason's challenges and recent missteps are plentiful and well-documented. One of the biggest was how a firm with nearly 70% of its assets in fixed income could see its assets under management drop by 35% over the four-year period through December — during which investors plowed more than $1 trillion into bond funds.

REVENUE STREAM

On that topic, even Mr. Sullivan admits poor performance was a likely culprit. But he also is quick to point out that while Legg Mason, through its eight asset manager affiliates, might have lopsided exposure to fixed income, the company's revenue stream actually is split evenly between the management of stocks and bonds.

Essentially, despite the poor stock performance, the stream of net outflows and even the rumblings of discontent coming from the decentralized affiliate managers, the stock remains fairly valued.

BREAKUP VALUE

Mr. Sykes, who has a “buy” rating on the stock, has set the company's breakup value at $42 a share, 50% above the current price of nearly $28.

“There's a significant amount of safety in terms of owning the company,” he said. “At the very least, the stock is attractive based on the amount of cash and the cheap valuation.”

Not only is Legg Mason generating more than $100 million worth of free cash per quarter, but the company has been using some of the money to reduce the amount of shares outstanding.

By the end of March, the fiscal year-end, Legg Mason will have bought 9% of its stock, reducing the total shares outstanding to 129 million.

Over the past three years, the company has reduced its corporate-level workforce by more than 800 jobs.

“They have done a lot of things over the past few years,” said Sonia Parechanian, an equity analyst at S&P Capital IQ.

She pointed out that many of the recent changes were initiated by former chief executive Mark Fetting, who resigned in October from the position he had held since 2008.

“I think people wanted to see changes come faster than they were moving,” said Ms. Parechanian, who has a “hold” rating on the stock.

Shareholder impatience hasn't gone away, and that will be one side of the double-edged sword Mr. Sullivan faces.

“When they announced him as the interim CEO, the stock reacted favorably because people thought it meant they were going to break up the company,” Ms. Parechanian said. “But now it doesn't seem like that's likely to happen.”

As an insider, Mr. Sullivan probably will face more pressure to make big changes in a hurry.

“The investment community won't give him as much time as they would somebody coming from the outside,” Ms. Parechanian said.

Meanwhile, there remains lingering chatter about breaking up the company, per the influence of activist investor and board member Nelson Peltz, founding partner of Trian Fund Management LP, which has a 9.5% Legg Mason ownership stake.

Mr. Peltz didn't respond to requests for comment.

SHAREHOLDER CONFIDENCE

“Nelson Peltz provides some confidence to shareholders because he has a history of improving shareholder value,” Mr. Sykes said.

A statement from Trian confirmed that Mr. Peltz supported hiring Mr. Sullivan, but that doesn't necessarily mean that Legg Mason's new leader won't feel some pressure from the renowned activist investor.

As Mr. Sykes said, “Legg Mason certainly has the potential for some financial engineering,” implying some kind of breakup or sale.

For investors, it adds up to a highly motivated new chief executive and/or a potentially lucrative alternative to Legg Mason as we know it.

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