Legg Mason’s Sullivan Turns to Takeovers Amid Redemptions
Legg Mason Inc. (LM) has a new growth strategy after five years of investor redemptions: Acquisitions.
Chief Executive Officer Joseph A. Sullivan, an insider who won the top job even as the Baltimore-based firm considered bringing in an outsider to shake things up, in March completed the purchase of fund-of-hedge-funds manager Fauchier Partners, Legg Mason’s first major takeover since 2005. Now he’s looking to add a unit for non-U.S. equities and to expand Legg Mason’s alternative-investment offerings, he said in an interview.
“I talk about making an acquisition every day” to add non-U.S. equities, Sullivan, a 55-year-old Minneapolis native, said in an interview June 11 in New York. “Beginning in the fall, I was directed to start moving and have a fresh-start mentality,” he said, referring to directives from Allen Reed, non-executive chairman of Legg Mason’s board.
Sullivan’s appetite for acquisitions marks a change of pace for a firm that, under predecessor Mark Fetting’s five-year tenure, had suffered so much from investor redemptions, subpar fund performance and discontent among affiliates that it was considered a candidate for a breakup. While Sullivan has repaired relations with the investment units, adding quality money managers may pose a challenge with assets down 35 percent from their $1 trillion peak to $654 billion, and the share price 76 percent below the 2006 high.
Sullivan, who became interim CEO in October before being named to the role permanently in February, worked for 12 years starting in 1994 at Legg Mason Wood Walker, a retail brokerage formerly owned by Legg Mason, before rejoining the parent firm in 2008 as chief administrative officer and eventually head of global distribution. In picking Sullivan, Legg Mason turned down the option to reach for an external candidate to lead the company.
“Additional acquisitions are clearly a priority for this management team,” Daniel Fannon, a San Francisco-based analyst at Jefferies & Co., wrote May 29 in a note to clients. “The company appears to be in much more of an offensive mode than it has been in recent history.”
Legg Mason has the capacity to do a $300 million to $500 million transaction while still maintaining its share buy-back program, according to Fannon. The firm is expecting its cash balance to decline to about $600 million in the quarter ending June 30 because of bonus payments made in mid-May.
Acquisitions would help diversify Legg Mason, where bonds managed by its Western Asset unit account for about 70 percent of assets after $158 billion in equity redemptions since 2007.
Although Sullivan is focused on expanding, he and other executives have said they won’t do any deal so large it would radically transform the company. The CEO will have to convince potential acquisition targets that Legg Mason’s centralized distribution model for retail products makes sense and won’t undermine their independence. He’ll also have to avoid alienating existing affiliates when giving newly acquired units equity-share agreements.
Legg Mason’s eight main investment affiliates, which include equity managers ClearBridge Investments and Royce & Associates, operate independently with separate revenue-sharing agreements.
Sullivan is spending more time calming the affiliates since he took over last year. During the quarter ended Dec. 31, Legg Mason completed an agreement with hedge-fund unit Permal Group, which includes a management equity plan, a revised revenue-sharing agreement and new multiyear employment contracts with key employees. Sullivan said during the interview he wants to have a couple more equity plans in place with other affiliates within the next 12 months.
“By doing that, it gives the affiliate skin in the game and equity in the growth of the franchise,” Sullivan said. “It’s a better algorithm.”
Legg Mason, which grew from a regional brokerage to one of the nation’s biggest money managers through acquisitions, made its last significant purchase in 2005, when it acquired Citigroup Inc.’s investment unit as well as Permal Group. The firm, which shot to prominence in the previous decade as home to famed stock-picker Bill Miller, saw assets decline as subpar performance in stock and bond funds prompted investor defections. Legg Mason was also hurt as money-market funds acquired from Citigroup suffered losses on mortgage-related investments.
Fetting spent his first year as CEO bolstering Legg Mason’s money funds. He then went on to eliminate jobs, cut costs at investment units and buy back shares.
Nelson Peltz took a stake in Legg Mason in 2009, leading to speculation that he would want a breakup of the company since the activist investor is known for pushing companies to increase value by reducing costs or splitting up. Peltz’s Trian Fund Management LP owned 10 percent of Legg Mason as of March 31, making it the largest investor after T. Rowe Price Group Inc., according to data compiled by Bloomberg.
Fetting stepped down as chairman and CEO of Legg Mason two months before a standstill agreement with Peltz expired, after failing to end client withdrawals and reverse the decline in shares.
During the board’s five month search for a CEO before picking Sullivan, two large private-equity investors showed interest in financing a buyout led by Western Asset, according to a Reuters report in January.
Under Sullivan, Legg Mason had the lowest level of stock and bond fund withdrawals in the three months ended March 31 since the quarter ended Sept. 30, 2007. The stock has risen 25 percent this year, compared with a 24 percent increase in the 20-company Standard & Poor’s index of asset managers and custody banks.
In March, Legg Mason completed the purchase of Fauchier Partners, which added about $5 billion in assets to its Permal unit. Sullivan said Legg Mason had started to work on the Fauchier transaction before he became CEO.
Legg Mason created about 20 new products that raised more than $3 billion in assets in the year ended March 31, Sullivan said during a presentation earlier this month. By expanding product offerings and relying on Legg Mason’s centralized sales network of more than 500 employees, the firm can get back to growth, said Sullivan.
“Since the Fauchier transaction, we’ve had a number of interesting conversations in recent months about similar types of opportunities,” he said during the June 11 presentation. “We are accelerating our efforts to capitalize on them.”
Sullivan said ideally he wants an equity manager that offers both non-U.S. developed market and emerging-market stock funds.
In terms of alternative offerings, Sullivan said he’ll either acquire a separate manager or tack on teams that may specialize in private equity, real estate and infrastructure to Permal.
Sullivan said he’s looking for an executive to lead an expanded business and product-development role, who will assist with acquisitions. He doesn’t envision Legg Mason becoming like Affiliated Managers Group Inc. (AMG), which is a Beverly, Massachusetts-based global asset manager with about 25 affiliates ranging from AQR Capital Management to Yacktman Asset Management.
“I want fewer bigger, broader affiliates,” Sullivan said. “We have a different approach than AMG. We won’t have 15, maybe 10.”
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