As an investment manager myself, I always enjoy researching companies such as Legg Mason (NYSE:LM) who are in the business of investing clients assets. The company reported earnings Tuesday morning ahead of a miserable day for anyone long equities. It is interesting to ponder whether the stock was down yesterday due to its earnings report or more as a function of the overall market. Because the company invests clients assets so broadly, a day like yesterday invariably takes a toll on the assets under management due to investment losses.
On the surface, the numbers were very strong with revenues at $1.21 billion for the quarter and EPS of $1.32 (22% above the same quarter in 2006). The company increased its Assets Under Management [AUM] to $992 billion and it was especially noteworthy that all three categories of assets (Managed Investments, Institutional, and Wealth Management) contributed to the increase in AUM. The company noted that equity performance was particularly strong in small cap and emerging market categories.
All that information, however, appears to be the silver lining that may be distracting investors from a large overhanging cloud. Unfortunately, the company has had difficulty in keeping pace with the competition in many of their large equity funds. The company has been trying very hard to improve this performance, but sometimes when a manager gets out of synch with the markets it can be very difficult to get back on the ball (I’ve definitely been there). So when looking closely at this important group of funds, it turns out that clients added $8 billion to investments (aggressive and talented marketing), managers increased the value by $1 billion (mediocre), and clients withdrew $7 billion (ouch). All of this leads to a less than stellar $2 billion increase.
When asked about what could be done to increase performance in these areas, Chip Mason [CEO] seemed a bit unsure about how to deal with the problem. After failing to fully take advantage of the last 4 years of relatively bullish movement in the markets, it is imperative that this group start performing well in order to keep from bleeding assets - especially if we begin to see more bearish movement from the overall equity markets.
Another key point taken from the conference call is that the company is not happy with its international asset management program. They have voiced their desire to acquire an international asset manager which has a few analysts concerned that such a merger could cause the company to pay too high a premium for their find, and spend too much human capital and talent trying to integrate such a purchase. While the balance sheet is strong and the company could definitely afford to make a fairly large acquisition, investors would likely rather see the cash flow used to re-purchase shares. The company does enjoy a healthy balance sheet with $1.2 billion in cash and $1.1 billion in debt. Cash flow from operations is being used both to pay down debt and in a share repurchase program that could cover up to a million shares.
I am disappointed to say that in looking at the valuation of the company, I think it is a better short candidate than an investment proposition. Trading at 16 times earnings, it is in the high range for most investment managers and there appear to be some legitimate concerns growing. The dividend is not high enough to support the stock at this level and it appears institutional holders may begin to liquidate some of their positions. While I am not currently short this stock, it is on a growing list of names I would like to begin building positions in.
LM 1-yr chart
Disclosure: Author does not have a position in LM