Sterne Agee analyst Jason Weyeneth takes a look at Legg Mason’s recent deal, predicting that on balance, it shouldn’t impact the company’s flexibility in the long term.
We believe Legg Mason Inc (NYSE:LM)’s announced deal for QS Investors makes strategic sense and will prove nicely accretive over time. Importantly, the deal doesn’t limit Legg Mason Inc (NYSE:LM)’s financial flexibility to pursue other transactions and/or buy back stock.
Acquiring QS investors & folding In batterymarch and Legg Mason global asset allocation (LMGAA)
Legg Mason Inc (NYSE:LM) announced the acquisition of QS Investors, a quantitative equity and asset allocation manager for institutional investors. Following the anticipated June quarter close, LM plans to fold BatteryMarch and LMGAA into QS. With QS’s institutional focus, Legg Mason Inc (NYSE:LM) sees a strong opportunity to scale the combined operations with deeper institutional penetration and launch retail strategies distributed through Legg Mason Inc (NYSE:LM)’s strong global platform. Retail versions of QS’s asset allocation and liquid alternative strategies should line up well with retail demand trends. QS currently manages $4.1 billion of assets directly and has nearly $100 billion on their multi-manager advisory platform.
Modestly accretive excluding restructuring costs
Management indicated the deal would be “modestly” accretive in fiscal ’15 excluding $30 million ($0.17) of anticipated restructuring costs. Assuming fee rates of 5 bps on the ~$100 billion of assets under administration (AUA) and 35 bps on the $4.1 billion of assets under management (AUM), and a 25% pretax margin imply roughly $0.09 of annual GAAP accretion. Margins should scale nicely with AUM growth as it was indicated the current team with similar infrastructure managed nearly $50 billion of assets prior to their 2010 management buyout from Deutsche Bank Asset Management.
Deal doesn’t limit near-term flexibility
While this deal is accretive in year 1 with sizable upside seemingly possible, it likely wasn’t the type of deal investors anticipated. Importantly, this deal has only a modest upfront cash payment (with earn-outs), leaving Legg Mason Inc (NYSE:LM) in a position to continue repurchasing stock and looking for deals to expand their global equity capabilities.
Adjusting estimates. raising target
We are lowering our fiscal ’14/’15 estimates to $2.32/$2.68 from $2.33/$2.76 reflecting announced restructuring costs partially offset by deal accretion. We are raising our fiscal ’16 estimate to $3.30 from $3.20 reflecting deal accretion (partially offset by lingering restructuring costs). Our price target is raised $3 to $50 based on 14x calendar ’15 cash operating earnings plus $5 for net cash and investments and the present value of tax assets.
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