Market Selloff Affects Franklin Resources’ Flows and AUM; Lowering Fair value Estimate to $29

Business Strategy & Outlook:

A confluence of several issues—poor relative active investment performance, the growth of low-cost index-based products, and the expanding power of the retail-advised channel—has made it increasingly difficult for active asset managers to generate organic growth, leaving them more dependent on market gains to increase their assets under management. While there will always be room for active management, think the advantage for getting and maintaining placement on platforms will go to managers that have greater scale, established brands, solid long-term performance, and reasonable fees. As such, it’s been big proponents of consolidation among the U.S.-based asset managers the past several years, with firms expected to pursue scale as a means of offsetting the impact of fee and margin compression (driven by the growth of low-cost passive products). However, a combination of narrow-moat Franklin Resources with no-moat Legg Mason was not even on the radar; it is believed both firms were more likely acquirers of smaller asset managers as opposed to either one being an acquisition target.

The combined firm closed out April 2022 with $1.456 trillion in managed assets, composed primarily of equity (32%), fixed-income (39%), multi-asset/balanced (10%) funds, alternatives (15%) and money market funds (4%), giving it the size and scale necessary to be competitive. The new Franklin provides investment management services to retail (52% of managed assets), institutional (46%) and high-net-worth (2%) clients and is one of the more global firms of the U.S.-based asset managers with more than 35% of its AUM invested in global/international strategies and 25% of managed assets sourced from clients domiciled outside the U.S. While the Legg Mason deal to keep margins from deteriorating in the face of industrywide fee compression and rising costs (necessary to improve investment performance and enhance product distribution), near-term organic growth will struggle to stay positive, albeit better than the solidly negative growth profile for a stand-alone Franklin Resources.

Financial Strengths:

Franklin entered fiscal 2022 with $3.2 billion in principal debt (including debt issued/acquired as part of the Legg Mason deal): $300 million of 2.8% notes due September2022, $250 million of 3.95% notes due July 2024, $400 million of 2.85% notes due March 2025, $450 million of 4.75% notes due March 2026, $850 million of 1.6% notes due October 2030, $550 million of 5.625% notes due January 2044, and $350 million of 2.95% notes due August 2051. At the end of March 2022, the firm had $5.8 billion in cash and investments on its books. More than half of thesetypes of assets have traditionally been held overseas, with as much as one third of that half used to meet regulator capital requirements, seed capital for new funds, or supplyfunding for acquisitions. Assuming Franklin closes out the year and, it will enter fiscal 2023 with a debt/total capital ratio of around 22%, interest coverage of around 20 times, and a debt/EBITDA ratio of 1.5 times. Franklin has generally returned excess capital to shareholders as share repurchases and dividends. During the past 10 fiscal years, the firm repurchased $7.4 billion of common stock and paid out $7.1 billion as dividends(including special dividends). While Franklin’s current payout ratio of 30%-35% is lower than the 40% average payout (when excluding special dividends) during the past five years, and only low-single-digit annual increases in the dividend until the integration of the Legg Mason deal is well behind it. As for share repurchases, Franklin spent $208 million, $219 million, and $755 million buying back 7.3 million, 9.0 million, and 24.6 million shares, respectively, during fiscal 2021, 2020, and 2019. Given the likelihood that Franklin may decide to pay off some of its debt as it comes due the next several years, and it isn’t expect to see a large level of share repurchases in the near term.

Bulls Say:

Franklin Resources is one of the 20 largest U.S.-based asset managers, with more than two thirds of its AUM sourced from domestic clients. It is also the fifth- largest global manager of cross-border funds.
The purchase of Legg Mason has lifted Franklin’s AUM to around $1.5 trillion, hoisting it into the second- largest tier of U.S.-based asset managers, which includes firms like Pimco, Capital Group, and J.P. Morgan Asset Management.
Franklin maintains thousands of active financial advisor relationships worldwide and has close to 1,000 institutional client relationships.

Company Description:

Franklin Resources provides investment services for individual and institutional investors. At the end of April 2022, Franklin had $1.456 trillion in managed assets, composed primarily of equity (32%), fixed-income (39%), multi-asset/balanced (10%) funds, alternatives (15%) and money market funds (4%). Distribution tends to be weighted more toward retail investors (52% of AUM) investors, as opposed to institutional (46%) and high-net-worth (2%) clients. Franklin is also one of the more global firms of the U.S.-based asset managers, with more than 35% of its AUM invested in global/international strategies and 25% of managed assets sourced from clients domiciled outside the United States.

(Source: Morningstar)

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