In March, I called shares of Franklin Resources (NYSE:BEN) cheap for a reason. This came as the company was aggressive in dealmaking in an attempt to halt asset outflows, and while buying assets under management helps, it does not address the fundamental issue of a soft competitive position, which is the real concern.
M&A efforts have depleted net cash holdings and while a 10 times earnings multiple looks cheap, certainly on an unleveraged basis, it was cheap for good reasons.
A Recap
Franklin Resources, known as Franklin Templeton, has joined the industry consolidation efforts when it announced a $5.7 billion deal to acquire Legg Mason in 2019. That deal was driven by the desire to get more scale and diversification needed as the continued and prolific rise of ETFs made that fees were under continued pressure.
Franklin was actually smaller with $700 billion in assets under management at the time of the deal, while Legg Mason would boost this number to $1.5 trillion on a pro forma basis, only coming in at a fifth of the $7.5 trillion in assets reported by BlackRock (BLK) at the time, while it also trailed the assets under management reported by both Fidelity and Vanguard.
Franklin generated $5.8 billion in revenues at the time, with revenues equal to 83 basis points of the reported assets under management. Legg Mason only generated $2.9 billion in revenues, with the revenue taking equal to 36 basis points of assets under management. Pro forma, the company could post $8.5 billion in sales and $2.4 billion in EBITDA, translating into a $3 earnings per share number. This looked compelling, but the underlying issue, that of high expense rates and sequential asset outflows, was not addressed.
A $35 stock in 2019 fell to the $15 mark during the outbreak of the pandemic (for obvious reasons), recovered to $35 following the boom period in markets in 2021, and ever since has traded in a range between the low-twenties and low-thirties. After the deal with Legg Mason, the company acquired O’Shaughnessy Asset Management, Lexington Partners, and Alcentra, all relative bolt-on deals.
In the fall of 2022, the company posted its 2022 results (that is, for the period which ended in September 2022). Revenues were down 2% to $8.3 billion, and while assets under management averaged $1.47 trillion for the year (largely in line pro forma, the deal with Legg Mason), they ended the year at just $1.30 trillion following depressed valuations but outflows as well.
The company still managed to post adjusted earnings of $2.3 billion, equal to $3.63 per share. The issue was seen in the outflows, amounting to $29 billion in 2022.
The pressure on the results was seen in the first quarter results for 2023, as reported in January. Revenues fell 12% on an annual basis to $1.97 billion, as assets under management had risen to $1.45 trillion on the back of market appreciation and the closing of the Alcentra deal. More worrying, the company saw $11 billion in outflows during the quarter, with earnings being cut in half to $0.51 per share.
With pro forma sales trending a billion lower than seen at the time of the Legg Mason deal, while the cash position has been depleted, it is hard to become upbeat on the shares here. With shares trading at $28 in March, I was cautious even as a 10 times multiple looked cheap, but was not necessarily cheap.
Coming Down
Since March, shares have only fallen further from $28 to $25, despite a general rally in the market, certainly in recent weeks. If we look at the underlying trends, we see that assets under management stabilized at $1.42 trillion in February and March.
Early in May, the company announced another deal, acquiring early-stage business volScout. This SMA provider provides managed option strategies with $110 billion in SMA assets under management, with no other financial details on the deal being announced.
Early in May, the company posted its second-quarter results for the quarter ended in March. Revenues of $1.93 billion, slipped 2% on a sequential basis, while down 7% from $2.08 billion this period last year as adjusted earnings fell 36% to $0.61 per share, actually up ten cents from the quarter before. Total net flows for the quarter were minus $8 billion, split roughly half-half between long-term investment flows and cash management.
On the final day of May, Franklin Resources announced a massive deal to acquire Putnam Investments, an asset management firm with $136 billion in assets under management. The deal comes at a $925 million price tag, but the transaction structure is interesting, with $825 million being paid for in stock (which trades at current lower levels). Furthermore, contingent payments to the tune of $375 million are in order, as an upfront hundred million cash consideration is payable as well.
After posting steady AUM at $1.42 trillion in April, it slipped to $1.40 trillion in May, although the June numbers likely are a bit stronger, following the market recovery (to be released soon). Of course, these numbers are ahead of the Putnam deal, set to (temporarily) push AUM above the $1.5 trillion mark as the fundamental problem of outflows is not tackled.
While shares are now down about 10% from March, the company continues with the same strategy of pursuing deals to keep up assets under management, as the softer underlying results in real profit compression. In the meantime, these deals start to add to leverage and interest expenses, perhaps the reason why the company has structured the Putnam deal in an almost entire stock deal.
Given these dynamics, with the root cause of the problems not being tackled, I am still cautious on the shares here, despite their cheapness.
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