Continuing its acquisition spree of the past two years, Legg Mason announced deals Friday to buy stakes in three financial management companies, spending more than $1 billion.
The deals are part of an effort by the Baltimore-based money management firm to position itself for the 21st century by diversifying its investment offerings. It comes as investors increasingly demand more options and are losing interest in the traditional model of actively managed mutual funds that were long Legg Mason's bread and butter.
"For the asset management industry, evolution is not an option. It is a necessity," Joseph A. Sullivan, chairman and CEO of Legg Mason, said in a presentation Friday to investors in New York.
The biggest deal Legg announced was $585 million for an 83 percent stake in New York City-based Clarion Partners, a diversified real estate investment firm that manages $40 billion in assets.
Legg also announced it would combine Permal, its hedge fund platform, with New York City-based EnTrust Capital, another hedge fund and alternative investment firm that has about $12 billion in assets under management. Legg will own 65 percent of the new company, called EnTrustPermal, paying $400 million for the stake, according to documents filed with the U.S. Securities and Exchange Commission. The remaining 35 percent will be owned by Gregg S. Hymowitz, EnTrust's co-founder and managing partner.
The restructuring and transition related to the Permal merger would cost about $100 million, Legg said.
Legg also acquired a 19.9 percent stake in Precidian Investments, which creates financial products such as exchange-traded funds and the systems behind them. Legg launched its first ETFs in the fall, after several years of working on their launch. Terms of that deal were not disclosed.
All three represent different investment strategies, adding to Legg's quiver of offerings. Legg's cast of affiliates will expand to 10 from five just two years ago.
The acquisitions came as Legg released its earnings for the last three months of 2015. Legg reported a $138.6 million loss, or $1.31 per share, compared to earnings of $77 million, or 67 cents a share, in the same quarter the year before.
After initially skidding nearly 5 percent, Legg's stock ended the day down nearly 1.8 percent at $31.21 a share.
Analysts at Citi wrote in a research note that the drop in stock price was "understandable" but "seemingly severe" considering the diversification of the franchise. The companies being acquired have solid earnings, they noted.
Bank of America analysts wrote that the deals could go either way, sounding a note of worry about asset flows.
"A return to past under-performance at key affiliates is also a risk for Legg, given its fragile recovery and brand issues," analyst Michael Carrier wrote.
Yuval Bar-Or, an assistant professor at Johns Hopkins Carey Business School, said that the series of acquisitions could be a risk.
Speaking generally, Bar-Or said companies that make a series of acquisitions at once sometimes stretch themselves too thin, not performing the due diligence necessary to determine whether the purchase is smart. If the corporate cultures clash, the key people at the purchased company could leave. And other hoped for cost reductions as a result of the acquisition may not be possible, he said.
"They're venturing away from their comfort zone, something they've been doing for several decades," Bar-Or said. "From a strategic perspective, there's uncertainty."
Being a minority shareholder, as in the case with Legg's stake in Precidian Investments, was risky too, Bar-Or said, because it may be difficult to sell a minority stake as well as hard to influence the company's direction.
Karyl Leggio, a finance professor at Loyola University Maryland, said Legg's move would help draw investors who were skittish of the stock market in what could be a turbulent year.
"In general I think diversifying mergers are not good for companies," she said, "but I don't see this so much as a diversification but a product line expansion."
The timing of the announcement, Leggio added, helped take some of the sting out of Legg's report of a loss.
"This is the balance to what would have been a really tough earnings call," she said.
Legg attributed the bulk of the quarterly loss to a $371 million, or $2.79 per share, loss from the write-off of good will at Permal as its assets under management dropped to $17.6 billion as of Dec. 31 from $18.2 billion three months earlier. When the fair value of an intangible asset such as good will declines, the difference must be charged off as an expense.
Other Legg affiliates also saw assets under management fall. Western Asset Management saw assets under management slip 3 percent, which Sullivan attributed to market turmoil.
Investors pulled $2.8 billion out of Royce and Associates investments during the quarter as its managed assets dropped 13 percent to $18.6 billion from $21.2 billion.
Sullivan said Royce had a "tough quarter" and was changing some of its strategies.
"We recognize that the situation at Royce is very challenging," he said. "The turnaround at Royce will take time."
Assets under management at the remaining Legg affiliates rose, so overall its managed assets were essentially flat, declining less than a tenth of a percent to $671.5 billion as of Dec. 31, from $672.1 billion as of Sept. 30.
The new deals follow Legg's acquisition of Sydney, Australia-based RARE Infrastructure, which closed in October. In 2014, Legg also acquired Martin Currie, an Edinburgh, Scotland-based specialist in international equity, and QS Investors, a New York firm that offers mostly institutional investors an array of actively managed U.S. and global stocks and liquid alternatives.
Sullivan said diversifying Legg's affiliates and offerings would be critical and would help "smooth" its future quarterly earnings reports.
"We're not calling for the end of the mutual fund or the end of active management," Sullivan said.
He presented a slide to investors showing classic active management strategies losing ground to traditional passive strategies such as index funds and next generation active strategies, which are alternatives such as unconstrained fixed income, absolute returns, real assets or infrastructure.
"We have a very simple and focused strategy: providing our global clients with an increasing number of choices for investment strategies," Sullivan said. "Clients today expect that commitment."