With its plans to acquire an Australian infrastructure investment firm, Legg Mason is stepping into new territory, yet the move could prove a crucial growth opportunity.
The proposed $205 million deal to acquire Sydney-based RARE Infrastructure, expected to close by the end of the year, would expand Legg Mason's cast of seven affiliates to eight and give the Baltimore-based firm a greater foothold in global markets. RARE invests in infrastructure companies and projects worldwide including airports, roads, railroads, electricity, gas and water. It manages $7.6 billion for institutional and retail clients.
"It's pretty much a pure diversification play," said Karyl Leggio, a finance professor at Loyola University Maryland. "This is a growth area for financial services firms. The acquisition looks to be a good sign for the fiscal strength of Legg Mason and its foresight into directions that the market's moving."
Infrastructure investing has grown in popularity as governments seek help from the private sector to launch new projects like bridges and roads and to replace aging infrastructure.
In Maryland, for example, the General Assembly passed legislation in 2013 encouraging the use of public-private partnerships to address the state's growing infrastructure needs. The strategy has been used in agreements such as the Maryland Port Administration's $1.3 billion deal with Ports America Chesapeake to enlarge the Seagirt Marine Terminal.
Investors like infrastructure because such investments often offer sustainable long-term returns.
While private investment in infrastructure is growing in the United States, much of the recent rise globally has been driven by China, which has been on an infrastructure spending spree. Yet China's economic growth has been slowing.
"Certainly the outlook for infrastructure investing is challenging at this point, but the long-term outlook is positive," said Mac Sykes, an analyst at Gabelli & Co. in Rye, N.Y. "China was a huge consumer of infrastructure, now it's having its own issues. At the moment, the landscape is a little more challenged than it is in the past."
Still, investors made wary by the economic crisis of 2008 are looking for ways to diversify their portfolios, and infrastructure investment offers them the opportunity to do that. Sykes said,
"It's an asset class that's gaining a lot of momentum in terms of importance in asset allocation," he said. "It is a good alternative for fixed income. Given today's [interest] rates, people are looking for alternative solutions. It provides income-oriented returns, global diversification. There's a number of ways in which this would be positive."
Joseph A. Sullivan, Legg's chairman and CEO, cited a number of reasons why the deal seemed compelling during a recent conference call to discuss the firm's quarterly earnings.
He said the sector was poised to grow because governments would turn increasingly to the private sector for financing of infrastructure projects amid tight budgets. RARE also offered an opportunity to diversify Legg with a new asset class as investor interest in "alternative" investments grows. And RARE has had solid returns and a confident strategy.
"The opportunity is still developing, which gives us the opportunity to be a market leader in a growing area," Sullivan said. "When you think about this transaction, it fits all the boxes for us. It's a classic Legg transaction."
The RARE acquisition, announced July 28, would give Legg a 75 percent ownership stake. RARE's management team would retain a 15 percent equity stake, and The Treasury Group, a previous minority owner, would retain 10 percent. RARE has offices in Sydney and Melbourne, Australia, as well as London and Chicago, with a 15-person investment team.
The strategy of leaving some of RARE's equity in the hands of its founders is a new one for Legg, but RARE's founders said it was a selling point in the deal.
"Their affiliate model allows management to run the business independently with governance and oversight from the board," said Richard Elmslie, RARE's co-founder and co-CEO, in a statement. He added that Legg's "goals and culture are highly aligned with RARE's vision."
Established in 2006, RARE stands for risk-adjusted returns on equity. While the company has a variety of funds, structured so they can be sold in various places around the world, it essentially offers three approaches.
RARE Infrastructure Value invests in infrastructure securities mostly in developed countries like those in the European Union, the United States, Japan, Hong Kong and Singapore. It has a five-year average annual return of 15.4 percent.
RARE Emerging Markets consists of infrastructure stocks mostly in emerging countries such as Brazil, Russia, India and China, and has a five-year average annual return of 11.8 percent.
And RARE Yield, currently only available in Australia and New Zealand, aims to offer investors a stable income stream from dividends, distributions and interest by investing in infrastructure equities around the world. It has a five-year average annual return of 15.3 percent.
While RARE funds are available in Australia, New Zealand, Europe, Asia, the Middle East and Canada, it does not sell now in the United States. Legg said it plans to makes RARE funds available on its global platform, including domestically, some time after the deal closes.
Legg's other affiliates, with the exception of hedge fund manager Permal, generally represent tried-and-true strategies such as fixed income and small company stock-picking.
Legg's acquisition last year of Martin Currie, an Edinburgh, Scotland-based specialist in international equity, was an attempt to diversify its lineup by filling a void in international investment.
It also acquired QS Investors last year, adding a New York firm that offers mostly institutional investors an array of actively managed U.S. and global stocks and liquid alternatives. Legg folded its Batterymarch Financial Management and Legg Mason Global Asset Allocation divisions into QS Investors.
Sullivan has long said the company favors fewer, larger affiliates to avoid competition between its partners.
The recent acquisitions come as the investment firm bounces back from the recession and reversed in spring 2014 a six-year trend of clients pulling their cash out of Legg. Legg and its affiliates had $699.2 billion under management as of June 30.
Infrastructure investing represents a new area for Legg. Erik Oja, an equity analyst at S&P Capital IQ, said he was cautiously optimistic on the move.
"It's an extension out of their core," Oja said. "It's a good idea, it's an interesting idea to try something slightly new. They have a pretty good track record of integrating asset managers, so this should be fine."