Thursday, November 1, 2012

Cranky Children: Investment Subsidiaries

Cranky Children: Investment Subsidiaries

In 1999, the former Chairman of United Asset Management came to a conference sponsored by my former employer Legg Mason to discuss the opportunities and pitfalls of running a public company that acquires and owns money managers.  Old Mutual, a South African financial company had just acquired UAM, after struggling for several years to rekindle its growth.  We were pretty smug about our successes, as Legg Mason was growing rapidly.  What was not apparent, and only became evident about six years later, is that Legg Mason was suffering from the same ailments as UAM. 

Investment Problems (1999)

In recent days, the press has reported a rift between Legg Mason and its biggest subsidiary Western Asset Management.  The media thinks that the dispute is new, but it has been going on for over 20 years and is typical of the relationship between the holding company and its money management subsidiaries.  The relationship is like that of an ill-behaved adult-child living with his parents.  Things are barely tolerable while the business is going well, because the parent can afford to dole out cash and stock options to the money managers.  However, money managers have an insatiable appetite for money, and when markets falter or the business slows, they get very cranky and even obnoxious.  During the tough times, the children feel like they are being forced to support the parent.

Western Asset has been cranky for years, and the issues are the same ones that make most of these relationships falter.  The older managers in the subsidiary have enjoyed one or more large paydays as they sold their interest to the parent and phased out their involvement in the business.  This leaves the younger managers who now run the business resentful and hungering for more money and control.  Thus, there’s an ongoing fight between the young bucks and the parent about the revenue or profit sharing arrangement between the subsidiary and parent.  In my experience this is a never-ending battle.

The parent company always promises its subsidiaries that it will help with distribution (mainly promoting mutual funds), and there are a few instances where this has happened.  However, in most cases those efforts don’t amount to much, and the subsidiary feels like they’re getting no value from the relationship with their parent.  The subsidiary resents having part of its profits up-streamed to the parent.  Despite the fact that the managers of the subsidiary are highly compensated, they hate sending dividend checks to the parent.

What the subsidiary tends to forget are the instances over the years when the parent came to the rescue of the subsidiary.   Invariably there is an instance or two where the parent bailed out the child, but those episodes are usually forgotten.  Western Asset has, over the years, been rescued and supported by Legg Mason.  Unfortunately, investment subsidiaries aren’t the nicest children, and tend to have short memories.

The folks at Western Asset Management know that Legg Mason is vulnerable at the moment.  Legg Mason is searching for a new CEO and trying to find a way to get their overall business growing again (UAM never found the answer to this problem).  According to press reports, Western’s management is making noises about going its separate way.   In all likelihood, Legg Mason will have to accede to the demands of its obstreperous child or watch employees leave en masse.  In money management, the employees are the principal asset of the business; if they leave, the parent is left with chairs, desks, and computers.

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