Friday, March 7, 2014

Acquisition and Consolidation: The Wrong Road to Growth in Asset Management

Acquisition and Consolidation: The Wrong Road to Growth in Asset Management

Almost twenty years ago, Legg Mason acquired Batterymarch for $60 million plus $60 million in incentive payments.  The acquisition was one of Legg Mason’s early efforts to build a sizable investment management firm by harnessing the power of Batterymarch’s quantitative prowess.  At the time, the firm had $23 billion in assets under management.[1]  Through the next two decades, Legg Mason and Batterymarch searched for a way to expand the business.  Those efforts came to naught.  Today it manages $12 billion.
Distribution Model (1999)
Batterymarch’s experience could have been anticipated.  On the whole, money management acquisitions don’t work.  Fortunately for investment bankers, a few deals do work. Thus there are always some firms willing to make acquisitions in order to try to expand their investment management platform.   It’s much like active money management: it doesn’t work as a whole, but the occasional successes are enough to encourage investors to try it.

If you are looking for even longer odds against success, try merging two asset management firms into a single entity.  My former employer, Legg Mason, recently announced that it is acquiring a money manager and then merging it together with two other firms already in its investment stable.  I wish them luck in making this work.

The acquisition, QS Investors, will cost Legg Mason $10 million plus another $30 million in contingent payments.  Legg Mason will also take a $35 million charge related to severance and restructuring expenses because Batterymarch Financial Management and Legg Mason Global Asset Allocation will be merged with QS Investors. Batterymarch, one of the pioneers in institutional money management, will disappear. Conceptually, the acquisition and mergers make sense.  While all three managers are quantitatively based, they apply their quantitative expertise in complimentary ways.   Nonetheless, when the theory of this deal meets the reality of money management, I’m betting against the transaction.

In a teleconference with analysts, Legg Mason’s CEO Joseph Sullivan said the acquisition, “is entirely in keeping with what I have said many times, namely that we intend to have fewer and larger affiliates to brand and to market."[2]   Mr. Sullivan’s goal makes sense.  Legg Mason’s product line up has long consisted of too many scattered pieces.  In my view, an asset management firm cannot acquire and merge its way to a well-balanced investment platform, as I’ll explain in a moment.

Janet Campagna, QS Investors’ CEO, indicated that she was looking for help with sales and marketing when she agreed to the transaction.  She said, "We needed a strong global distribution partner.”[3] Clearly, Legg Mason’s two existing quantitative shops weren’t growing fast enough, or Mr. Sullivan wouldn’t have entered into this deal.  However, he’s just acquired a firm that has exactly the same problem.  Not only doesn’t this bode well for Legg Mason, but I’ll bet that the QS Investor’s employees are going to be frustrated in the coming years.  How do I know?  When I worked at Legg Mason, the employees at every one of the acquired subsidiaries were incredibly irritated over the failure of distribution to drive growth.  The problem hasn’t been solved in over two decades.

Let’s return for a moment to the merger of the three investment entities, QS Investors, Batterymarch, and LM Global Asset Allocation.  While all three managers are quantitatively driven, they most assuredly have different cultures.  Those cultures are going to clash as QS Investors tries to bring all three businesses under one umbrella.  In addition, there will be an extended period during which all three firms will be inwardly focused on the organizational structure and impending layoffs. They’ll also be spending a great deal of time reassuring clients.  As with most acquisitions, performance will probably suffer, which will make business expansion all the more difficult once all the internal issues are sorted out.

Legg Mason has $680 billion in asset management across eight principal managers and many other platforms.  Finding hundred of billions of dollars in new assets to manage isn’t to be found in the pitch books of Wall Street or by paring costs via consolidation.  If Legg Mason can’t find the growth from internal sources, they might think about breaking themselves into pieces.  It’s probably a better strategy than relying on acquisitions and consolidation.

[3] Ibid.

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