Legg Mason Q3 Earnings Beat; Non-Cash Impairment High

Effective cost control led Legg Mason Inc.LM to deliver a positive earnings surprise of 44% in the third-quarter of fiscal 2016 (ended Dec 31). Adjusted earnings of $1.45 per share beat the Zacks Consensus Estimate of $1.01. Moreover, the reported figure came above the year-ago adjusted earnings of 98 cents per share.

Lower expenses reflect prudent expense management. However, reduced revenues and decreased assets under management (AUM) were the headwinds.

Adjusted income came in at $158.5 million compared with $113.1 million in the prior-year quarter. Including one-time items, Legg Mason reported net loss of $138.6 million or $1.31 per share for fiscal third-quarter, compared with a net income of $77 million or 67 cents in the prior-year quarter.

Notably, Legg Mason recorded $296.8 million after-tax, or $2.79 per share, in non-cash impairment charges associated with intangible assets at Permal.

Legg Mason Inc. (LM) EPS BNRI & Surprise Percent - Last 5 Quarters | FindTheCompany

Performance in Detail

Legg Mason's total operating revenue came in at $659.6 million, down 9% year over year. The decline was due to lower investment advisory fees that came on the back of decreased performance fees and lower fees from funds and separate accounts. Also, revenues came in below the Zacks Consensus Estimate of $674 million.

Investment advisory fees decreased 11% year over year to $563.2 million in the quarter. However, distribution and service fees were up 7% year over year to $95.9 million. Moreover, other revenues declined 56% year over year to $0.46 million.

Adjusted operating expenses declined 12% to $529.2 million on a year-over-year basis. The fall was primarily due to lower costs related to compensation and benefits along with reduced distribution and servicing and other expenses. Notably, the reported quarter as well as the prior-year quarter excluded certain non-recurring items.

Adjusted operating margin of Legg Mason was 20.6%, down from 21.4% in the prior-year quarter.

Assets Position

As of Dec 31, 2015, Legg Mason's AUM was $671.5 billion, down 5% year over year from $709.1 billion. Of the total AUM, fixed income constituted 55%, equity 28% and liquidity 17%.

Liquidity and equity outflows were around $10.9 billion and $4.6 billion, respectively, while fixed income inflows were around $2.2 billion, for the quarter. Additionally, average AUM was $683 billion, compared with $710.9 billion in the prior-year quarter.

Balance Sheet

As of Dec 31, 2015, Legg Mason had $563 million in cash, down from $619 million in the prior quarter. Total debt was $1.1 billion, in line with the prior quarter. Shareholders' equity was $4.3 billion, down from $4.5 billion in the prior quarter.

The ratio of total debt to total capital (total equity plus total debt excluding consolidated investment vehicles) was 20%, up from 19% in the prior quarter.

The company repurchased 0.58 million shares in the reported quarter.

Other Developments

Prior to its earnings release, Legg Mason made three strategic announcements.

Firstly, Legg Mason has signed a definitive agreement with an independent hedge fund investor and alternative asset manager - EnTrust Capital to combine Permal, Legg Mason's existing hedge fund platform. In the combined entity - EnTrustPermal, which is expected to close by mid-2016, Legg Mason will hold 65% stake, while the remaining 35% stake will be held by Gregg S. Hymowitz, EnTrust's Co-founder and Managing Partner.

Secondly, Legg Mason acquired a minority equity position in Precidian Investments, an innovator of products particularly for the ETF market. Per terms of the deal, a new class of preferred equity was bought by Legg Mason which entitles the company to hold 19.9% of common equity. Moreover, it has the option of acquiring a majority interest in the common equity. However, remaining terms of the agreement were undisclosed.

Thirdly, Legg Mason has signed a definitive agreement to acquire a majority equity interest in Clarion Partners, a diversified real estate investment firm. Per the terms of the deal, Legg Mason will be the holder of 83% ownership stake in Clarion Partners for $585 million.

Our Viewpoint

We believe Legg Mason has the potential to outperform its peers in the long run, given its diversified product mix and leverage in the changing market demography. Further, with strategic acquisitions, restructuring initiatives and cost-cutting measures, we expect operating efficiencies to improve and steady capital deployment activities to continue to boost investor confidence in the stock.

However, decline in assets under management and lower revenues remain concerns. Legg Mason currently carries a Zacks Rank #3 (Hold).

Among other investment management firms, T. Rowe Price Group, Inc. TROW and Federated Investors Inc. FII are both scheduled to report December quarter-end results on Jan 28, while Lazard Ltd. LAZ will report on Feb 2.

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T ROWE PRICE (TROW): Free Stock Analysis Report

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LAZARD LTD (LAZ): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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