|Shares Out. (in M):||585||P/E||14.3||19.6|
|Market Cap (in $M):||20,385||P/FCF||11.9||16.1|
|Net Debt (in $M):||5,427||EBIT||2,078||1,477|
|Borrow Cost:||General Collateral|
For those who are not aware of the story, BEN is a large asset manager that is mostly active in mutual funds, heavy retail concentration, and sold mostly via the broker/dealer channels with notoriously high fees. I am not going to rehash the business in this writeup, but instead, my aim is to highlight recent developments that make this company a structural short. For an overview of the Company, you can refer to past writeups from Abra399 and lvampa1070.
Franklin Resources is a large, old-line dinosaur asset manager that is a structural short in today's environment. The performance of the Company's products have been horrible for the last several years, and the unspoken reality is Franklin's products are sold, not bought. The Company is a big player in US retail and gets away with charging very high fees to retail individuals. US retail AUM is about ~$450bn, of which 50% (~$225bn) charges a load greater than 4%!! Moreover, the Company's products have significant performance issues: In their two largest funds FKINX ($77bn AUM) and TPINX ($48bn AUM), both have 3 year performance in the bottom quintile and 1 year average performance of -9% and -10%, respectively (vs. mkt -3% and 0.4%)!! Typically, product sales are driven by 1 & 3 year performance, which despite being horrible, the Company has been able to chug along because financial advisors within their distribution network are incentivized with kickbacks/revenue share for selling Franklin's high fee products into their client base.
At Franklin, the Company is class agnostic when it comes to selling products: advisors choose which class of shares to purchase but management fees across all classes are the same. While they are not the ones directly selling their own high fee products to clients, they nevertheless have a large incentive structure in place with distributors that creates a conflict of interest between the advisor and the client. Consolidated fee rates across products (~60bps) are among the highest in the industry (~30% higher than competing products). Expensive funds (Classes A, B, C) represent 30-35% of AUM (vs. >15% industry average) and distribution revenue to AUM is ~25bps (vs. >10bps industry average).
With downward fee pressure and enhanced disclosure requirements imposed by regulators (ie. DOL/SEC/states), financial advisors will little incentive to sell Franklin's products because they are underperforming. The Company's distribution is overrated by the street. Analysts boast the wide reach of the distribution platform, but the reality is all products are sold entirely through financial intermediaries (broker-dealers, financial advisors, banks) into a heavy retail client base (~75% of AUM is retail) with nearly a quarter of the AUM in qualified accounts subject to DOL pressure.
Financial advisors nationwide are now under scrutiny to reduce fees and enhance disclosures. As a point of reference, LPL Financial, one of the largest independent broker/dealers in the nation (and a firm that has been proactively trying to stay ahead of regulatory developments), has told its own brokers that they can no longer sell Class A mutual funds (classes with upfront loads) to customers on its managed account platforms or receive ongoing 12b-1 fees (distribution revenue) from funds offered on its strategic asset management advisory program. On a go forward basis, LPL will sell only the institutional share class (generally the lowest cost share class). THIS IS HUGE and other industry players will probably follow suit. These developments will hurt Franklin because they are a major Class A and 12b-1 player.
While this franchise used to be great back in the day, the Company's distribution model is now clearly under pressure. Combine this with other systemic issues (poor performance, AUM concentration in Global Bond and Franklin Income funds, reliance on star manager (Michael Hasenstab), weak inflows, rise of ETFs/alternatives, etc.) and you get a structural short. It is simply an idle box of cash (of which 70% is OUS) + a core asset management franchise struggling for long term survival. I think there is potential M&A upside from using the cash but strategic asset management deals are hard to pull off and anything sizable (e.g. Henderson, Invesco, WisdomTree) will probably involve a competitive bidding process. The thought of doubling down on long only asset management at this point in time scares me so I am not optimistic about M&A.
So how do I value this? Even with better performance, it will take several years to turnaround, especially since you need the near term underperforming 1 and 3 year track records to roll-off. In the meantime, I assume redemptions continue at the current pace 20-25% per annum in line with the last several years for the next three years & new sales (as % of BOP AUM) slow to ~15% per annum. This takes 2018 AUM to ~$575bn. Revenue/AUM will probably come down too with fee pressure facing the industry, which I assume falls from 91+bps in 2015 to 77bps in 2018. The opex base falls to ~$3.5bn, with 5% annual cost cuts on comp. This gets me to an adjusted EPS of ~$1.30 in 2018. Apply a 10x P/E multiple and you get $13 for the core business + ~$9 cash (assumes total cash is discounted 25% and offshore cash is repatriated at 35% tax rate) + ~$2 real estate = $24 per share, or ~30% downside from today's price.
Continued decline of new product sales
More bad news for broker/dealers