Last year’s asset swap between Citigroup (C) and Legg Mason (LM) looked like a great move on the part of Legg. After all, retail brokers are hardly the future. Individual investors can only tolerate absurdly high commissions for so long, I would hope. Trading their retail brokers for Citi’s huge asset management division, including Smith Barney’s mutual funds, should be a huge lift for LM shareholders, and the stock’s movement since the deal was announced bears that out.Now we learn that Merrill Lynch (MER) has decided to send Merrill Lynch Investment Management (MLIM) to BlackRock (BLK) in exchange for a 49% stake in the newly formed asset management giant. As was the case with Legg Mason, Blackrock stock has gone through the roof on news of a deal.
Evidently this Merrill deal was a much better alternative than the “let’s change our fund company’s name to Princeton Research and Management and see if that helps get us more business.” Once Morgan Stanley’s deal to acquire BlackRock fell through, Merrill swooped in and decided it was a much better idea to hand over MLIM to a somebody who could better run it. Doing so also rids Merrill of having the appearance of conflicts of interest with its investment bankers, research analysts, and mutual fund managers all under the same roof.
So in a matter of months both Legg Mason and Blackrock have strengthened themselves as pure play asset managers, a business that has great margins. With the growing popularity of hedge funds and international investment options, their fortunes will be much less tied to the direction of the S&P 500 than they were five or ten years ago.
The stocks have soared, and on current profit estimates they do look pricey. However, it is apparent that margin expansion will occur, both due to cost-cutting and an overall higher average profit margin across the business. Accordingly, current analyst expectations for profits (about $6 for LM in 2006 and $5 for BLK) will prove quite conservative.
And they better since LM is trading over $130 and BLK recently hit $150 per share. It is entirely possible that 2006 is a transition year for the integration of these very large deals, but come 2007 and 2008, they should be coining money. Add in the fact that asset managers have always traded at a premium to the overall market and financial services sector, and the stocks could outperform for the rest of the decade even after the recent run-ups we’ve seen. Of the two, Legg Mason looks cheaper than Blockrock, however.