Franklin Resources (BEN, Financial) is an asset manager providing investment service to retail and institutional investors. Funds are marketed under the well known Franklin, Templeton, Mutual Series and other brands. Franklin has over $850 billion in AUM. The asset base is more risky than is typical for asset managers with a big chunk consisting of equity investments. AUM is divided about 50-50 between equities and fixed income actually. In addition, Franklin Resources owes almost a third of the AUM to foreign investors. Retail investors also make up an important group of clients. As retail investors are more fickle as compared to their institutional counterparts, that also raises the risk profile of the company. In short; not your run-off-the-mill rocksolid asset manager. On the other hand, this type of AUM usually comes with higher returns.
On a macro-economic level, which I want to stress is not my specialty, I like the firm’s exposure to foreign countries. The U.S. has a somewhat healthy and mature market for asset management but around me, in Europe, there is a lot to be gained. Individuals control only a fraction of the capital they are entitled to. Slowly politics are moving towards an environment where individuals have greater control over allocation decisions. Franklin should ultimately benefit from that. However, it is my goal to not rely on long term macro tailwinds in any investment, including this one.
The firm’s funds in the aggregate have not performed in line with investors expectation recently, and this has caused AUM to shrink. With investors heavily relying on recent performance, this means the company is in for a rough ride. The firm has bet a lot on the bonds of energy companies after the oil price decline but this has, so far, not worked to their advantage. Bloomberg has reported on the issue in more detail.
I am certainly not the only one who likes the company as gurus like Lee Ainslie (Trades, Portfolio), Scott Black (Trades, Portfolio), David Dreman (Trades, Portfolio), Mason Hawkins (Trades, Portfolio), Jim Simons (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio) and Paul Tudor Jones (Trades, Portfolio) have all recently bought in. Many others already own shares for a while. Bill Nygren (Trades, Portfolio) of Oakmark select fund commented on the investment in the first quarter 2014 investor letter:
We established a position in Franklin Resources (BEN), one of the world’s largest global mutual fund companies, with leading products in both equities and fixed income. For starters, we believe asset management is an attractive business and Franklin has a history of strong fund performance across various asset classes and geographies. The company is selling for less than 14x our estimate of this year’s EPS and just over 11x adjusting for net cash and securities. In our view, this is a cheap price for a well-run company in such an attractive industry. Management has historically returned capital to shareholders through stock buybacks and dividends, and with insiders owning 35% of outstanding shares, we expect Franklin to continue to be good stewards of shareholders’ capital.
Financial strength
The company is financially sound. It holds $9.5 billion of cash and is unlikely to deploy it in a foolish way. Its historical record of achieving high RoIC is sound. Over the last 3 years, it achieved 17% RoiC and that is fairly representative for its longer term record as well. The firm has only $2.5 billion in debt and could pay its off with TTM Ebitda and have a third left over. I am not worried about its financial position.
Risks
I have already touched on a few of the risks that you are faced with investing in Franklin Resources. With so much revenue coming from managing assets (mostly management fees), that means AUM directly predicts revenue. Asset management is a winner take all market. Assets flow to those who have recently been most successful. A key risk is that the Franklin funds do not show up in the top performance lists by category often enough. Without taking a few of these coveted top spots (for example as tracked by Morningstar) it is hard to maintain AUM. Of course there are many other risks, like political risks and currency and (indirect) commodity exposures.
One trend that is obvious to everyone investing in the asset management industry is the move towards ETF’s and in particular passively managed ETF’s. Blackrock is enjoying this trend with its powerful iShares brand. If you ask me this should ultimately result in either a blow-up or a natural push back. Whenever more assets are passively managed, this decreases the efficiency of the market and it slowly but surely becomes easier for active managers to actually outperform the market. As more and more of their competing assets do not engage in active valuation of equities, the competition decreases and high quality experienced active managers should be able to outperform. In the medium term, this trend can and may very well continue, resulting in outflows of the Franklin funds and Blackrock laughing all the way to the bank.
A final thing to keep an eye on is the AUM is fairly concentrated in a couple of funds:
Franklin Income - ~$90 billion (recently downgraded from positive to neutral on the performance aspect grading)
- Templeton Global Bond - ~$70 billion
- Mutual Global Discovery - ~$25 billion
- Templeton Growth - ~$17 billion (graded neutral in performance by Morningstar)
- Franklin Mutual Shares - ~$16 billion (graded neutral in performance by Morningstar)
If these funds have a terrible year, expect to see big outflows from this asset manager. If these funds have a stellar year, expect the opposite.
Management
Franklin Resources is a family company with Gregory Johnson having taken over from his father in 2004. The family controls 30%+ of the outstanding shares and is heavily incentivized to see the company do well. In 2009, Johnson and other execs took a cut in pay which is actually really unusual in the Western World. It is much more common to see execs in Asian countries (Japan/Korea) decrease their own pay when the company is in trouble. I think the fact that this is a family company plays a role in that respect and think this shows their commitment to the company to such extent it is worth mentioning several years later.
Valuation
Valuing an asset manager on an EV/Ebitda basis works fairly well. Below you can observe that Franklin Resources trades at a pretty low level compared with its historic multiple. Its favorable cash position really helps to bring the multiple down. Once in a while, the management team decides to issue a special dividend which can turn out to be a nice surprise. The last one was issued on 12/29/2014 and was rather small, but in 2011 the firm last issued a big one. Buying in on an EV/Ebitda multiple of just 7x, I feel good about putting some money to work in this name. On a relative basis the company is also fairly cheap. Although Blackrock is a very big player in the hot space of ETF’s, the discrepancy is still extremely large. At some point Franklin Resources distinct and actively managed funds are going to outperform and assets will flood in. This may take some patience, but I do not mind staying in a name where management owns so much stock and incentives are well aligned with mine.
Outlook
Predicting when Franklin Resources is going to get back in the good graces of the market is near impossible. It would help tremendously if its large funds outperformed the market in a big way, but we may be waiting for a little while. These have a value bent and many value managers are struggling in the current environment. Major catalysts would be: a special dividend being issued or Franklins important funds outperforming the market; for example on a broad energy rebound. Over the medium to long term, the reversion to the mean effects, oil prices around the $70 level and the decreasing relative effectiveness of passive strategies as they become more popular should help the firm.
