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Moody's Affirms Franklin Ratings, Puts Legg Mason on Review

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Following the merger announcement of Legg Mason and Franklin Resources (BEN - Free Report) , Moody's Investors Service has placed the ratings of the former under review for upgrade, while has affirmed the A2 senior unsecured debt rating for the latter. Outlook for Franklin's ratings remains stable on the back of its impressive bottom line and solid balance sheet.

Earlier this week, Franklin announced plans to acquire Baltimore, MD-based Legg Mason in an all-cash acquisition deal, per which, the former will acquire the latter for $50 per share of common stock. (Read More: Franklin to Acquire Legg Mason for $4.5 Billion)

Regarding Franklin, Moody’s is of opinion that the buyout is likely to help expand its revenue sources through the addition of Legg Mason’s separate managed account platform and institutional sales capabilities. Also, Franklin’s strong liquidity position and ability to generate cash will help fund the cash purchase.

However, per the ratings agency, Franklin has been witnessing declining revenues and significant outflows of assets under management (AUM). Legg Mason's revenue trend also has been weak, with organic growth at some of its affiliates offset by losses of others. Thus, this seems to be a challenge for the company.

Further, Moody’s feels that the asset management sector is facing risks from elevated market valuations and the effect of low interest rates on global credit quality, which could result in volatile financial performance of the combined firm.

For Legg Mason, Moody’s expects its key investment platforms to continue functioning independently as subsidiaries of Franklin, post acquisition. Also, as the deal involves Franklin acquiring Legg Mason’s outstanding debt worth $2 billion, latter’s risk profile is expected to converge with the former.

Legg Mason’s senior unsecured and junior subordinate ratings have been put under review. Notably, Moody's review will focus on the approval and execution of the acquisition, ultimate organizational structure and capital management plans of the combined company.

What Can Lead to a Rating Upgrade?

Ratings of Franklin can be upgraded if it is able to exceed operational scale beyond $6 billion, improve AUM sales and witness organic growth. Also, the company’s ability to penetrate market of new products and increasing presence in institutional channels can result in an upside.

On the other hand, Legg Mason's ratings could be upgraded upon closing of the transaction depending on Moody's assessment of Franklin's implicit and explicit support. Also, continued stable operating performance and credit fundamentals of the companies in the quarters ahead will be contributing factors.

When Can the Ratings be Downgraded?

Franklin’s ratings could be downgraded if its scale declines to $3.5 billion or lower, or is the firm witnesses weak investment performance or negative organic growth despite improved performance, or if there is persistently weak or negative trend of revenues and margins.

Termination of the planned acquisition, with no material change to Legg Mason's current financial profile, would most likely result in a confirmation of the current ratings with a stable outlook.

Currently, Legg Mason is sporting a Zacks Rank #1 (Strong Buy) and Franklin is carrying a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank stocks here.

Other Stocks to Consider

T. Rowe Price Group, Inc. (TROW - Free Report) has witnessed upward earnings estimate revisions for the current year over the past 60 days. Moreover, this Zacks Rank #1 stock has rallied 29%, over the past six months.

Lazard Ltd (LAZ - Free Report) current-year earnings estimates have been revised upward over the past 60 days. Further, the company’s shares have gained 24.8% in six months’ time. At present, it has a Zacks Rank of 1.

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