On Thursday, Baltimore-based Legg Mason, Inc. (LM) and its affiliate, Permal Group, announced the acquisition of London-based fund-of-hedge-funds firm - Fauchier Partners from BNP Paribas Investment Partners, an asset management unit of BNP Paribas SA (BNPQY). Financial terms of the deal were not disclosed.

At the close of the transaction, which is expected in the first quarter of 2013, Fauchier Partners, with assets under management (:AUM) worth $6 billion will be integrated into global alternative asset manager - Permal and will jointly create a combined entity with about $24 billion in AUM. The entity will operate through 9 offices and a global investment team based in New York, London, Paris and Singapore.

Moreover, the acquisition is anticipated to be accretive to Legg Mason's earnings in the first year, reflecting management’s continuing assurance to create shareholder value.

Industry Data

Generally, fund-of-hedge-funds firms invest in the hedge funds of other firms in addition to personal direct investments in securities. The aforesaid agreement sets another example of the fund-of-funds market consolidation led by decline in margins and augmented withdrawals attributable to credit crisis.

During 2012, similar acquisitions include Franklin Resources Inc.’s (BEN) purchase of a majority stake in K2 Advisors, buyout of Prisma Capital Partners by private-equity group, Kohlberg Kravis Roberts & Co. (KKR), and Man Strategic Holdings plc’s (MNGPY) acquisition of FRM Holdings Limited.

Direct investments by investors into hedge funds have led to shrinkage in hedge fund assets of fund-of-hedge-funds firms. Therefore, these firms recorded sixth consecutive quarter of outflows in the third quarter of 2012, summing upto $4.4 billion compared with significant inflows of $80 billion in the industry in the prior periods.

After-effects of the Deal

Concurrent with the announcement of Permal's purchase of Fauchier Partners, Legg Mason announced the revision in its employment and other arrangements with the management of Permal. The company will record non-cash impairment charges in the range of $650 million to $750 million ($460 million to $550 million after net tax benefits) for impairment of two noteworthy indefinite-life fund management contract intangible assets in the current quarter.

Having strengthened its foothold over the years in global macro and fixed income credit, Permal commands a strong presence in the US. On the other hand, Fauchier is superior in equity long-short and event-driven and has a strong business in UK. Therefore, with the acquisition of Fauchier, Permal will expand globally with the help of the acquired firm’s asset management brand and proficiency.

Moreover, the acquisition demonstrates Legg Mason’s aim of providing exceptional services to its clients with the purchase of such a flourishing asset management firm. The completion of the deal will significantly expand Permal's institutional business globally.

On the other hand, the deal widens Fauchier’s scope and will help its expansion efforts with the commitment of providing best investment decisions to its clients. Overall, the clients of Fauchier will have access to the industry's largest managed account platforms provided by Permal, while the company will take advantage of Fauchier's investment management potencies. Therefore, the combined entity will be beneficial for clients of both firms aided by enhanced investment talent and resources.

Our Viewpoint

The acquisitions of such asset management companies are welcome as they play a major role in preserving investor confidence in the stock.

We also believe that Legg Mason’s diverse revenue stream and sturdy capital position augur well for investors. Capital deployment efforts also bode well and boost investors’ confidence. Yet, the unsettled economic environment, low interest rate and stringent regulatory issues are matters of concern.

Legg Mason currently retains its Zacks #3 Rank, which translates into a short-term Hold rating. We believe the announcement of such acquisitions will be beneficial for leading upward earnings estimate revisions. This, in turn, could cause an upgrade in the Zacks Rank.