A series of good news from Legg Mason Inc. (LM) has led to a significant jump in its stock price in the past two days. On Wednesday, the company has announced its plan of repurchasing $1.25 billion in debt held by a fund which is managed by Kohlberg Kravis Roberts & Co. L.P. (KKR).
Besides reducing its debt, Legg Mason has also declared a $1.0 billion authorization for share buybacks. During the quarter, the company intends to deploy the residual $155 million in share buybacks from its prior authorization.
To finance the buyback of $1.25 billion convertible senior notes held by KKR, Legg Mason will make use of $250 million drawn on its existing revolving credit facility, other debts and cash on hand. The move is a strategic fit as it will lead to a net reduction in outstanding debt. Notably, Legg Mason had issued convertible senior notes to KKR way back in 2008 to infuse capital in its business. The 2.5% senior notes were due in 2015.
With this early debt extinguishment, Legg Mason expects to report a non-cash charge of around $70 to $80 million in the company's first fiscal quarter. However, it is expected to be accretive from the second quarter of fiscal 2013.
The terms of this buyback include a repayment at par, a prepayment fee of $6.25 million to KKR. Moreover, it includes issuance of new warrants to KKR that provide for the purchase of approximately 14.2 million shares of common stock at $88 per share. Moreover, Scott Nuttall, the head of KKR’s global capital, will step down from the Board of Directors at Legg Mason. The company has issued $650 million of 5.5% senior notes due 2019 to finance its KKR debt buyback.
Our Take
We believe these strategic initiatives would help Legg Mason in strengthening its balance sheet and enhance its capital structure. Its gross debt will be immediately reduced by $350 million. Moreover, the period for debt maturities will be lengthened. Such moves will add flexibility and help Legg Mason in returning wealth back to its shareholders. Such measures according to our opinion, will give a fillip to investors’ confidence on the stock.
We believe the company has the potential to outperform its peers in the long run, given its diversified product mix and leverage to the changing market demography. Although, in the near term, assets outflows will remain a headwind, yet with the restructuring initiatives and the cost-cutting measures, we expect operating efficiencies to improve. Moreover, strategic investments in both organic as well as opportunistic acquisitions would help boost its business going forward.
Legg Mason currently retains its Zacks #3 Rank, which translates to a short-term Hold rating. Considering the fundamentals, we also maintain a Neutral recommendation on the stock.
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