At least, that’s been the case. But now we have something else to worry about before deciding reflexively that Price is right for us. That’s the fact that he’s agreed to sell his fund-management business for a gazillion dollars. Price, 45, and his top honchos have signed five-year employment contracts with the buyer. But the change of ownership nonetheless raises the question: can we still trust them with our money? Will Price stay hungry enough to keep on top of his game, or will he turn out to be one of those high-paid athletes with long-term guaranteed contracts who start underperforming because they’re financially secure?
This is a more than academic question to me. I have about 824,000 (serious money for me) in one of Price’s funds. Some of my NEWSWEEK colleagues own Price funds, too. AU told, the excellent return he has made by buying unpopular, undervalued securities has lured about 500,000 investors, who have entrusted about $17 billion to his safekeeping. What’s more, your stockbroker may be calling as early as this fall to peddle shares in Price’s Mutual Series funds. That’s because the funds’ new owner, Franklin Resources, will offer Mutual Series funds through the nation’s brokers. The brokers Will in turn be pitching Price’s superb long-term record, which you can see in the table adjacent to this story. The brokers themselves will be motivated by the obscene fees that Franklin will stick on the funds to give the brokers incentive to sell them. Brokers aren’t likely to tell you that Price’s funds, which now carry no front-end commissions or annual “distribution” charges, lose a good chunk of their advantage over the Standard & Poor’s 500 Index when you factor in Franklin’s extra fees. In fact, the 10-year performance of Price’s flagship Mutual Shares fund falls below the S&P when you add in the fees, according to Morningstar, the Chicago-based fund analysis company. To wit: Mutual Shares’ 10-year record drops from 14.18 percent a year to 13.37 for Franklin Class 1 shares and 12.92 for Class 2, compared with 13.81 for the S&P. The five-year record, now a solid two points a year above the S&P, shrinks to a mere 0.75-point advantage when you factor in Franklin’s fees.
(Note that existing investors -along with anyone who buys into the funds before Franklin takes formal ownership in October–can continue buying shares directly and duck the new front-end fees. I’m not touting Price, but if you think you might want to buy into his funds someday, you should think about opening a $1,000 account before Franklin takes over.)
Any reasonably skeptical person would think that Price, sensing a peak in both the stock market and the mutual-fund business, is selling out -at what he thinks is the top. After all, the man has spent half his life working at Mutual Series, trying to buy undervalued securities cheap and sell them when they get dear. That’s why they call him a value investor. Price insists he wanted to ensure continuity of management for his investors. Selling out, he said in an interview, “had nothing to do with a market view or an industry view.” His five-year contract and his pride would keep him working as hard as ever. maybe harder, he added. “Franklin will handle administration and promotion for us” leaving him more time to pick stocks.
Indeed, Franklin has gone to great lengths to make sure that Price has lots of financial incentives to keep his funds performing well. Consider, for instance, the structure of the sale. Price will get $550 million in cash and 1.1 million Franklin shares, currently worth about $60 million, when the deal closes. Say he has to fork over about $200 million for capital-gains taxes, leaving him $400 million. Of this, the $60 million is locked up in Franklin shares that he’s not allowed to sell for years. and another $150 million has to go into Mutual Series shares of Price’s choosing. Thus, about half of his after-tax take will be tied to the success of the deal. On Wall Street, they call this eating your own cooking.
(To simplify things, I’m assuming that Price gets all the money. In fact, some of his associates have a piece of the action, probably around 10 percent.)
“We wanted him to have to put his money where his mouth is,” said Martin Flanagan, Franklin’s chief financial officer, who negotiated with Price. Price points out that he made sure his existing shareholders will never have to pay Franklin’s extra fees, and will be able to move money out of those funds into other Franklin funds without incurring any of the front-end fees that other Franklin investors have to pay. “The deal was woven beautifully to fit everyone,” said Price. “The structure is really great.”
Don’t worry about Franklin, either. Thanks to the way the deal is structured, Franklin will be able to deduct virtually all of the $600 million payment from its taxable income over 15 years. That will reduce the company’s tax bill by more than $200 million, offsetting some of the purchase price. Should Franklin be forced to pay Price his maximum incentive fee of $192.5 million over the next five years, the company will be thrilled. It’s not that Franklin likes to give away money. Rather, it’s because the incentive payments are based on the funds’ size. If Price maxes out on his incentives, the funds will have grown to more than $37 billion from today’s $17 billion or so. The added assets would add more than $120 million a year to Franklin’s fee income.
So the deal is great for Price and Franklin. What about for us? Franklin has done everything to keep Price interested and involved after the sale, so this is much more complicated than deciding whether to stick with Magellan Fund when Peter Lynch hit the silk, or whether to stay with Berkshire Hathaway when Warren Buffett is no longer with us. For me, I’m going to leave my money with Price, and even add to it. But I’m going to keep a sharper eye than usual on him to make sure that he hasn’t left his game in the gym.
