This past week BlackRock agreed to acquire Barclays Global Investors (BGI) from the British banking firm Barclays. The new firm will manage $2.7 trillion in assets, making BlackRock by far the largest asset manager on the planet. The price tag? A staggering $13.5 billion. Barclays will retain a 20 percent interest in the new firm, which values the entire BGI operation at nearly $17 billion.
Aside from the fact that the transaction confirms that the field of asset management remains lucrative in spite of the current bear market and the increased financial regulation that it has brought, the deal also brings with it a host of questions. Let’s consider a few of them.
1. Why? It was announced months ago that Barclays was soliciting offers for its iShares unit, the exchange-traded funds (ETFs) run by BGI. With nearly $300 billion in assets, iShares was easily the largest manager in the rapidly expanding ETF field, with a market share just shy of 50 percent.
When rumors of the sale first came out, in early 2009, it made a certain amount of sense. Barclays, like most of the world’s large banks, desperately needed capital, and there were precious few sources. As the months went by, however, the environment changed. Citigroup, Bank of America, and a host of other banks in the same boat were able to meet the capital requirements set by the Treasury Department’s stress tests. (Bank of America, for instance, raised $35 billion — $17 billion of which came from the sale of new stock or converting preferred stock.)
So why, when the tides shifted, did Barclays not just follow through with their initial plan, but expand it by selling the entire BGI unit? If raising capital was truly the prime motivation, why not just turn to the capital markets instead of selling off your entire asset management arm? Maybe they felt they were selling high, but this has never been explained to me in a satisfactory way.
2. Where was Fidelity? When I first heard rumors of the iShares sale in January, my first thought was “Here comes Fidelity.” It seemed to be a dream come true from their perspective. Why? First, ETFs have been the mutual fund industry’s fastest-growing segment. They’ve nearly doubled their share of equity fund assets since 2005 — from 6 percent to 11 percent.
Which leads to the second reason — Fidelity has essentially no presence in this field. They’ve spurned ETFs in favor of traditional mutual funds. But here’s a dirty little secret: Although they have broad name recognition, Fidelity’s market share of long-term assets (i.e. stock and bond funds) has declined in nine of the past ten years, falling from a peak of 13.8 percent in 1999 to 9.8 percent currently. They’re still minting money, of course. With annual revenues of nearly $13 billion last year, Fidelity could have easily swallowed iShares and instantly become the largest player in the industry’s most promising field. Even better, the move would have been viewed as a shot across the bow of their rival Vanguard (the third-largest player in the ETF field), something that would have doubtlessly pleased Fidelity Chairman Ned Johnson.
Given that I never heard Fidelity mentioned in any iShares rumors, I can only draw two conclusions. First, someone at Fidelity pitched this idea to Johnson, because it made a great deal of sense. Second, Johnson quickly shot it down. Why? We’ll likely never know.
3. How much? $13.5 billion is a lot of money, especially so when you consider that most of BGI’s assets are in very low margin index or quantitative index funds. And at nearly six times BGI’s 2008 revenue of $2.9 billion, BlackRock’s 80 percent stake seems to come at a hefty premium. Mammoth acquisitions are nothing new in corporate America, of course, and it’s possible that this one will succeed. But if that’s the case, it will be a relative rarity, because numerous studies have shown that the majority of corporate mergers actually destroy shareholder value.
4. Now what? BlackRock enjoys a strong reputation in the industry — one that is not entirely justified. They are largely known for their bond funds, but the fact of the matter is that their bond funds got creamed last year — their average closed-end bond fund lost over 23 percent. As for their stock funds, well, the jury is still out. They’re largely populated by former Merrill Lynch funds, which BlackRock took over in 2006. Improving on Merrill’s record won’t be difficult, but proving worthy of investor interest will be.
Of course, what matters most to investors impacted by the current deal is what they’ll do with iShares. Will BlackRock raise their expense ratios to help justify the steep price they paid? (BlackRock CEO Larry Fink says the answer is no, but as they say, the proof of the pudding is in the eating.) How far will they go in expanding their ETF empire? Will they launch a slate of ETFs with questionable utility but slam-dunk marketability, such as leveraged and inverse funds (which FINRA recently stated are “unsuitable for retail investors who plan to hold them for longer than one trading session”)?
All of this remains to be seen, of course. But in considering the answer to questions like these, it might help to remember that Merrill Lynch retains a 49.8 percent interest in BlackRock. It’s easy to imagine Merrill pushing BlackRock to create ETFs that are easily marketed by the Thundering Herd (”Worried about the market falling? How about one of these ETFs that provide triple the market’s inverse return?’), providing a win-win for BlackRock and its largest owner.
Perhaps I’m too skeptical, and this will result in nothing more than more investors gaining access to low-cost broadly diversified index funds, run by a manager happy to exchange a nominal management fee for an increasing market share, and sold by brokers content to earn a modest fee on a wrap account made up of prudently selected ETFs.
I suppose that’s possible. I wouldn’t bet on it, but it is possible.
Image via Flickr user laurakgibbs CC 2.0
