Are asset-management businesses worth what they were in 2003? Investment banks are struggling to decide.
According to report on
is studying the acquisition of a controlling stake in
, the hugely successful bond-fund manager, in a transaction valued at up to $10 billion. Publicly traded BlackRock is 70% owned by
While the deal could take various forms, the reasoning behind it is clear. By acquiring BlackRock, assets under management in Morgan Stanley's investment arm would nearly double. Morgan would get a share in one of the hottest money managers on Wall Street, plus a seasoned management team that has run the firm for an uninterrupted stretch of almost two decades.
By teaming with Morgan Stanley, BlackRock would get broader distribution, including a far larger international presence. It would also diversify its asset mix, which is currently focused heavily on bonds and the money market.
The pressing question is whether BlackRock is currently too expensive to acquire. The stock is already richly priced and could be valued higher in a takeover scenario.
BlackRock's stock, which was trading at 26 times projected 2006 earnings last week, is now going for 31 times estimates after jumping 6% Friday after word of Morgan Stanley's interest broke. Even before the takeover premium was built in, the stock was trading well above the average multiple for asset managers, which is around 18. Ironically, Morgan Stanley's own analyst, Chris Meyer, called the valuation "too rich" in a note issued Thursday after BlackRock ran up on blowout earnings.
"While BlackRock continues to post strong flows, solid earnings growth and a healthy pipeline, we remain cautious on valuation. It is difficult to recommend the stock here, especially on a day when it had a 7.6% run-up," the note said. While Meyer's research didn't encompass any synergies related to a Morgan Stanley combination, he did note that the stock was trading at a premium to its historic valuation and to its historic premium to the sector.
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Notwithstanding price concerns, the acquisition of asset managers by securities firms has been a theme on Wall Street for three years, and a lot of momentum exists to get such deals done. Recently,
swapped its asset management division to Legg Mason for brokerage assets valued at $2.1 billion. At the time, Legg Mason had about $430 billion in assets under management, and Citigroup had about the same.
In October 2003,
purchased Neuberger Berman for $3.1 billion. Shortly afterward,
bought the private money-management group from
While it is too early to judge the success of the Citigroup and Legg Mason exchange, the Lehman and Charles Schwab acquisitions are both viewed favorably. This year, Charles Schwab announced earnings that met Wall Street's high expectations -- almost tripling its profit in the fourth quarter of 2005 compared with the prior year.
Meanwhile, few would argue with Lehman's outsize success in 2005 -- much of which the company and the market associated with the Neuberger acquisition. Lehman's investment management division had total revenue of $1.93 billion in the year ended Nov. 30, up 14% from 2004.
John Mack -- who took helm at the Morgan Stanley after a high-profile management struggle -- is clearly on the acquisition trail. A purchase of BlackRock would fit nicely into this strategy. Given Lehman's success with Neuberger, some on Wall Street expect Mack to find a way to make an acquisition of BlackRock palatable.
On Monday, UBS research analyst Glenn Schorr said in a note that combining Morgan Stanley Investment Management with BlackRock could produce an entity that is worth 30% more than its constituent parts. The math included a 20% boost from operational synergies and the transfer of some of BlackRock's higher earnings multiple to the Morgan Stanley operations.
Under Schorr's model, Morgan Stanley would spin off its investment management arm to BlackRock and get shares representing a controlling interest in the combined firm. The main benefit of the structure would be to make the deal palatable to PNC, which would surrender a controlling stake in BlackRock but still collect about the same amount of earnings from the combined firm.
"In general, the attractiveness of any broker increasing earnings from asset management is clear (and no surprise that most broker acquisitions over the past years have been in asset management) -- strong earnings growth, a very attractive return on equity and little capital needs -- though price and a willing seller are typically the hurdles needed to overcome," Schorr wrote.
How far Morgan Stanley is willing to go to clear those hurdles remains to be seen.