Updated from 11:59 a.m. EST
confirmed a widely anticipated deal Wednesday to merge its mutual fund division with
, creating a money-management behemoth with $1 trillion in assets.
The New York brokerage will fold Merrill Lynch Investment Management into BlackRock, heretofore a publicly traded unit of
, in return for 49.8% of the combined entity. PNC's stake in BlackRock will fall from 70% to 34%, while the public's share goes from 30% to 17%.
In an interview Wednesday afternoon with
, Merrill Lynch Investment Managers president Bob Doll said, "You could take a page out of the Blackrock culture book and you could put Merrill Lynch's name on the top of it," emphasizing that the fit was right for the both companies. "The management of BlackRock has brought the company from zero to over $400 billion since 1988, and, as I like to say, that's a whole lot more than luck."
Seven years after coming public and 20 after being carved out of private equity company BlackStone Group, shares of fixed-income titan BlackRock are up tenfold since their debut on the
New York Stock Exchange
. With the transaction, the company adds extraordinary scope to its already stellar reputation for managing institutional money.
"The $1 trillion mark has always been something to achieve, and others have come close," said Denise Valentine, a senior analyst at Boston-based financial research and consulting firm Celent. "But it must be pretty heady to be the first $1 trillion asset manager. Not even the behemoths like Vanguard can say that." (Fidelity Investments also eclipses the trillion-dollar mark when trust assets are counted.)
For Merrill, the deal is a way out of the day-to-day administration of asset management, a lucrative Wall Street business that occasionally is the source of conflicts when operated and marketed by a brokerage. Merrill loses that headache while retaining a sizable stake in a firm that will now boast more than 4,500 employees and become the country's biggest fixed-income manager.
"We will gain what amounts to a half-interest in a firm twice the size of our unit, with enhanced growth prospects, both organically and through potential acquisitions, with its own publicly traded stock," Merrill Lynch CEO Stan O'Neal said in a statement. "Additionally, this transaction frees up significant capital for Merrill Lynch, which we can deploy to further enhance shareholder value."
Merrill also inherits the services of one of the industry's most respected executive teams, with BlackRock CEO Laurence Fink and President Ralph Schlosstein agreeing to remain in their posts. Robert Doll, the president of Merrill Lynch Investment Management, will be vice chairman of global equities and chairman of the private client operating committee.
O'Neal harped on the potential for redeploying capital in his statement, but for now, Merrill's management will have its hands full with executing the merger.
"The next step would be buying back shares, because you want to tighten up the balance sheet after a transaction of this size," Valentine speculated. "You don't go out and buy something else right away. From an integration standpoint, you have to really hunker down and concentrate on this acquisition." Doll says that integrating the two companies will be his next focus, and Merrill Lynch and Blackrock have formed a committee to help the two businesses merge more seamlessly. "Over the last two weeks, the focus has just been on getting the deal done," said Doll. "So next order of business is to come up with a transition plan to look at how we look at putting the businesses together."
Merrill will report a $1.1 billion gain on the transaction, reflecting the high valuation afforded BlackRock stock relative to its own. BlackRock's shares closed at $145.96 Tuesday, up from $119.35 on Jan. 19, the day before a story broke that
was interested in a merger. Those talks broke down two weeks ago over price, setting the stage for Wednesday's announcement.
Doll noted in the interview that Merrill's interest in BlackRock had nothing to do with Morgan Stanley's interest and failure to close a deal. "These conversations with BlackRock have only been going on for a couple of weeks," he said, "The good news is, neither of these organizations was or is in any sort of trouble. Both are growing nicely but recognize that strategically they could grow better and faster if they were together."
The closing price of BlackRock's shares Tuesday reflected a multiple of 29 times this year's expected earnings of $4.87 a share, one of the highest P/Es afforded any U.S. asset manager, in part reflecting optimism the Merrill deal would get done.
The stock tacked on another 9% to $158.75 Wednesday -- the fourth time in a month that the shares have rallied. The stock gained about 7% following its fourth-quarter earnings report; jumped again when the Morgan Stanley talks were leaked; then vaulted anew after Merrill's interest was reported. All told, the stock is up 40% over the last 20 trading days.
The run-up has pleased arbitrage investors, some of whom say BlackRock has more room to climb. "The deal gives the company a more balanced portfolio mix and allows them to book in a capital gain," said one arbitrage investor, "It's a great deal."
This investor believes that Wednesday's run-up is justified because Merrill is a much better partner than Morgan Stanley. "The Morgan Stanley deal was smaller and a different type of deal culturally. Size-wise and benefits-wise, this deal is far better."
Merrill shares closed at $75.16 Tuesday, just 12.8 times this year's expected earnings. PNC -- which expects to record a $1.6 billion gain on the deal -- ended at $66.97. In early trading Wednesday, Merrill added 28 cents to $75.44 and PNC jumped $1.93 to $68.90.
"Merrill Lynch Investment Management and BlackRock are highly complementary, in terms of both expertise and culture," Fink said in a release. "Together, we will benefit from a singular focus on investment and risk management, as well as a deep pool of talented professionals who share a commitment to teamwork, excellence and integrity. We will also benefit from an ongoing strategic partnership with Merrill Lynch as we work together to serve our shared clients. Lastly, we will move quickly to establish a robust operating platform that leverages our BlackRock Solutions capabilities and ensures a seamless transition for BlackRock and MLIM clients."
Merrill's investment arm has a strong presence with retail investors while BlackRock specializes in institutional bond-fund management. At present, Merrill runs 154 mutual funds, including 108 open- and closed-end funds in the U.S. BlackRock runs more than 100 funds, mostly in fixed-income.
Merrill also sees its marketing enhanced by the separation of asset management from its brokerage. "Merrill Lynch can highlight the fact that they have removed any type of conflict of interest," said Valentine, "Once that is done, they can go into product discussion with clients, and the products become easier to sell."
But Merill Lynch's Doll said that conflict of interest concerns had "zero" to do with this acquisition. "We felt great about that part of the business," he said, "If we had any concerns, we probably wouldn't have entered into this type of acquisition; we would have sold MLIM."
Meanwhile, Doll also noted that MLIM recently rebranded its retail asset management business by renaming it "Princeton Portfolio Research & Management." The new brand was meant to help give its brokers more independence when selling products to clients, and this transaction just expands on that strategy, Doll said.
On a combined basis, Merrill/BlackRock will manage $286 billion in equity/balanced assets; $415 billion in fixed income; $208 billion in liquidity products, like money-market accounts; $38 billion in alternative assets and real estate investments; and $44 billion in retail separately managed accounts.
The transaction, which has been approved by directors of both companies, is expected to close in the third quarter of 2006. Under the terms of the agreement, Merrill agreed to certain restrictions on the sale or acquisition of shares in the new BlackRock, but will have the right to maintain its ownership percentage in the event of BlackRock's issuance of additional shares in the future.
After the deal closes, Merrill will account for its investment management division using the equity method of accounting, a standard that is applied to subsidiaries that a company doesn't control. Under the equity method, BlackRock's earnings will be shown as a component of net revenue. Previously, the results had been fully consolidated into Merrill's financial statements.
In 2007, Merrill Lynch expects the transaction to be slightly dilutive to its earnings and earnings per share. In 2008, Merrill expects the transaction to be neutral to its earnings and earnings per share, "assuming no redeployment of equity capital freed up by the transaction, and accretive assuming redeployment of capital."