Blackrock Inc.


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Blackrock Inc.

  1. 1. Sector: Financials Industry: Asset Management Archway Investment Fund  Blackrock Inc. Analyst: Brian Griffin (139) Ticker: BLK Recommendation: BUY Date: April 20, 2008 Current Price: $194.57 Target Price: $225.00 Highlights • Outperformed competitors, XLF, and S&P 500 in 2007 • Recorded substantial revenue growth and net income growth in 2007, 130.92% and 208.51% respectively • $1.357 trillion assets under management, 21% increase from year prior • Increased international diversification: International revenues consisted of 36.6% of total revenues in 2007, up from 18.3% in 2006 Market Profile 52 Week Price Range 139.20 – 231.99 Average Daily Volume (3m) 670,993 Beta 1.34 Dividend Yield 1.53 Shares Outstanding (millions) 117.28 Market Cap (millions) 23,966.17 Trailing P/E 24.01 Forward P/E 23.09 Institutional Holdings 71.50% Insider Holdings 40.03% Book Value per Share (mrq) 89.45 Debt to Equity 10.80 Return on Equity (%) 8.58 Return on Assets (%) 4.78 Sources: Thomson One, Yahoo Finance Bryant University 1150 Douglas Pike Smithfield, RI 02917
  2. 2. Archway Investment Fund 4/30/2010 Investment Summary During 2007, Blackrock (BLK) positioned itself as a best-in-breed firm among asset managers. BLK avoided substantial write-downs related to subprime mortgages that have been incurred by many major financial institutions. This has allowed the firm to maintain a strong balance sheet without the need to raise substantial capital. Additionally, strong revenue growth driven by administrative, advisory, and performance fees associated with increases in assets under management (AUM) are likely to continue in 2008. BLK’s strong performance in 2007 indicates that the firm can continue to grow despite volatility in the financial sector and the weakening U.S. economy. BLK’s excellent track record, position among competitors, and prospects for future growth make it an appealing investment for the AIF financial sector. Business Description Blackrock Inc. (BLK) is one of the largest investment management firms in the U.S. with 1.357 trillion assets under management (AUM) as of December 31, 2007. Blackrock manages assets for institutional investors and high wealth individuals through an assortment of fixed income, equity, money market/liquidity, and alternative asset accounts and funds. Additionally, BLK also provides risk management and financial advisory services to institutional clients. In 2007, fixed income funds accounted for 39% of total AUM, equity funds accounted for 34% of AUM, money market/liquidity accounts accounted for 23% of AUM, and alternative asset funds accounted for 4% of AUM. BLK is globally diversified with 70 offices in 19 countries throughout the U.S., Europe, Asia, and Australia. The firm was founded in 1988 and is headquartered in New York City. BLK is currently lead by CEO Laurence D. Fink, co-founder of the firm who has helped guide BLK to superior performance and year-over-year increases in AUM since the company’s inception. Merrill Lynch currently owns 49% of BLK’s capital stock, and PNC Bancorp owns 33.5% of the company’s capital stock. Sector & Industry Overview The financial sector has continued suffering poor performance in the first quarter of 2008 due to the effects of the subprime mortgage crisis, tightening credit markets, and falling equity markets. The Fed has tried to ease problems in the financial markets by steadily decreasing the federal funds rate which now stands at 2.25%. Asset managers have also been affected by exposure to subprime-backed assets and overall market volatility. Many asset managers have been forced to write down assets related to asset-backed commercial paper, structured investment vehicles, collateralized debt obligations, and mortgage-backed securities. Additionally, falling equity markets have made it difficult for managers to generate performance fees. Mutual funds have been a bright spot in the subsector as assets under management (AUM) increased significantly in 2007. Fund inflows are expected to increase again in 2008, although at a slightly slower rate compared to 2007. Asset managers are also expected to see increased demand for internationally focused funds and higher AUM from international investors.1 Drivers The primary drivers for BLK are increased assets under management from international clients, higher fund inflows from an aging population, and overall market conditions. Market leading asset managers are likely to see an increase in assets under management from international clients in 2008. Both developed and developing countries are demanding financial services as their 1 Standard & Poors Net Advantage 2
  3. 3. economies grow, and they will likely seek these services from leading firms in the investment management industry. Additional international clients (both institutional and high net worth clients) will drive revenues in BLK’s asset management unit due to fees associated with AUM, and international demand for financial advisory will also increase BLK’s revenues. Higher fund inflows from the aging U.S. population will also increase BLK’s profitability. As Baby boomers near retirement in the U.S., they will increase fund inflows to continue saving for retirement and make up for lost income. Increased fund inflows will drive BLK’s fee based income streams. Additionally, the aging population will seek investment advisory services to ensure their retirement plans are sound. Finally, market conditions have a considerable effect in determining the profitability of asset managers. Market volatility and falling equity markets make it difficult for asset managers to attract new fund inflows and meet performance fees. Although market volatility may continue within next quarter, a rebound in the 2nd half of 2008 will likely improve the performance of asset managers. Company Positives Unlike the majority of companies in the financial industry, BLK recorded strong performance in 2007 despite difficult economic conditions. Assets under management (AUM) increased $232.02 Billion, or 20.63%. This increase drove higher administrative and advisory fee income, which led to revenue growth of 130.92%. Additionally, 36.6% of 2007 revenues were derived from international clients, which is a 100% increase compared to 2006. BLK’s growth in international revenues is a major driver for the company’s future performance. Another positive is that BLK avoided substantial write-downs in assets that have plagued many asset managers and investment banks in the financial industry, weakening their balance sheets considerably. Not only has BLK’s balance sheet remained strong by avoiding write-downs, superior risk management has also increased BLK’s brand. Investors are more willing to increase fund inflows in BLK since there is less fear that BLK will incur subprime write-downs. Lastly, BLK’s fixed income, equity, and money market funds performed strongly relative to competitors in 2007. 58% of BLK’s bond fund assets, and 84% of BLK’s equity fund assets are in the top half of their peer groups. Additionally, 87% of BLK’s money market funds performed above their benchmarks. Strong fund results will attract additional AUM and increase performance fees.2 Competitor Comparison Key: BLK STT LM UBS (Note: UBS is not displayed due to a significant price depreciation that skews graph) 2 Blackstone Inc.’s Company Filings: 10K
  4. 4. BLK’s competitors include State Street Corp. (STT), Legg Mason (LM) and UBS AG (UBS). These competitors were chosen based on product overlap, market cap, and historical Price-to-earnings (among other comparison data). During 2007, BLK outperformed all of its competitors, the XLF, and the S&P 500. BLK recorded the strongest performance as the firm acquired a substantial increase in AUM, which generated substantial administration, servicing, and performance fees. Additionally, BLK beat earnings estimates in all quarters during 2007. STT recorded the closest performance to BLK, however poor performance from fixed income funds, along with a difficult transition from acquiring the firm Investors Financial hurt the company’s growth. LM substantially underperformed BLK, primarily caused by a decrease in assets under management, which are the primary revenue drivers at an asset management firm. Additionally, exposure to the struggling asset backed commercial paper market may require the firm to write-down a proportion of its assets. UBS has suffered the worst performance compared to BLK due to $34.7 billion in write-downs related to subprime-backed assets.3 However, the analysis between BLK and UBS is somewhat skewed since UBS is substantially larger than BLK and offers a wider variety of services. Comparison Data (FY 2007) BLK UBS LM STT Market Cap (millions) 23,966.17 67,650.00 7,788.72 26,752.53 Revenue Growth 130.92% 11.50% 64.21% 24.07% Net Income Growth 208.51% -12.26% -43.47% 14.01% Net Profit Margin 20.54% -3.12% 14.89% 10.67% ROA 4.78% -0.25% 7.33% 1.13% ROE 8.89% -10.20% 10.44% 13.59% P/E (TTM) 24.01 -20.40 12.19 17.40 (Sources: Thomson One, Yahoo Finance) By analyzing the above ratios in more detail, BLK has the highest revenue growth, net income growth, and net profit margin relative to competitors. Additionally, BLK’s ROA and ROE are on par with competitors. BLK’s trailing P/E multiple is higher than its competitors due to high expected earnings in 2008 and 2009. BLK’s Past performance and future prospects place the firm in the strongest position relative to its competitors. Investment Risks The most significant risk to BLK’s performance is severely deteriorating market conditions. If the economy and financial markets weaken considerably, BLK would have difficulty meeting hurdle rates and earning performance fees. Additionally, severely deteriorated market conditions may discourage investors from investing and BLK could incur an outflow in assets under management. In general, asset managers do not perform as well in bear markets compared to bull markets. As an asset management company, BLK is subject to extensive regulation in the U.S. and around the world. Violation of applicable laws or regulations could result in fines, temporary or permanent prohibition of the engagement in certain activities, reputational harm, suspensions of personnel or revocation of their licenses, suspension or termination of investment adviser or broker-dealer registrations, or other sanctions, which could cause the company’s earnings or stock price to decline. Finally, liquidity is a risk to BLK’s business. Sufficient funds are required for asset management firms to make daily investments and to complete large deals, and an inability to raise these funds would significantly decrease performance. Additionally, an inability to sell assets at fair market value (due to decreased demand) if funds are needed to meet obligations could pose a potential problem. 3 ValueLine
  5. 5. Financial Analysis Financial Analysis 2007 2006 2005 2004 4,844,65 2,097,97 1,191,38 Revenue (thousands) 5 6 6 725,311 Revenue Growth 130.92% 76.10% 64.26% 21.15% Net Income (thousands) 995,272 322,602 233,908 141,141 Net Income Growth 208.51% 37.92% 65.73% -9.18% Net Margin 20.54% 15.38% 19.63% 19.74% ROE 8.89% 5.51% 27.67% 19.32% ROA 4.78% 2.95% 15.97% 13.60% (Sources: Blackrock Inc.’s Company Filings: 10K, Thomson One) Over the past four years, BLK has recorded strong revenue growth and net income growth. Gains in revenue are attributable to constant increases in assets under management (AUM). BLK derives a substantial portion of its revenue from investment advisory and administration fees, which are primarily based on pre-determined percentages of the market value of AUM, or percentages of committed capital during investment periods. In 2007, BLK experienced a 21% increase in total AUM which is primarily responsible for the 130.92% increase in revenue growth. Net income growth was also at a record level in 2007 of 208.51%. Net income growth was strong because expenses in 2007 were minimized, showing that BLK is benefiting from economies of scale as AUM have increased. 2007 ROE and ROA also increased modestly compared to 2006, indicating that BLK is using its resources efficiently. Additionally, BLK’s balance sheet appears strong, especially compared to other firms in the financial sector that have recorded billions of dollars in write-downs that have required substantial cash infusions. Using manual calculations, I determined BLK’s current ratio to be 2.66. A current ratio above 2.00 shows BLK is in strong financial condition and that the firm has the ability to pay off short term obligations. BLK should have little trouble in financing operations during 2008. Earnings History 7-Jun 7-Sep 7-Dec 8-Mar EPS Estimate 1.68 1.91 2.15 2.00 EPS Actual 1.8 2.29 2.52 1.9 Difference 0.12 0.38 0.37 -0.1 Surprise % 7.10% 19.90% 17.20% -5.00% Source: Yahoo Finance In 2007, BLK beat earnings estimates in the 2nd, 3rd, and 4th quarters due to stronger than expected revenue growth generated from fees associated with increased AUM. In the 1 st quarter of 2008 Blackrock reported higher profit from continued increases in AUM, however earnings fell short of analyst’s estimates due to significant market turmoil. BLK’s stock price dropped after missing estimates, but has rebounded since in response to expectations of higher earnings for 2008 and 2009.
  6. 6. Valuation Using a beta of 1.34 (Thomson One), a risk free rate of 1.295% (3-Month T-bill Yield, WSJ), a market risk premium of 7.00%, a dividend yield of 1.53%, and a $194.57 price as of market close on April 22, 2008, a zero alpha price of $212.36 is assigned to BLK. Three methods were used to valuate BLK: a historical price-to-book valuation, a historical price-to-earnings valuation, and a forward price to earnings valuation. The results of these valuations are discussed below. Using a historical price-to-book valuation model, BLK yields an estimated price target of $239.73. This price target was determined by using a 3 year industry composite average price-to-book ratio of 2.68, multiplied by BLK’s book value per share of $89.45 (Thomson One). The 3 year industry composite price- to-book ratio was determined by averaging the price-to-book values of BLK and its competitors over the past three years. The $239.73 price target represents 12.88% positive alpha. Using a historical price-to-earnings valuation model, BLK yields an estimated price target of $218.77. This price target was determined by using a 3 year industry composite average price-to-earnings ratio of 24.72, multiplied BLK’s 2008 estimated earnings per share of $8.85. The 3 year industry composite price-to- earnings ratio was determined by averaging the high/low price-to-book values of BLK and its competitors over the past three years. The $218.77 price target represents 3.02% positive alpha. Using a forward price-to-earnings model, BLK yields an estimated price target of 243.37. This price target was determined by using BLK’s forward price-to-earnings multiple of $23.09, multiplied by BLK’s 2009 estimated earnings per share of $10.54. The $243.37 price target represents 14.60% positive alpha. With a zero alpha price of $212.36, BLK is given a $225.00 one year price target. This price target was determined by weighting the historical price-to-book valuation 25%, the historical price-to-earnings valuation 50%, and the forward price-to-earnings valuation 25%. The historical price-to-earnings valuation was weighted higher because it more realistically valuates BLK’s potential in 2008. Additionally, I scaled down my weighted price target to reflect volatility in the financial sector that may adversely affect BLK’s price. BLK’s $225.00 price target represents 5.95% positive alpha. Recommendation and Sell Discipline With a $225.00 one year price target representing 5.95% positive alpha, Blackrock Inc. is given a buy recommendation for the Archway Investment Fund. Blackrock is the strongest positioned firm in the investment management industry, and strong revenue growth and net income growth is expected to continue in 2008. BLK will likely experience increased fund inflow and assets under management due to high international demand for financial services and an aging population searching for retirement services in the U.S. If BLK’s price reaches its $225.00 price target, this would represent a 16% price appreciation and the stock should be re-evaluated to examine if future growth will continue or if the stock should be sold. Contrastingly, if BLK’s stock price falls to $155.66, this would represent a 20% price depreciation and the stock should be re-evaluated to see if the loss should be realized. Valuation Models
  7. 7. Historical Price-to-Book Valuation Historical Price-to-Earnings Valuation Forward Price-to-Earnings Valuation BlackRock, Inc. Consolidated Statements of Financial Condition (Dollar amounts in thousands, except per share data)
  8. 8. December 31, 2007 2006 Assets Cash and cash equivalents $ $ 1,656,200 1,160,304 Accounts receivable 1,235,940 964,366 Due from related parties 174,853 113,184 Investments 1,999,944 2,097,574 Separate account assets 4,669,874 4,299,879 Deferred mutual fund sales commissions 174,849 177,242 Property and equipment, net 266,460 214,784 Intangible assets, net 6,553,122 5,882,430 Goodwill 5,519,714 5,257,017 Other assets 310,559 302,712 Total assets $ 22,561,51 $ 20,469,49 5 2 Liabilities Accrued compensation and benefits $ $ 1,086,590 1,051,273 Accounts payable and accrued liabilities 788,968 753,839 Due to related parties 114,347 243,836 Short-term borrowings 300,000 — Long-term borrowings 947,021 253,167 Separate account liabilities 4,669,874 4,299,879 Deferred tax liabilities 2,059,980 1,738,670 Other liabilities 419,570 237,856 Total liabilities 10,386,35 0 8,578,520 Non-controlling interest 578,210 1,109,092 Commitments and Contingencies (Note 11) Stockholders’ equity Common stock ($0.01 par value, 500,000,000 shares authorized, 118,573,367 and 117,381,582 shares issued and 116,059,560 and 116,408,897 shares outstanding at December 31, 2007 and 2006, respectively) 1,186 1,174 Series A participating preferred stock ($0.01 par value, 500,000,000 shares authorized and 12,604,918 shares issued and outstanding at December 31, 2007 and 2006) 126 126 Additional paid-in capital 10,274,09 6 9,799,447 Retained earnings 1,622,041 993,821 Accumulated other comprehensive income, net 71,020 44,666 Escrow shares, common, at cost (1,191,785 and 0 shares held at December 31, 2007 and 2006, respectively) (187,500 ) — Treasury stock, common, at cost (1,322,022 and 972,685 shares held at December 31, 2007 and 2006, respectively) (184,014 ) (57,354 ) Total stockholders’ equity 11,596,95 10,781,88 5 0 Total liabilities, non-controlling interest and stockholders’ equity $ 22,561,51 $ 20,469,49 5 2
  9. 9. BlackRock, Inc. Consolidated Statements of Income (Dollar amounts in thousands, except per share data) Year ended December 31, 2007 2006 2005 Revenue Investment advisory and administration base fees Related parties $ $ $ 2,640,275 864,998 344,943 Other 1,369,786 733,743 505,435 Investment advisory performance fees 350,188 242,282 167,994 Investment advisory and administration fees 4,360,249 1,841,023 1,018,372 Distribution fees 123,052 35,903 11,333 Other revenue Other 338,278 212,450 156,111 Related parties 23,076 8,600 5,570 Total revenue 4,844,655 2,097,976 1,191,386 Expenses Employee compensation and benefits 1,767,063 934,887 587,773 Portfolio administration and servicing costs Other 77,879 46,358 41,552 Related parties 469,741 126,173 23,059 Amortization of deferred sales commissions 108,091 29,940 9,346 General and administration Other 777,697 399,103 179,130 Related parties 92,670 17,750 2,480 Termination of closed-end fund administration and servicing arrangements 128,114 — — Fee sharing payment — 34,450 — Amortization of intangible assets 129,736 37,515 7,505 Total expenses 3,550,991 1,626,176 850,845 Operating income 1,293,664 471,800 340,541 Non-operating income (expense) Net gain on investments 504,001 36,930 24,226 Interest and dividend income 74,466 29,419 18,912 Interest expense (49,412 ) (9,916 ) (7,924 ) Total non-operating income 529,055 56,433 35,214 Income before income taxes and non-controlling interest 1,822,719 528,233 375,755 Income tax expense 463,832 189,463 138,558 Income before non-controlling interest 1,358,887 338,770 237,197 Non-controlling interest 363,615 16,168 3,289 Net income $ $ $ 995,272 322,602 233,908 Earnings per share Basic $ $ $ 7.75 4.00 3.64 Diluted $ $ $ 7.53 3.87 3.50
  10. 10. Dividends declared and paid per share $ $ $ 2.68 1.68 1.20 Weighted-average shares outstanding Basic 128,488,56 80,638,16 64,182,76 1 7 6 Diluted 132,088,81 83,358,39 66,875,14 0 4 9