BlackRock Should Benefit From Industry Consolidation

An estimation from PwC’s ‘2023 Global Asset and Wealth Management Survey‘ is that 1 in 6 asset and wealth management companies globally are likely to disappear or be acquired by 2027; this is twice the normal turnover rate. In my opinion, Blackrock (BLK) will benefit from this industry consolidation.

The survey of 250 asset managers and 250 institutional investors paints the picture of an industry grappling with a set of challenges:

• digital transformation;
• shifting investor expectations; and
• consolidation.

As a result, 73% of asset managers are considering a strategic consolidation with another asset manager in the coming months to:

• gain access to new segments;
• build market share; and
• mitigate risks.

Firms are also turning to technology to transform; more than 90% of asset managers already use disruptive technological tools (including big data, AI and blockchain) to enhance investment performance.

At its core, BLK is a passive investment asset manager. This should continue to enable it to minimize many of the secular headwinds facing traditional asset managers.

Business Overview

BLK was founded in 1988 and is a leading publicly traded investment management firm.

BLK held its 2023 Investor Day on June 14, 2023. The investor presentation provides a good overview of the company.

While the current ~$9.425T of assets under management (‘AUM’) at the end of Q2 2023 falls shy of the $9.75T record high in Q4 2021, there is no denying that BLK’s growth over the past decade is impressive.

BLK sources ~66% of its managed assets (and close to half of its revenue) from passive products (its iShares exchange-traded fund platform and institutional index fund offerings).

It is well-positioned to navigate in an environment where retail-advised and institutional clients seek out:

• providers of passive products;
• active asset managers with greater scale;
• established brands;
• solid long-term performance; and
• reasonable fees.

With its established leadership positions in high-growth areas such as ETFs, private markets, outsourced solutions and technology, BLK should be able to continue to drive top- and bottom-line growth.

A comprehensive overview of BLK is provided in Part 1 Item 1 in BLK’s FY2022 Form 10-K.

BLK and Cryptocurrencies

On June 15, BLK filed for a bitcoin exchange-traded fund with the Securities and Exchange Commission.

In a wide-ranging July 5 interview, BLK CEO Larry Fink states that bitcoin, tokenizing assets and securities, could ‘revolutionize’ finance. However, the SEC informed the Nasdaq and CBOE Global Markets exchanges that the recent wave of bitcoin ETF applications has not been sufficiently clear or comprehensive.

CEO and NEO Compensation

Investors would be wise to review the Compensation Discussion and Analysis component within BLK’s annual proxy statement; this commences on page 67.

The structure of BLK’s compensation program and individual pay decisions should support the company’s long-term business strategy that is designed to ultimately create value for shareholders and other key stakeholders, including the firm’s employees, customers, consumers and the communities in which the company operates.

I am particularly interested in the percentage weighting of each compensation element that comprises the target Total Direct Compensation (TDC) of a company’s CEO and the Named Executive Officers (NEO). If the long-term incentive component makes up a large percentage of the TDC, I envision that a company’s CEO and the NEOs will make decisions that are closely aligned with the interests of long-term shareholders.

The Compensation Discussion and Analysis component within BLK’s 2023 Proxy Statement is several pages in length. However, the following illustrates that a significant percentage of the total annual compensation for BLK’s NEOs is variable and based on performance.

Blackrock’s Financial Results

Q2 and YTD2023

On June 14, BLK released its Q2 and YTD2023 results. Details are provided in the earnings release and earnings supplement.

In Q2, it generated total net inflows of $80B, representing 4% annualized organic asset growth and 2% annualized organic base fee growth.

The Q2 revenue of $4.5B was 1% lower YoY, primarily driven by the impact of market movements over the last 12 months on the average AUM mix.

Total expense was modestly lower YoY. Lower incentive compensation and distribution and servicing costs were partially offset by higher direct fund expenses. Employee compensation and benefits expenses were flat YoY, primarily reflecting lower incentive compensation due to lower operating income, offset by higher base compensation.

Operating income of $1.7B was down 3% YoY, while EPS of $9.28 was up 26%, reflecting meaningfully higher non-operating income compared to Q2 2022. Non-operating results for the quarter included $0.158B of net investment gains, driven primarily by non-cash mark-to-market gains in the value of BLK’s private-equity co-investment portfolio.

BLK’s adjusted operating margin of 42.5% was down 120 bps from Q2 2022, reflecting the negative impact of market movements on quarterly revenue.

The adjusted tax rate in Q2 was ~25% and projections are for a similar tax rate for the remainder of 2023. The actual effective tax rate, however, may differ because of non-recurring or discrete items or potential changes in tax legislation.

Capital Allocation

BLK’s capital management strategy remains first to invest in the business and then to return excess cash to shareholders through a combination of dividends and share repurchases.

BLK continues to invest through prudent use of its balance sheet to best position the firm for sustained success, primarily through seed and co-investments to support organic growth. At times, it may make inorganic investments where it identifies an opportunity to accelerate growth and support the firm’s strategic initiatives.

Consistent with this inorganic strategy, BLK announced a definitive agreement on June 8 under which it will acquire full control of Kreos Capital; Kreos is a leading provider of growth and venture debt financing to companies in the technology and healthcare industries.

A Q3 2023 close is forecast which will add venture debt capabilities and further bolster BLK’s Global Credit franchise. Through BLK’s technology partnership with Avaloq, BLK aims to link Aladdin Wealth and Avaloq’s core banking system, which will ultimately scale both businesses and better serve joint clients. On June 14, 2023, Avaloq a subsidiary of NEC Corporation, and BLK, through its Aladdin Wealth business, announced that it had formed a strategic partnership aimed at enhancing BLK’s investment technology solutions for wealth managers and private banks. As part of the strategic partnership, BLK made a minority investment in Avaloq.

FY2023 Guidance

BLK does not issue guidance.

Credit Ratings

In May, BLK capitalized on the improved conditions for debt issuance and issued $1.25B of 10-year debt at a coupon of 4.75%.

The current plan is to invest the proceeds of the offering at substantially the same rate as the cost of borrowing. This will effectively eliminate the incremental cost of carrying additional debt in 2023.

In June 2018, Moody’s upgraded BLK’s domestic senior unsecured credit rating to Aa3 from A1. This Aa3 rating, affirmed in October 2022, has been in effect since this upgrade and Moody’s assigns a stable outlook.

In May 2014, S&P Global upgraded BLK’s domestic senior unsecured credit rating to AA- from A+. This AA- rating, affirmed in June 2023, has been in effect since this upgrade and S&P Global assigns a stable outlook.

Both ratings are at the bottom tier in the high-grade investment-grade category. These ratings define BLK as having a very strong capacity to meet its financial commitments. The ratings differ from the highest-rated obligors only to a small degree.

These investment-grade ratings are acceptable for my purposes.

Dividend Metrics

BLK declared its first dividend on August 18, 2003 (see dividend history).

The compound annual growth rate of BLK’s dividend over 2003 – Q1 2023 is ~17%. The majority of BLK’s total long-term investment return, however, should continue to be predominantly in the form of capital gains.

The following reflects BLK’s historical returns starting from the declaration date of BLK’s first quarterly dividend (August 18, 2003) to mid-July 2023.

On January 25, BLK announced that its Board had approved a 2.5% increase in the quarterly cash dividend from $4.88/share to $5.00/share. This is the 14th straight increase, making the stock a Dividend Contender. Assuming the next 2 quarterly dividend payments remain at $5, the current dividend yield is ~2.7% based on the current ~$728 share price.

If we conservatively estimate that BLK will increase its quarterly dividend by 3% from $5 to $5.15 in January 2024, the next 4 dividend payments will total $20.30. Using the same ~$728 share price as noted above, the forward dividend yield is ~2.8%.

Share Repurchases

BLK has significantly reduced its diluted weighted average common shares outstanding since 2013.

During FY2022, BLK repurchased 2.7 million common shares under its existing share repurchase program for ~$1.9B. On December 31, 2022, there were ~0.9 million shares still authorized to be repurchased under the program. In January 2023, BLK announced that its Board authorized the repurchase of an additional 7 million shares under the Company’s existing share repurchase program for a total of up to ~7.9 million shares of BLK common stock.

On a combined basis, BLK has returned ~32% more to shareholders through dividends and share repurchases in FY2022 versus FY2021.

In Q2 2023, BLK repurchased $0.375B worth of common shares. Based on the current capital spending plans for the year and subject to market conditions, BLK anticipates repurchasing at least $0.375B of shares per quarter for the balance of the year for a total of ~$1.5B. This is consistent with BLK’s January guidance

BlackRock’s Valuation

In the first half of FY2023, BLK generated $16.70 and $17.21 in diluted EPS and adjusted diluted EPS, respectively.

BLK’s forward valuation based on currently available adjusted earnings estimates and the current ~$728 share price is:

• FY2023 – 15 brokers – mean of $35.21 and low/high of $34.10 – $36.47. Using the mean estimate, the forward adjusted diluted PE is ~20.7.
• FY2024 – 15 brokers – mean of $40.49 and low/high of $37.30 – $45.19. Using the mean estimate, the forward adjusted diluted PE is ~17.8.
• FY2025 – 8 brokers – mean of $45.97 and low/high of $41.36 – $49.06. Using the mean estimate, the forward adjusted diluted PE is ~15.3.

It is conceivable that BLK will be able to double its YTD diluted EPS. If we use $33.40 as BLK’s FY2023 diluted EPS and the current ~$728 share price, the forward diluted PE for FY2023 is ~21.8. In comparison, BLK’s FY2013 – FY2022 PE levels based on diluted EPS are 19.93, 18.57, 17.58, 20.08, 24.16, 11.30, 19.47, 24.07, 24.45, and 19.60.

BlackRock Should Benefit From Industry Consolidation – Final Thoughts

Although PwC’s recent survey suggests 1 in 6 asset and wealth management companies globally are likely to disappear or be acquired by 2027, I am confident BLK will benefit from this industry consolidation.

In my March 9, 2023 post at Financial Freedom Is A Journey, I disclose a new position in BLK. I subsequently disclose the purchase of additional shares in this May 12 post in conjunction with the purchase of additional Blackstone Inc. (BX) shares.

My last purchase was at ~$635.35 on May 9. However, BLK’s share price has surged to ~$728 at the time I compose this post. The ~$93 share price appreciation has reduced the attractiveness of BLK’s shares. I now deem BLK to be fairly valued versus undervalued.

I intend to periodically acquire additional BLK shares. However, I will selectively add shares when BLK’s valuation retraces to the level at which I recently added to my exposure. I am looking for an FY2023 forward adjusted diluted PE level below 19 (19 x $35.21 = ~$670 share price).

Author Disclosure: I am long BLK and BX. I disclose holdings held in the FFJ Portfolio and the dividend income generated from the holdings within this portfolio. I do not disclose details of holdings held in various tax-advantaged accounts for confidentiality reasons.

Author Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.

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