Financial Giant Flexes Its Muscles

08/17/2010 1:00 pm EST

Focus: STOCKS

Paul Larson

Editor, Morningstar StockInvestor

Paul Larson, editor of Morningstar StockInvestor, and analyst Greggory Warren say the world’s largest asset manager has a strategy that should be profitable for some time.

With more than $3 trillion in assets under management, BlackRock (NYSE: BLK) is the largest asset manager in the world. A diverse product portfolio and the ability to offer both active and passive asset-management strategies give the firm a huge leg up.

BlackRock provides asset-management services primarily for institutional investors, which account for 75% of the firm’s assets under management. [Its assets are] invested in equity (44% of total AUM), fixed-income (34%), and money-market (9%) funds, with the remainder in multi-asset-class, alternative-investment, and long-term portfolio liquidation strategies. Passive equity and fixed-income funds account for half of managed assets.

Before 2006, BlackRock was one of the premier names in institutional fixed-income investing. While the firm had made efforts to expand its equity operations, it still had more than 70% of its assets under management (AUM) tied to fixed-income products.

All that changed, however, when BlackRock purchased Merrill Lynch Investment Managers. This purchase more than doubled BlackRock’s AUM and greatly expanded the firm’s exposure to equity strategies, leaving its managed assets more evenly split across equity, fixed-income, and cash management.

With more than 70% of its AUM sourced from institutional clients, BlackRock had also secured a far stickier set of investors than could be found on the retail side of the business. These two attributes played a big part in the firm’s ability to not only hold on to assets during the bear market, but also attract investor inflows when they started to flood into fixed-income products during 2009.

BlackRock’s purchase of Barclays Global Investors from Barclays (NYSE: BCS) last year, which also more than doubled the firm’s AUM, did little to alter this successful business model.

The biggest change from the deal has been that BlackRock now has half of its AUM derived from passive investment strategies. This effectively makes the firm agnostic to shifts among asset classes and investment strategies, limiting the impact that market swings can have.

We recently lowered our fair value estimate to $220 per share to adjust for the impact that the market decline during the second quarter will have on the firm’s AUM, revenue, and profitability. With close to half of its AUM tied up in equity strategies, BlackRock was hit a bit harder by the drop in the equity markets than we had been expecting. The company also reported $34 billion in merger-related outflows.

Given the ongoing weakness in the equity markets and the likelihood that merger-related outflows will continue into the third quarter, we now expect BlackRock’s revenue to increase by less than 75% this year. We continue to believe that the firm will be able to generate around 8% annual revenue growth longer term. We believe that the expense benefits that will accrue to BlackRock from the increased size and scale of its operations will allow it to generate operating margins in excess of 35%.

(The stock closed below $151 Monday—Editor.)

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