BGI, with iShares, is looking attractive

Sale of full asset management unit could cancel out deal for ETF unit

042009 grossman
Transitioning: Blake Grossman said he has no concerns about the future of BGI without iShares.

BlackRock (BLK) Inc. (BLK), Fidelity Investments and Goldman Sachs & Co. are among the firms that could make a serious bid for all of BGI, market insiders say.

Such a bid could trump the deal parent Barclays PLC announced April 9 to sell BGI's crown jewel iShares exchange-traded funds division to a private equity investor.

Investment bankers, who declined to be named, said they have clients interested in buying both BGI's mature institutional business and its fast-growing, retail-oriented ETF business. They wouldn't name them.

Other industry sources, who likewise declined to be named, said BGI executives would favor that outcome, rather than seeing iShares ripped from the organization.

Bids would have to be made during the 45-business-day “go-shop” period for competing offers that started April 15, under the agreement Barclays reached April 9 to sell iShares to Luxembourg-based CVC Capital Partners Group for $4.4 billion.

Most bankers say CVC remains the odds-on favorite to win the fast-growing iShares business. One private equity veteran, who declined to be named, called the price CVC agreed to pay, at 10 times iShares' 2008 earnings, an extremely attractive “bird in hand” for Barclays that a buyer looking to take all of BGI would be hard-pressed to top.

Behind the scenes, however, industry veterans say some BGI executives, caught flat-footed by their capital-squeezed parent's speedy auction of iShares, have begun pressing Barclays to think through the implications of the CVC deal. Those executives argue that severing the operational and product development links between iShares and BGI could prove far messier than anticipated, leaving the value of both franchises well below that of the combined entity.

Before the market meltdown left banks scrambling to mend their balance sheets, BGI executives had been looking to more closely integrate stridently independent iShares into its operations. Market sources said BGI was looking to replace Lee Kranefuss, iShares' entrepreneurial chief investment officer, with an executive more amenable to a closer relationship.

Mr. Kranefuss did not respond to e-mails and telephone calls seeking comment.

On the day the CVC deal was announced, it was revealed that Mr. Kranefuss would become iShares' non-executive chairman, focusing more on strategy and less on day-to-day management, while Mike Latham and Rory Tobin would step in as co-CEOs of the business, said BGI spokesman Lance Berg.

Barclays' London-based spoke-sman, Alistair Smith, declined to comment when asked of talk of lingering concerns about the iShares deal.

Smooth transition

In a recent interview, BGI CEO Blake Grossman promised “a smooth and effective transition,” saying he doesn't have concerns about BGI's growth prospects: “We have the talent, the strategy and the resources to serve institutions so that they will not be directly impacted” by the sale of iShares, he said.

But observers say that officials at Barclays PLC, eager to raise capital in lieu of joining the list of battered banks seeking government support, haven't dwelt on the difficulties of separating iShares from BGI.

“Barclays doesn't care, but BGI has that concern,” said one New York-based investment banker with a client interested in “the whole thing,” who declined to be named.

The “go-shop” period is “a chance to relook at this before it closes,” and consider the “residual risks that happen when you take two businesses with a fair amount of integration and operational efficiencies ... and chop them apart with a meat cleaver,” said one industry veteran, who declined to be named.

With few details available about the iShares deal, investment consultants looking at different parts of BGI's business are reporting differing first impressions.

Michael Rosen, a principal with Santa Monica, Calif.-based Angeles Investment Advisors, said the iShares business was segregated well enough that he doesn't expect the sale to have “much of an impact on our relationships,” which focus on BGI's alpha strategies.

But Janice Fritz-Snyder, director of North American research with Watson Wyatt Worldwide in Stamford, Conn., said questions about what an iShares sale would mean for BGI's passive institutional strategies will be an added uncertainty at a time when institutional clients could be facing an unusual number of asset allocation adjustments and searches for replacement managers.

Institutional clients say the initial feedback they got from BGI officials about the ripple effects of a CVC iShares purchase was soothing.

The latest word coming from sources close to BGI, however, is more jangling. “It's a lot more difficult than they thought it was going to be,” said one executive recruiter, who declined to be named. “What's the firm going to look like? Who's going to stay? Who's going to leave? No one knows what the implications are yet.”

Another industry executive familiar with BGI, who declined to be named, said losing the lucrative, fast-growing ETF business would force BGI's management to make tough decisions on the institutional side of the business — decisions they've been able to avoid in recent years because of the flood of iShares earnings.

Coming at a time when BGI's tens of billions of dollars in hedge fund strategies — another pillar of the firm's revenue and compensation — have struggled, the loss of the iShares revenue, and the resulting adjustments that would have to be made to employee compensation and equity packages will make it harder to retain talent, some observers predict. A lot of people there “are looking for an exit,” according to another executive recruiter, who declined to be named.

However, unlike some investment bankers, who predict there will be few buyers capable of making an $8 billion to $10 billion purchase for all of BGI, the industry executive familiar with BGI said the logic of keeping the institutional and retail franchises together is compelling enough to make a broader deal likely.

The willingness of Barclays, which pledged $3.1 billion in loans for the $4.4 billion CVC bid, to provide similar backing for a BGI deal would certainly widen the pool of potential buyers.

If Barclays were willing to provide $5 billion or more in financing, a cash-rich firm such as Franklin Resources Inc. could be in the running, said one investment banker, who declined to be named.

Financial muscle

BlackRock (BLK), Goldman Sachs, Fidelity and the Capital Group Companies are among the handful of strategic buyers that would have the financial muscle to make a serious bid, but the latter two firms have shown little or no appetite for acquisitions. Other investment bankers say BNY Mellon Asset Management and Vanguard Group might also be kicking BGI's tires.

One executive with a private equity firm that has made past investments in money managers said his company would “poke around” to see if it could structure a deal. And others say sovereign wealth funds might yet be part of a bid for BGI.

Some investment bankers and investors in money management firms say it's not out of the question that CVC officials might be having second thoughts about completing the deal. While one investment banker, who declined to be named, said iShares' breakneck growth makes the price CVC agreed to a reasonable one, more felt it was way too rich. It's difficult to see how CVC is going to make money on the deal, predicted one investor in money management firms, who declined to be named.

Christina Stenson, a New York-based spokeswoman for CVC, called talk that CVC execs are having second thoughts about the iShares deal “100% false.”

Reporter Thao Hua contributed to this story.