BlackRock outlook good despite stock slip

BlackRock Inc.'s stock price has suffered this year following the firm's blockbuster acquisition of Barclays Global Investors last December, but some analysts and bankers say the deal should eventually prove a triumph for CEO Laurence D. Fink.

Mr. Fink is poised to “reset our understanding of how large a global (money management) business can be,” said Donald H. Putnam, San Francisco-based managing partner of investment bank Grail Partners.

For the moment, the market's assessment appears harsh.

At Friday's close of $145.40 a share, BlackRock's stock was down 37% from the start of the year, while the Standard & Poor's 500 index slipped a mere 3.9%.

Meanwhile, the price-earnings premium BlackRock's stock consistently enjoyed — as a series of acquisitions morphed the fixed-income giant into a $3 trillion manager with strengths in exchange-traded funds, equities, alternatives and indexing as well — has evaporated.

BlackRock's price-earnings premium of more than 20% over the sector's average has given way to a 3% to 5% discount, noted one analyst at a money management firm whose portfolio managers own a healthy dollop of BlackRock stock. He declined to be named.

That BlackRock's stock reached an intraday high of $243.80 on Jan. 11 suggests investors were receptive early on to arguments Mr. Fink has made in successive earnings calls: Combining strengths in passive and active management, bonds, equities and alternatives, as well as risk controls and portfolio construction, leaves BlackRock uniquely positioned as investors increasingly seek out “partners” to help them meet their retirement savings and investment goals.

Efforts to reach Mr. Fink, who was on vacation, were unsuccessful.

BlackRock Vice Chairman Susan L. Wagner has quarterbacked the firm's acquisition strategy. In a recent interview, she said it's still “early days” for the BGI integration, but BlackRock can already point to some “significant mandates ... which neither of us would have won alone.”

In addition to the announcement in May of a $3.5 billion 529 savings plan mandate from the Columbus-based Ohio Tuition Trust Authority, Ms. Wagner cited a number of wins from clients at home and abroad; she wouldn't name the clients.

Those included a total of more than $11 billion; the biggest, $7.5 billion, was for fiduciary outsourcing from a Dutch company.

Some of those hirings are included in the close to $60 billion pipeline of net long-dated wins Mr. Fink reported for the company's latest results through June 30 — a total analysts cite as a healthy 8% clip of organic growth, or net client inflows, for the company.

For the first two post-acquisition quarters, however, outflows due to “concentration issues” — by clients looking to limit the proportion of their portfolios being handled by a single manager — and terminations due to weak results for some of BGI's active quantitative strategies helped depress sentiment toward the stock.

For the quarter ended June 30, net outflows from active quant strategies surged to $26.3 billion, from $8.8 billion for the prior quarter.

Amid a broad backlash against quant strategies since the first rumblings of the financial crisis erupted in the summer of 2007, BGI's legacy quant business has shrunk from a high of $300 billion in assets under management, to $175 billion when the firm was acquired by BlackRock, to roughly $100 billion today.

Concentration-related outflows, meanwhile, came to $7.6 billion in the second quarter. A BlackRock spokeswoman declined to provide a first-quarter figure for those outflows, but Mr. Fink, in a conference call with analysts about the company's second-quarter results, noted that the firm's latest pipeline total was factoring in $15 billion in concentration-related outflows from a single client for the third quarter.

All told, BlackRock came away with only a couple of billion dollars of net long-term inflows for the enlarged firm's first fiscal half.

The acquisition's strategic rationale remains sound, but the analyst community got ahead of itself in predicting how quickly the deal's benefits would flow through to investors, noted Jeffrey Hopson, an analyst covering publicly held money managers for Stifel Nicolaus & Co., New York.

Higher-than-expected client “churn” and quant outflows helped deflate that optimism, said Mr. Hopson, who nonetheless predicted the deal would inevitably turn out to be a “terrific transaction.”

In BlackRock's latest earnings conference call, Mr. Fink said those outflows — along with other integration-related hurdles — were well within the expectations of BlackRock executives.

However, industry veterans said other setbacks appear to have been more of a surprise. Among them, the departures of key executives such as Kristi Mitchem, who left as head of BlackRock's defined contribution business in March to take the same position with State Street Global Advisors, and the August decision of Curtis Arledge, the firm's chief investment officer for fundamental fixed-income strategies, to accept the CEO job at BNY Mellon Asset Management.

The loss of Ms. Mitchem, who had headed BGI's defined contribution business, in particular was a considerable setback, according to one institutional client of the firm who declined to be named.

BlackRock is never happy to lose valued colleagues, said Ms. Wagner, but the company's deep bench has allowed business segments such as 401(k) to continue building momentum this year. Chip Castille, a managing director in BlackRock's defined contribution group, replaced Ms. Mitchem. Mr. Arledge was replaced by his deputy CIO, Rick Rieder.

Some analysts say BlackRock boasts an array of strengths, but the company's management team will have to prove to the market that it can marshal those strengths effectively.

“The jury's still out,” said Robert Lee, an analyst with New York-based investment bank Keefe, Bruyette & Woods. It will take time to master this “big, global, diversified business,” and prove that it can grow “faster than its peer group,” he said.

BlackRock's stock shouldn't trade at a discount, but it could face a “tough road to regain a premium valuation,” Mr. Lee added.

With BlackRock managing $1.5 trillion more in client assets than its next biggest competitor, it's tough to measure BlackRock's growth against an industry average that includes far smaller firms. Instead, BlackRock will continue to focus on offering “value to our clients,” on the conviction that success there will leave clients wanting “to do more things with us,” Ms Wagner said.

Marc Irizarry, an analyst with Goldman Sachs & Co., New York, says he remains optimistic about BlackRock's prospects. The firm's ability to generate organic growth, and to grow profitability, will make or break the deal, but all signs point to growing momentum, he said.

Craig Siegenthaler, an analyst covering publicly held money managers for Credit Suisse, New York, said he believes BlackRock has ample room to regain its premium P/E ratio over the coming year, as the short-term factors driving recent outflows dissipate.

In terms of organic growth, the firm should experience the best rate of change in the industry over the coming two quarters, he predicted, calling BlackRock his top long-term pick. Few competitors are as well placed to ride secular trends such as growing demand from Asian investors or flows to ETF products, he said.

Meanwhile, with two quarters in a row of outflows, BlackRock, traditionally a growth stock, is garnering more interest from value investors, noted Mr. Siegenthaler.