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Dilantha De Silva
Dilantha De Silva
Articles (156)  | Author's Website |

BlackRock Continues to Expand

The asset manager will acquire Aperio

November 25, 2020 | About:

When companies expand, growth opportunities generally tend to diminish. There are, however, a certain group of companies that defy the odds and find new growth avenues despite the massive scale of their business operations. BlackRock, Inc. (NYSE:BLK) is certainly one such company.

Despite being the leading asset manager in the world, the company continues to invest in its future while rewarding shareholders handsomely through dividends and stock buybacks. On Nov. 23, BlackRock announced its decision to buy Aperio, a pioneer of customized index strategies. According to company filings, this deal will boost BlackRock's assets under management representing separately managed accounts to approximately $160 billion. This is one of the many decisions taken by the asset manager to secure long-term earnings growth, and shares are still trading in attractive valuation territory despite rising 37% since I last discussed the stock almost a year ago.

Aperio fits in well with the existing business

The asset manager has been fond of acquisitions since its inception three decades ago, and such investments have gone a long way in helping the company become the behemoth it is today. The below table comprises data of the most important acquisitions carried out by BlackRock in the recent past.

Acquired company

Year

Merrill Lynch Investment Management

2006

Barclay's Global Investors

2009

eFront

2019

CacheMatrix

2017

State Street Research and Management

2004

iShares

2009

FutureAdvisor

2015

Source: Company filings.

Aperio will soon be added to this list when BlackRock completes the transaction, and the company is set to pay $1.05 billion in cash to fund this deal. Aperio has an operating history spanning two decades and the company is considered a pioneer in building customized, tax-optimized index equity strategies in the United States. Commenting on the value that would be added by Aperio, head of BlackRock's U.S. wealth advisory business Martin Small said:

"The wealth manager's portfolio of the future will be powered by the twin engines of better after-tax performance and hyper-personalization. BlackRock and Aperio, working together, will bring unmatched capabilities to meet these objectives. The combination will bring institutional quality, personalized portfolios to ultra-high net worth advisors and will create one of the most compelling client opportunities in the investment management industry today."

BlackRock has an in-house separately managed accounts team already, but the company primarily focuses on bond and multiasset strategies at the moment. Aperio, however, mainly focuses on equity strategies, which would prove to be a nice addition to BlackRock's existing business. Because of the trust and the brand name built over the years by Aperio, BlackRock has decided to let Aperio function on a standalone business, which seems to be the right way forward in achieving the desired synergies.

A top pick for dividend growth investors

The success of BlackRock in the recent past has pushed the stock price to historic highs. With this, earnings multiples have expanded beyond historical means, so it would be natural for investors to be wary of this situation. However, there are a few reasons to believe that BlackRock will deliver attractive returns in the coming years.

First, the company enjoys competitive advantages over its peers, which will help it generate economic profits over a long period of time. Morningstar assigns the company a wide-moat rating, which is a confirmation of the strength of BlackRock's economic moat. Empirical evidence suggests that companies enjoying economic moats will outperform their peer groups in the long run. Research conducted by Srinidhi Kanuri of the University of Southern Mississippi and Robert Mcleod of the University of Alabama found proof of this. Commenting on their findings, they wrote:

"Using the Morningstar classification of 'Wide Moat' stocks, we construct annually rebalanced equal- and value-weighted portfolios to analyze their performance in order to determine if they deliver superior performance relative to standard benchmark portfolios. The period for our analysis extends from June 2002 through May 2014. We find that the 'Wide Moat' portfolios outperform both the S&P 500 and Russell 3000 indices generating higher average monthly and annualized returns, Sharpe Ratio, Sortino Ratio, Treynor Ratio, Omega Ratio, Upside Potential Ratio, M2, M2 Alpha, and cumulative returns. When we compute alpha using Carhart four-factor and Fama–French five-factor models, we find that 'Wide Moat' portfolios had significantly positive risk-adjusted alphas with both the models. 'Wide Moat' portfolios also lost less value during the 2007–2009 financial crisis compared to both S&P 500 and Russell 3000. In conclusion, we find that 'Wide Moat' stocks have created significant value for their investors over the course of our study."

BlackRock shares are trading at a forward price-earnings ratio of 22.57, which is considerably higher than the sector median of just 13 according to data from Reuters. Because of its market-leading position, however, the company is likely to trade at a premium to the sector average in the foreseeable future. There are many examples to suggest that industry leaders generally trade at premium valuation multiples. Facebook Inc. (NASDAQ:FB) is a classic example. The company trades at a price-earnings ratio of 29 in comparison to the sector average of just 19, and this has been the case since 2012.

Second, an investment decision in a dividend growth stock should be based on the free cash flow profile of a company, not just accounting profits. BlackRock has increased its annual dividend per share every year since 2009, and the company is still paying out just a fraction of its free cash flow.

At present, management is trying to strike a balance between retained earnings and dividends because BlackRock is not done with investing for the future. According to company filings, millions of dollars are invested every year to improve the technical aspects of the business, and acquisitions are a key part of the capital allocation strategy. However, when the company eventually matures, a higher percentage of free cash flow is likely to be distributed among shareholders, which is good news for income investors.

At the market price of around $700 per share as of Nov. 25, BlackRock yields a modest 2.08%. The income return will improve in the future as the company generates higher profits, so dividend investors will be able to book a handsome capital appreciation return once its investments start yielding results as well.

Takeaway

Growing through acquisitions is not as easy as it sounds. More often than not, acquirers tend to overpay, resulting in disappointing earnings down the line. On the other hand, desired synergies tend to be overestimated in most instances. BlackRock, however, is an exception. The company has acquired many other players in the asset management industry over the last few decades, and most of these investments have proven to be value accretive. If not for BlackRock's acquisition of iShares a decade ago, the company would never have become the leading investment manager in the world today.

As BlackRock continues to expand and invest in its future, the stock is likely to trade above industry average multiples, so income investors are likely to be rewarded with continuous dividend hikes, which has been the case over the last 11 years.

Disclosure: The author does not own any stocks mentioned in this article.

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About the author:

Dilantha De Silva
I am an investment professional with 5-years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. I am a strong believer that the best investment opportunities could be found in under-covered equities.

I currently work with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, GuruFocus, and TradeGrill to produce investment-related content.

I\'m a CFA level 2 candidate and an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK). I am a registered candidate for the Chartered Wealth Manager program as well. During my free time, I enjoy reading.

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