Description

Thesis:

This is a very simple thesis, the long term bull case has indeed played out. BLK is the de facto leader in the secular trend to passive investing, vacuuming the most low hanging fruit at the lowest fees since 2009. However we will contend that this is a shrinking margin business that has seen the peak in net new flows whereas every incremental dollar has declining economies of scale, and while BlackRock trades at nearly 6 handle multiple premium to its peer average, BLK should see multiple compression as the street realizes that its organic inflow growth is decelerating and that its incremental growth comes with a declining margin profile.  

Brief Company Description:

BlackRock is the world’s largest asset manager with $6.3 trillion in AUM.  BlackRock’s AUM is diversified by product, client type, style, and region. BlackRock generates a large and increasing portion of its revenue from passively-managed products.  BlackRock greatly expanded its exposure to passively-managed products with its purchase of Barclays Global Investors and its iShares franchise in 2009. iShares ETFs and other index products now represent 67% of current AUM, 53% of LTM investment advisory revenue.

The Bull Case:

The bull case rests on investors’ view that BlackRock is consistently taking share in the asset management industry, and these share gains are highly likely to continue, making it a long-term compounder. The secular shift to passive asset management is main growth driver.

Short Thesis:

Slowing Organic Inflow Growth:

Ten years of a near zero interest rate environment has accelerated the trend to passive investing and BLK has been the main beneficiary. As in all cycles the 10 year secular trend to passive investing is starting to slow as market volatility and downside protection awareness make comebacks in normalized market environments. While there are certainly strong merits to some passive investing, it is the strategy du jour of QE induced bull markets where price discovery and volatility are dampened by the incessant flows of free money. We believe that the tide of mindless “indexing” because its cheap is starting to turn. Since 2016 BlackRocks Organic inflow growth rate has decelerated to approximately 2% on a yoy basis. Coincidently, 2018 briefly marked the return of volatility in Q4 and investors were reminded that they own 100% up capture and 100% down capture in their in newly passive portfolios.

Fee Compression:

The race to the bottom in fees is one competition that BlackRock is not leading. Despite industry ETF 10 year growth CAGR of 21%, fees have only compressed over that time period. In the last 7 years, BlackRock’s fee effective fees have declined nearly 18% adjusting for acquisitions. More importantly BLK’s average fee on tier top 20 ETF by asset is nearly 2.5 greater than their best competitor Vanguard who has as blended fee of 7 bps on their top 20 ETFs.  

Source: Company Filings

BlackRock Effective Fee:

Source: Company Presentation

Valuation:

As the preeminent commoditized asset gatherer there was a time where an industry CAGR of 21%, 60% share in net flows, and a legacy high margin active management business, deserved a premium multiple to the peer group. That time is over. Pick a number, a modest 20% premium to peers is 12x 2020 EPS 29 getting you $350 20% downside. Any inability to manage the SG&A pressures the denominator and should the market stop rewarding commoditized businesses as if they are hyper growth subscription models relative to their peers the multiple could easily be 10x $29 bucks getting you to $290, 33% downside.

Conclusion:

There is no smoking gun here. This is a slow death that has a premium multiple for a business that has declining economics. The stock doesn't kill you on beta up days and has lost the momentum bid that was present in 2017 making this a far more compelling short than in the past. We reiterate that despite continued growth in flows it comes at lower margin and is less incremental to the bottom line making the premium multiple unwarranted. We expect 10x 2020 EPS of 29, target price of $290, 33% downside.

Catalyst

Slowing Inflows, declining fees multiple compression