|Shares Out. (in M):||153||P/E||0||0|
|Market Cap (in $M):||97,000||P/FCF||0||0|
|Net Debt (in $M):||-3,000||EBIT||0||0|
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BlackRock’s juggernaut risk management software platform Aladdin is likely to be spun off, potentially driving *at least* a doubling of the extraordinarily cheap shares.
BlackRock, Inc. (“BlackRock” or “BLK”), based in New York, is the world’s largest and most diverse asset manager and technology service provider. Led by its founder, Chairman and CEO Larry Fink, BlackRock manages over $7.8 trillion in client assets. The company enjoys the benefits associated with an “asset-lite” business model, through which high operating margins and minimal capital intensity combine to drive growing recurring revenue, free cash flow generation and shareholder returns in a variety of market environments.
Notwithstanding these wonderful attributes, which on their own could certainly merit our investment, my excitement for investing in BLK shares is driven by the company’s Aladdin subsidiary, which is a fast-growing and nascent monopoly in risk management software, and likely the most systemically important software platform in the world today. As Peter Thiel wrote in Zero to One, “Monopolists lie to protect themselves…usually by exaggerating the power of their (nonexistent) competition.” Unsurprisingly, BlackRock COO and Aladdin chief Rob Goldstein reportedly said “Even though it’s a crucial piece of infrastructure, there are many critical pieces of infrastructures that clients have in their inner workings. We live in an incredibly competitive environment.” It seems to me that BlackRock management is vastly understating Aladdin's market position.
While BlackRock is going to great lengths to conceal how wildly successful and powerful the Aladdin platform has become, I expect that this massive “hidden asset” will become mainstream soon enough. Owing to substantial conflicts of interest and sparse disclosure relating to Aladdin, I believe that BlackRock ultimately will have little choice but to separate the unit via a spin-off transaction, creating two attractive stand-alone businesses: (i) a pure-play, market-leading investment management company, BlackRock and (ii) a pure-play, quasi-monopoly subscription software company, Aladdin, which could grow much faster independently.
Keys to the thesis include:
* Diverse, global and growing core business. Since leaving First Boston in 1988, Chairman Fink has built BlackRock, initially in partnership with Steve Schwarzman and Pete Peterson’s Blackstone, into a preeminent investment management firm. Due in part to timely acquisitions of State Street Research & Management (2004), Merrill Lynch Investment Managers (2006) and, most importantly, the transformative financial crisis deal for Barclays Global Investors and its iShares ETF unit (2009), BlackRock has developed expansive reach and unmatched economies of scale. With actively managed and passive products, the company serves institutional, retail and governmental/sovereign clients. In 2019, revenues were derived from its equity (48%), fixed income (28%), multi-asset (10%), alternatives (7%) and cash (5%) products, with 34% of its revenues derived from EMEA and Asia-Pacific regions.
* Fortress balance sheet. BlackRock’s fee-based, agency business model is an attractive one, requiring little balance sheet usage. Capital expenditures are minimal, averaging less than 2% of revenue over the last ten years. Total gross debt of $7.2 billion has spread maturities extending from 2021 to 2030, representing about 1x EBITDA, and on a net basis is more than offset by $5.5 billion of cash plus $5.2 billion of long-term investments.
* Aladdin, a massive hidden asset. Aladdin, the primary brand name of BlackRock’s technology services division and risk management software platform, is an enigma. Judging by management’s comments and bare minimum disclosure level, my assessment is that they are temporarily obfuscating the immense value of this business. A subscription-based software platform with clients ranging from central banks to commercial banks to the largest technology companies to other investment managers, Aladdin is afforded only a single line item – “Technology services revenue” – on BlackRock’s income statement. This line item will likely show a run-rate revenue level of about $1.2 billion as of year-end, and currently represents less than 8% of BlackRock’s total revenue base. The platform’s client base is effectively permanent, and this reported revenue level excludes fees that BlackRock, Aladdin’s largest client, would be paying if the two businesses were independent. In 2018, Goldstein estimated the addressable market for “core Aladdin” (excluding adjacent markets that Aladdin is now clearly pursuing) at $7 billion of annual revenue and said “Aladdin provides clients the ability to rent our scale. Aladdin implementations are hard, complex, major business transformations that basically reengineer the core operating processes of these companies, their people, their processes and their technology.” After President Rob Kapito off-handedly mentioned in February 2017 that $20 trillion of client assets were managed on the platform, I can find no further management quantification of Aladdin’s scale. Prior to the eFront (a platform serving the private equity industry) tuck-in acquisition earlier this year, the Financial Times estimated that over $21 trillion now sits on the platform from only one-third of Aladdin’s core clients. Aladdin has been growing revenues at a mid-to-high teens annualized rate. As such, excluding acquisitions and including a reasonable assumption for arms-length BlackRock fees, Aladdin could easily be a $1.9-2.2 billion run-rate revenue business in 2023. In a spin-off, a quasi-monopoly, high-growth subscription software platform with enormous pricing power such as Aladdin might command a valuation of 20x that level, or about $40 billion, nearly half of BlackRock’s total enterprise value.
* Aladdin spin-off makes sense and could create a windfall of value. Owing to (i) the platform’s immense scale, (ii) multiple conflicts of interest, whereby BlackRock itself owns shares of Aladdin clients, and Aladdin clients are often competitors of BlackRock’s own investment management businesses, and (iii) the likelihood that Aladdin chief Rob Goldstein, BlackRock’s “boy wonder” who graduated high school at 16 years old and joined BlackRock in 1994 when it had only 55 employees, deserves a CEO position, I believe that Aladdin is likely to be separated via a tax-free spin-off transaction, increasing transparency, eliminating conflicts and accelerating Aladdin’s growth. An activist investor could accelerate such action.
* Strong business momentum. Despite the chaos of the COVID-19 pandemic, BlackRock’s core investment management business attracted $129 billion of net inflows in the third quarter of 2020 alone, representing 7% annualized organic asset growth and 9% annualized organic base fee growth. On the Aladdin side, BlackRock CFO Gary Shedlin mentioned in July that they had “successfully implement[ed] over 18 Aladdin go-lives since the pandemic began.” Recent new and expanded Aladdin clients include Northern Trust, Citi, Santander and Brinker Capital. In April, Microsoft, in a big win against Amazon, announced that it had struck a partnership to bring Aladdin to its Azure cloud platform.
* Politically well-positioned. Notwithstanding BlackRock’s scale and systemic power (or perhaps because of it), Larry Fink is generally, though not entirely, a friend of both Republicans and Democrats. He has been a close advisor to Trump and a member of the President’s Business Council. Simultaneously, he has been frequently mentioned as a top pick for Biden’s Secretary of the Treasury.
* Cheap and misunderstood by investors. I estimate the shares are trading at about 15x 2022E net income and with an implied free cash flow yield of about 7% on the same year. With a current annualized dividend of $14.52, a 2.3% implied yield, there should be substantial free cash flow available to continue reducing the share count while also completing tuck-in acquisitions. This below-market valuation multiple is a result of a lingering bearish investor view, which for years has been that BlackRock will see declining fees and profit margins, while slowing inflows reduce AUM growth. However, for the five years ended 2019, investment management fees grew at 4% annually, operating margin expanded 80 basis points to 43.7%, AUM rose from $4.6 trillion to $7.4 trillion, and shares outstanding declined by 10 million due to consistent repurchases. To the latter point, and as a signal of management’s confidence, BlackRock recently capitalized on PNC’s “panic sale” of its 31.6 million BLK shares in May, repurchasing $1.1 billion worth of its own stock from PNC at a price 26% below the September 30th close. Even without a spin-off of Aladdin, I believe it is reasonable that three years from now BlackRock could generate free cash flow of $7+ billion, which, owing to strong recurring revenue growth and high free cash flow margins, could easily trade with a 3.5-4.0% free cash flow yield (consistent with its 2019 FCF yield), implying a potential $180-200 billion equity value, or roughly $1,250-1,400 per share including dividends.
In sum, BlackRock is a terrific, dominant business in its own right; however, its Aladdin subsidiary is a juggernaut that seems destined to continue growing at rapid rates for many years to come. Should this occur (and even if investors were simply to begin recognizing the situational dynamics and valuation discrepancy at work), I believe tremendous value could be created for BLK shareholders in a relatively short timeframe. Given that BlackRock’s current valuation is already cheap on an absolute basis, and before properly accounting for Aladdin’s standalone value potential, I believe investors are significantly misunderstanding the opportunity.
Disclaimer: The author of this idea presently has a long position in securities of this issuer and may trade in and out of these positions without notice. The data contained herein are prepared by the author from publicly available sources and the author's research and estimates. No representation or warranty is made as to the accuracy of the data or opinions contained herein. Please do your own research.
Spin-off of Aladdin.
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