BlackRock Will See Gains From Newly Acquired Money Market Funds Once Rates Rise

BlackRock (NYSE:BLK) recently inked a deal with Bank of America (NYSE:BAC) to acquire a portfolio of money market funds managed by BofA Global Capital Management for an undisclosed amount. ^[1] The deal, which is expected to close in the first half of 2016, will see $87 billion in assets under management shifting hands. Bank of America’s decision to sell the unit makes sense, as the low interest rate environment has squeezed out profits from the money market fund industry, and the only practical way to compete is to rely on economies of scale. Moreover, the move is in line with Bank of America’s strategy of streamlining its business model by getting rid of non-core units.

As for BlackRock, the acquisition will boost the size of its cash management platform to over $370 billion – making it the second largest player in the industry after Fidelity. Once finalized, the deal will help the asset management giant improve profits from the business in the short run, as the incremental revenues are expected to be greater than the corresponding increase in expenses. But more importantly, the larger exposure to money market funds puts BlackRock in a better position to gain from a hike in benchmark interest rates.

We have increased our price estimate for BlackRock’s shares upwards from $374 to $382. The new price estimate is slightly higher than the current market price.

See our full analysis for BlackRock

Over the years, money market funds have been the preferred investment vehicle for investors looking for solid returns over a time frame of just a few months. Money market funds in the U.S. currently manage more than $2.7 trillion worth of assets. ^[2] But several concerns were raised about these funds in the wake of the economic downturn of 2008, when the government was forced to step in to prevent a run on them after Lehman Brothers fell. To address these concerns, the SEC proposed several changes to regulations governing these funds last year. ^[3] Besides having to comply with the new regulatory requirements, incumbents in the industry have also seen revenues shrink due to the prevalent low interest rates, forcing them to do away with fees for many these funds. To put things in perspective, BlackRock’s fees from money market funds as a percentage of fund assets has shrunk from roughly 0.2% in 2008-2009 to just over 0.1% in 2014, as seen in the chart below.

BlackRock is a major player in the money market fund business, managing $285.7 billion in assets across its cash management offerings at the end of Q3 2015. ((3Q15 Earnings Release, BlackRock Press Releases, Oct 14 2015)) A majority of these assets are in U.S.-based funds, with Crane Data pegging the size of assets in BlackRock’s U.S. money market funds at $217 billion. ^[4] This represents a little over 8% of the U.S. industry size. In comparison, market leader Fidelity manages $413.7 billion in assets (15.3% market share) followed by JPMorgan with assets worth $254.6 billion (9.4% market share). The recently announced deal will give BlackRock a solid lead over JPMorgan, while also helping the company improve profit margins for the unit.

We expect the deal to have a strong positive impact on value in the medium- to long-run once the interest rate environment improves. This is because BlackRock will be able to enjoy the benefit of improving fees from cash management funds on a larger asset base, even as scale economies boost operating efficiency. You can see how a faster or slower growth in these assets impacts BlackRock’s share price by making changes to the chart below.

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1. BlackRock’s Cash Management Platform to Grow to Over $370 billion of AUM through Transaction with Bank of America’s BofA® Global Capital Management’s Asset Management Business, BlackRock Press Releases, Nov 3 2015 [↩]
2. Money Market Fund Assets, ICI Report, Nov 5 2015 [↩]
3. SEC Adopts Money Market Fund Reform Rules, SEC Press Releases, July 23 2014 [↩]
4. Money Fund Intelligence, Crane Data, Nov 2015 [↩]