Earlier this week, the global head of BlackRock’s (NYSE:BLK) iShares Exchange-Traded Fund (ETF) unit said that the company is reviewing its existing contracts with various index providers.  The move by the world’s largest asset manager does not entirely come as a surprise as just a few months ago competitor Vanguard announced its decision to opt out of indexes provided by MSCI (NYSE:MSCI) for as many as 22 of its ETFs to cut costs.  Vanguard is the world’s third largest provider of ETFs after BlackRock and State Street (NYSE:STT). And if discontinuing the use of certain indexes is a sound reason for it to cut costs, then it definitely should be good enough for the largest ETF provider too – more so considering that these players have been competing primarily on the basis of prices in the recent past (see How Sensitive Is Blackrock’s Stock To Changes In iShares Fees?).
The way we see it, switching to low-cost index providers does indeed provide a notable upside to BlackRock’s value. But as is the case in any zero-sum game, such a move by BlackRock (and similar moves by smaller players subsequently) will hit all index providers to ETFs – especially the largest, namely S&P, Dow Jones and MSCI.
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We maintain a $236 price estimate for BlackRock’s stock, which is slightly below current market price.
Where Exactly Do Index Providers Figure In BlackRock’s Business Model?
To answer this question, we must first understand BlackRock’s business model as a whole. As the world’s largest asset manager, BlackRock provides its investors with a wide range of fund options to invest in. This includes various equity-based funds, fixed-income securities-based funds, funds that manage multi-class assets, alternative funds and cash management funds which had $3.8 trillion in assets under management at the end of 2012.
Of all these assets, those worth $2.16 trillion are under indexed equity or fixed-income funds (ETFs and non-ETFs combined) as reported by BlackRock as part of its Q4 2012 earnings announcement. This means that about 57% of BlackRock’s total assets under management rely on some underlying index – no small proportion by any count.
And all these indexes come at a price as the index provider charges BlackRock a fixed amount for the use of a particular index for any given fund.
The Impact of BlackRock’s Decision to Discontinue The Use of Indexes
BlackRock reports the cost of using various indexes as part of “Direct Fund Expenses” in its income statement which were $591 million for 2012. Although the exact share of the fees paid to index providers is not available, we could safely assume that it would be around 30% of this amount. Now considering the scenario in which BlackRock halves the amount it pays for using various indexes, this would mean an almost $100 million in cost reduction for the firm. This in turn would lift margins up by one percentage point.
As you can see by making changes in the chart above, increasing margins for BlackRock by a single percentage point increases our price estimate for the company’s stock to $245 – about 5% upside from the simple decision to switch to cheaper indexes. No wonder BlackRock is conducting this review in the first place.Notes:
- BlackRock says reviewing ETF index contracts, nothing ‘imminent’, Reuters, Feb 11 2013 [↩]
- Vanguard dumps MSCI indexes from 22 funds to cut costs, Reuters, Oct 2 2013 [↩]