Here’s Why BlackRock Strikes The Right Note With Its Cost-Cutting Plan

BlackRock (NYSE:BLK) is reportedly trimming its workforce by around 300 over the next few months as it continues to work towards creating a sleeker, more profitable business model that will be more responsive to changing scenarios in the global asset management industry. ^[1] This represents 3% of the company’s 10,500 strong employee base at the end of 2012, and the retained employees will shoulder additional responsibilities going forward.

We believe that these job cuts are essential to BlackRock’s overall business objective of growing in the future by targeting retail investors – a market section that is currently underserved. To be able to do so profitably, BlackRock will need to offer retail investment products at very low price points, and this can only be possible if it first reins in associated operating costs. Needless to say, any cost-cutting measure by the asset management giant represents a sizable upside to its share price simply because of the sensitivity of its value to its operating expenses.

We maintain a $250 price estimate for BlackRock’s stock, which is around the current market price.

See our complete analysis of BlackRock’s stock here

BlackRock’s Future Growth Policy Demands Significant Cost Cutting

BlackRock is the undisputed leader of the asset management industry with nearly $4 trillion in assets under management around the globe. And it has achieved this position largely through acquisitions, especially of Barclays Global Investors (BGI) in late 2009 which added BGI’s most popular offering, iShares, to the company’s portfolio.

But going forward, the company’s management intends to grow organically by drawing in more investors towards their product offerings rather than inorganically through acquisitions. The natural outcome of this decision was for the company to direct its focus towards grabbing a larger share of the retail asset management industry – something that forms but a fraction of BlackRock’s total product offering. And to achieve this, the company has to reduce its overall expenses as retail investors pay particular attention to underlying fees while picking a product for investment.

And Reducing Jobs Looks Like The Right First Step Towards Achieving This Goal

BlackRock’s total corporate expenses have been slightly above $5.8 billion for each of the years 2011 and 2012. Employee compensation & benefits made up around $3.2 billion of these expenses each year – a good 55% share of the company’s total costs. Now considering that BlackRock intends to reduce its workforce by about 3%, this would mean a reduction in annual total expenses by at least $100 million. This cost reduction will not sacrifice any performance in terms of revenue growth due to the benefits of the ongoing reorganization.

While not a sizable figure in itself, it must be noted that BlackRock’s share value is very sensitive to its total expense figure. As you can check by making changes to the chart above, which represents BlackRock’s actual and forecast operating margins, an increase of just two percentage points in margin figures by the end of our forecast period pushes the share price value to almost $265 – an improvement of more than 5%.

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1. BlackRock to Cut About 300 Jobs in Fink’s Reorganization, Bloomberg, Mar 18 2013 [↩]