Strategy and Tax Benefits Mark the Black Rock Deal: MIM acquisition allows the fund manager to bulk up, access capital, and build core competency

A deft blend of strategic, dealmaking, and tax engineering led Black Rock Corp. into a merger with Merrill Lynch Corp.’s asset management arm -Merrill Lynch Investment Management (MIM) – in one of the most important deals in the restructuring of the fund management industry. The transaction made history because it marked the first time an equity carve-out – Black Rock was 71% owned by PNC Corp. – pulled off a merger of that type. However, Benjamin Phillips, a Managing Director at Putnam Lovell NBF Securities, a major dealmaker in the asset management field, says that this is one of several innovative deals in the field and he expects creativity to be important in future combinations. Phillips points to the merger of Citigroup’s asset management unit into Legg Mason Inc. for stock as another in this vein. “What you’re seeing is an overall shift in fund management strategies, and this is starting to show up in the transactions that are being done,” he says. In the Black Rock/Merrill deal, the stakes involved not only a strategic play on size and competency but also shielding of potentially harsh tax and financial consequences. Black Rock expands sharply in a tax-free deal, issuing shares to absorb MIM with Merrill’s deep pockets being a strong financing weapon. Had PNC unloaded its majority interest for cash, it would have been subject to a huge tax bill. But the tax benefits don’t end at the top. Merrill Lynch becomes the largest shareholder with a 48% interest, while PNC’s stake contracts to 34%. As a result, PNC, as a minority shareholder, can account for its interest through the equity method of accounting. Once the deal is completed, PNC’s main benefit will be in the form of dividend income from Black Rock but, says Robert Willens, a Managing Director at Lehman Brothers, the cash will flow in at a tax-favored rate. He estimates that the effective tax rate on the dividends, once an assortment of technical calculations and trade-offs are determined, will be only about 7%. “This is a real bonanza for PNC,” he says. Phillips regards the Black Rock/MIM linkup as a strategic coup. MIM goes to a management with a track record, and “with Merrill as a shareholder, they add to their ability to do product development.” “It’s win-win-win from the standpoint of strategy,” he says. Although Black Rock is expanding dramatically, Phillips says its deal and others in the industry are not based on size alone. “It’s not just scale, because that has been tried,” he says. “It’s a retreat toward core competency. The firms have been concentrating their assets – their strategic assets – on what they’re good at.” Legg Mason, Phillips points out, has morphed into an asset management company from its former mode, which included investment banking and securities brokerage. Now they can buy other asset management firms as the industry consolidates and reshapes. “Their skills are in building the portfolio and building the product,” he says. Citigroup’s fund management business, by contrast, “did not perform as well as it would have liked.” “They’re getting into businesses where they can do better and getting out of businesses in which they don’t believe they can achieve world dominance,” Phillips says. Helping support the extensive dealmaking is that stock prices of leading fund management companies have been selling at impressive multiples. “They have the equity to do the deals,” Phillips says. “The market valuations have gone up in anticipation of more transactions.” However, in a recent report on the industry, Phillips noted that financial buyers also are hunting for asset management deals and should “co-exist” with strategic buyers. (c) 2006 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com