Who could afford to buy iShares?
What Barclays' possible sale of iShares would mean for ETF/ETN investors, and who might make a bid
Barclays stunned the ETF (exchange-traded funds) community yesterday by announcing that it is considering the sale of all or part of its iShares division in order to raise up to £4 billion in much-needed cash.
The first question to answer for ETF investors is, "How will this affect any iShares ETFs that I own?" We think that this will have no effect on the ETFs currently supported by iShares. IShares creates, markets, and administers the funds upon their release, but it is not the market maker or clearing house for these ETFs. That happens on the exchanges. Overall, we feel confident that the unit is easily detachable from the bigger Barclays organisation. In fact, that is most likely one of the reasons that Barclays has chosen to put this group on the block in its quest for cash.
Although reports don't directly address iPath, iShares' ETN- (exchange-traded notes) sponsoring sibling, we predict that it would be included in the sale. We also think that it would likewise be unaffected. The ETNs that are backed by Barclays credit would continue to be backed by Barclays. There are plenty of other ETNs out there where the ETF sponsor and the backing bank are different firms. Ironically, iPath ETNs might even get a boost from Barclays' improved capital position as a result of this sale.
Banks, brokerages, and other providers are undoubtedly licking their chops at the opportunity of getting their hands on this asset. IShares is the largest fund provider in the fast-growing and highly profitable (when you have iShares' scale) ETF business. The company manages over £200 billion in assets and collects revenue on every one of those pounds. If you use an estimate of 25 basis points as an average fee for all iShares funds, then the company is generating around £530 million in revenue on an extremely scalable business that requires very little capital and generates tremendous free cash flow.
As great of a business as iShares might be, the problem is that the most logical buyers have empty wallets. Some of them are broke by circumstance (Bank of America, Citigroup, etc) and some--such as J.P. Morgan, Morgan Stanley, and Wells Fargo--are keeping their wallets tight by choice. J.P. Morgan and Wells recently cut their dividends to generate cash to pay back their TARP (Troubled Asset Relief Program) loans, and Morgan Stanley is busy digesting Smith Barney. This is not to say that one of these firms wouldn't stretch for such a desirable asset, but it is going to be difficult for any of them to raise that kind of cash.
Other logical buyers include Invesco--the backers of ETF-provider PowerShares, although this would be a lot for Invesco to swallow. We could see trading platforms such as CME Group or Nasdaq becoming interested. We think that the other goliaths in the ETF space, State Street and Vanguard, are unlikely buyers for anti-trust reasons.
The Financial Times reported today that Barclays is in discussions with a consortium that includes a fund management group and financial buyers. Citing a person familiar with the matter, the FT said the bank may provide some financing to the consortium at market rates and may keep a stake in the business.
There is, of course, the potential that another firm would simply infuse capital into Barclays by purchasing a portion of iShares in exchange for cash. If that happens, we think the overall upheaval of the ETF industry and iShares in general will be muted to the point of immateriality. Management will stay the same, and Barclays would most likely retain control. The only difference would be that another company would have claim to some large portion of the profits.
In the gamesmanship of dealmaking, Barclays' announcement that it is shopping around iShares is analogous to declaring the auction open for all. When you take into consideration the state of the capital markets, Barclays' weakened negotiating position, and a very back-of-the-envelope free cash flow calculation, it is difficult to get to the £3.5 to £4.3 billion price tag that has been tossed around in the media. We think the final number will more likely end up in the £2.5 to £3.2 billion range.
