Did BlackRock pick Merrill Lynch's pockets in its deal to purchase MLIM? Or is MLIM's business as impaired as the deal implies? One couldn't listen to this morning's conference call explaining the MLIM sale to Wall Street analysts without being hit over the head with that question. To see why analysts wondered about the valuation, one need only look at what BlackRock gained for its $9.5 billion worth of newly issued stock.

BlackRock will add $544 billion of assets to its existing pot of $453 billion of assets under management. That combination pushes the total assets in the newly bulked up BlackRock to $997 billion. Call it a trillion to make the math simpler. Analysts must have noted the obvious ...

• Merrill is contributing 54 percent of the assets to the deal but getting just 49.8 percent of the value of the combined firm. That suggests that Merrill's assets are coming at roughly a 20 percent discount to BlackRock's.

Interestingly, Merrill's existing AUM should be more valuable than BlackRock's, not less valuable as the deal reflects. BlackRock is known as a manager of institutional assets while MLIM carries a higher proportion of retail assets that bring with them higher fees and margins. In addition, BlackRock manages mostly low margin fixed income mandates while the majority of MLIM's assets are higher margin equity assets. (Bloomberg reports that 54 percent of MLIM's assets are equities compared to 23 percent in fixed income, the remainder is unnaccounted for).

Let's look at the price another way.

• BlackRock is paying a tad less than 1.75 percent of assets under management for MLIM.

One of the first questioners on the call wondered about this figure, asking why it was so low compared to other recent deals for asset managers. In most cases, managers of diversified pools of assets have realized in the three to four percent range for their businesses, suggesting that Merrill Lynch left half the potential cash on the table by selling to BlackRock at the reported price.

While BlackRock is valued at just 2.1 percent of assets, that valuation makes some sense in light of that its relatively limited retail distribution compared to its asset base and the fact that the bulk of its business derives from fixed income mandates with institutional investors.

Furthermore, 2.1 percent is a whole lot more than 1.75 percent. By this measure MLIM's assets are being discounted by 17 percent, a slightly slimmer squeeze than in the earlier analysis.

One can also use good, a old-fashioned P/E ratios to value the deal.

• BlackRock's PE is roughly 36 times its 2005 earnings.
• The typical asset manager trades at a 20 P/E.
• Merrill realized something less than a 20 multiple on its MLIM sale. (Merrill executives would not respond to questions on the MLIM P/E based on the sale to BlackRock).

MLIM earned a reported pre-tax profit of $586 million on revenue of $1.8 billion in 2005. That implies a multiple of 16 based on the $9.5 billion price cited by Merrill executives on the call. Meanwhile, the analyst asking Merrill Lynch CFO Jeff Edwards the question pegged the ratio at 14.

Either way, Edwards would not discuss the MLIM P/E. Not a surprising decision in light of the 50 percent discount implied by this metric, instead he explained that the deal was "all about relative growth rates" before adding that he is "confident that we are getting fair value for the growth that we are contributing."

In short, Merrill took a steep haircut on the deal because it thinks it can sell a lot more BlackRock product through its distribution arm than it could have sold MLIM product. That analysis makes sense -- MLIM grew AUM 8.6 percent last year while BlackRock grew its AUM 32 percent -- but it also shows the lack of confidence Merrill has developed in its own capabilities.

That lack of confidence should also give BlackRock CEO Larry Fink pause.

Merrill Lynch ended the 1980s as the largest retail mutual fund manager but has been a relative laggard in growing its AUM for the nearly two decades of the "open" distribution era. One reason is that it lacks any well-known fund in its extensive lineup. It was also caught with a value bent during the growth dominated 1990s, only to switch to growth right as value reemerged (remember Merrill's Internet stock fund anyone?). Finally, other distributors did not (and still do not) want to sell MLIM's funds, though MLIM didn't even try to do so until it recently tapped Bob Doll to oversee the effort.

In short, BlackRock is expanding its franchise and buying a lot of equity assets, but it is not necessarily buying a product line that customers want, nor is it necessarily gaining any retail distribition expertise judging by the track record of MLIM's people.

One MLIM asset Fink did point to on the call is MLIM's European distribution, calling that platform "impressive." He also said he looked forward to building an Asian platform with the help of the people at MLIM.

Still, to paraphrase Frank Sinatra, Europe and Asia are nice markets, but if you can't make it here in the U.S., you can't make it anywhere in the asset management business and Fink did not address how he will turn around MLIM's U.S. efforts. He did point out that with nearly a trillion dollars of AUM, BlackRock will be able to start significant retail branding, but he skipped the issue of whether brands are purely bought or built on top-notch products and services.

So the bottom line is that Fink is facing a challenge if he expects to grow BlackRock with MLIM the way he grew it as an institutionally-focused fixed income manager, but at least he got a bargain price. 

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