On Tuesday, reports broke that Barclays had entered into exclusive talks to sell most of its iShares business to private equity group CVC Partners--Barclays has since confirmed the news but we are still awaiting the final details. Initial reports indicate the total value of the iShares business at around £3.3 billion to £3.5 billion. Barclays will retain around a 20% stake in iShares through warrants and will be retaining the securities lending business that was previously bundled up with the group.
How this sale will impact the operations of Barclays is going to be a function of how much leverage is used to finance the purchase. Currently, the iShares business requires very little capital and therefore throws off a tremendous amount of cash. We estimate that the firm is generating around £330 million of earnings before interest and taxes, or EBIT, right now, which gives it plenty of capital to invest in growth. These growth projects support not only continued development of new products, but also the education of the investing community at large about the benefits and uses of ETFs.
Theoretically, if 70% of the purchase price was financed with debt at 8% (the midpoint between investment-grade and junk-bond rates right now) the firm would have to service £167 million of interest expense that previously didn't exist. That's half of the current EBIT, which would mean that there's significantly fewer pounds for long-term growth initiatives.
Of course, the wild card in this analysis is that we don't know how much money Barclays was siphoning off from the iShares group over the past few years. R&D and marketing expenses are already factored in to iShares' EBIT, and the company still has plenty of money left over. It is quite conceivable that without a cash-hungry parent company, iShares could expand its growth efforts.
Regardless, we don't think that iShares' presence in the market place will contract, even with private equity at the helm. Most people associate private equity with drastic cost-cutting and slash-and-burn business approaches. However, iShares is a growing business and not an auto supplier, so it will be in the best interest of any prospective buyer to continue its growth and maintain its market leading position.
The most interesting market dynamic that may come out of this whole transaction is an increase in the number of firms participating in the ETF industry. The amount of publicity this deal has generated for ETFs has been tremendous. More importantly, it shined a light on a highly profitable, growing business that was embedded in a massive bank. Don't think that other players in the financial world haven't taken notice at the size of the revenues and profit margins that iShares is generating off of ETF products. The question isn't whether there will be other entrants into the market, but rather when.
