Last October, Credit Suisse (NYSE:CS) announced it was putting its European exchange traded fund (ETF) operation up for sale in order to raise capital to meet new regulatory requirements. The only real suitors: BlackRock (NYSE:BLK) and State Street (NYSE:STT). Both were thought to be eager to add to their European businesses. Unfortunately for Credit Suisse, State Street dropped out of the bidding in December, leaving BlackRock as the only legitimate contender. Sources close to the situation suggest an official announcement will come shortly. The purchase by BlackRock is a perfect example of a fill-in acquisition. While it's good for BlackRock, I'll look at what it means to the rest of the ETF industry.
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The unknown at this point is how much BlackRock will pay for Credit Suisse's $17.6 billion in assets under management (AUM). Last March, it paid $210 million to buy Claymore Investments, Canada's second-largest ETF provider behind iShares. At the time the deal was completed, Claymore had approximately $7.6 billion in AUM, but more importantly an estimated 16% market share. Credit Suisse, the bigger of the two in terms of AUM, has a market share of just 5.3% compared to 42% for BlackRock. While the deal gives it additional market share, it doesn't gain a stranglehold on the European market like it did in Canada, so the premium paid is likely to be similar to the deal for Claymore, which sold for 2.8% of its AUM. That puts the transaction value around $200 million to $300 million. Not cheap by any means, but it's a drop in the bucket for a firm that manages $3.7 trillion globally, generating net income of $1.8 billion in the first nine months of 2012.
SEE: Analyzing An Acquisition Announcement
The Next One
According to ETF Global Insight, the acquisition of Credit Suisse's ETF business - the fourth largest in Europe - BlackRock will have approximately 47% market share. The next biggest player is Deutsche Bank's (NYSE:DB) db X-trackers with 14% of the $331-billion market and Societe Generale's (OTC:SCGLY) Lyxor unit at 12%. To gain similar market share dominance in Europe as it possesses in Canada, it will have to pay a significant premium to pry loose either of its next largest competitors. Furthermore, all three of BlackRock's current competitors, including Credit Suisse, are in the midst of a transformation from offering primarily synthetic ETFs, which rely on derivatives and swaps to mimic indexes, to physical ETFs, which own the actual shares. BlackRock, which does offer some synthetic products, tends to focus on physical ETFs. Therefore, it's hard to know how attractive the remaining players are to BlackRock. Only time will tell.
SEE: An Introduction To Swaps
Less is Not More
ETFs were originally created for investors as an easy and cheaper way to invest in stock indexes. The first ETF, the SPDR S&P 500 (ARCA:SPY) came to be on Jan. 22, 1993. Today, it has $128 billion in total assets under management and is by far the biggest and most widely traded ETF in the United States. Fifteen years later, Bear Stearns created the first actively managed ETF. Unfortunately, it folded within seven months of the investment bank going bust. Today, there are just 54 actively managed funds compared to more than 1,400 passive ones. Every week it seems funds are opening or closing, making it difficult to keep track. Despite this problem, there's no reason to stand by while BlackRock continues to take over the world. It's beyond comprehension that State Street didn't stay in the hunt for Credit Suisse's European business given its minuscule market share on that continent. Now iShares has almost half of ETF market in Europe.
The Bottom Line
This might be a good deal for BlackRock (assuming it happens), but it's terrible for ETF investors. Less competition is definitely a bad thing. Think about it: the top three companies in the U.S. control 83% of the ETF business; the top three in Europe, 73%; and the top three in Canada, a whopping 97%. With that kind of domination, you can bet fees aren't going to come down quickly, if at all. Eventually, there will be fewer than five companies worldwide controlling most of the ETF business. Like they used to say about mutual funds, it's better to invest in the companies themselves rather than in their products, because your returns will likely be higher.
At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.