Summary
- State Street hired Goldman Sachs to find a buyer for its asset management division.
- State Street’s focus is on developing a new platform to compete with Bloomberg and BlackRock.
- A deal could be transformative and its terms might determine the future direction of the bank.
Thesis
A decision to focus on a new software platform offering front-, middle-, and back-office support to their custody clients coupled with it falling further behind market leaders BlackRock Inc. (BLK) and The Vanguard Group Inc. in the ETF market seems to have prompted State Street Corporation (STT) to sell its asset management business. The company hired Goldman Sachs to look for a buyer and interest has been expressed by competitors and investment banks. A cash deal permitting a full divestiture would allow State Street Corp. (STT) to pursue their new strategy unencumbered, but any type of merger, partial sale, or complicated arrangement giving State Street a large equity holding in the acquiring company may be counterproductive. Although its long-term investment servicing strategy holds promise, one would do well to wait before buying the stock until a deal is struck and the terms can be reviewed.
Focus on Investment Servicing
In recent years State Street has concentrated on two major lines of business: Investment Servicing, which provides asset managers with middle- and back-office support; and Investment management, done through State Street Global Advisors (SSGA), which provides a range of investment products such as the well-known SPDR ETF (SPY).
Although the asset management arm is better known to investors and the public, the Investment Servicing unit provides over 80% of the company’s revenue. In 2018 the unit took on even greater importance when the company bought Charles River Development (CRD) for $2.6B. CRD was a privately held company, with $300 million in sales at the time, specializing in automating front-office investment management functions. In the years since the acquisition, State Street worked hard on integrating CRD’s platform with its global custody and middle-office support products, allowing it to develop a front-to-back platform strategy named Alpha, a one-stop shop handling everything from pre-trade analytics to post trade reporting and reconciliation.
The rationale for the move was a demand for greater cost reductions by asset managers who themselves have been squeezed by the growing popularity of passive investing. They are less willing to pay custodial banks for their tradition back-office services of settling trades, holding securities, keeping records and exchanging currencies. Price sensitive asset managers increasingly view custody services as a commodity with little differentiation between providers. Ron O’Hanley, Chief Executive of State Street, told the Financial Times that it was at risk of ending up “in a position where we would be doing all the hard work yet being paid commodity rates”. State Street is betting that their new front-to-back platform will prove to be a good value proposition differentiating it from competitors with more limited offerings.
This shift in strategy, however, has brought it into direct competition with Bloomberg L.P. and BlackRock, which offers a similar service called Aladdin. Most, if not all, of State Street’s largest competitors in the custody space responded by signing with either Bloomberg or BlackRock. Not all of these were State Street customers to begin with some beginning to use these services to replace custom-made in-house systems.
