New York-listed fund house BlackRock has offered to buy Barclays Global Investors (BGI) from British bank Barclays PLC for $13.5 billion in a deal that is expected to create the world's largest asset management company.

The resulting company -- BlackRock Global Investors -- will merge market leaders in active and index strategies and bring their combined assets under management to more than $2.7 trillion. While this figure represents only about 3% to 5% of the total assets under management of fund houses worldwide, it is significant in the sense that it's nearly double the size of its next strongest competitors.

BlackRock's offer includes the purchase of BGI's exchange traded funds business, iShares. Barclays previously entered into an agreement to sell BGI's iShares business to private-equity firm CVC Capital Partners Group, but the deal included a "go-shop" arrangement that enables Barclays to solicit other offers. Unless Barclays receives an offer from CVC within five business days that matches the terms of BlackRock's agreement to acquire BGI, the board of directors of Barclays will execute the purchase agreement with BlackRock and recommend it to Barclays' shareholders for approval. Barclays will also have to pay CVC an undisclosed "break free" for the termination of the negotiations. In the event that CVC comes back with a matching or better offer, then Barclays would proceed with negotiations with the private equity firm.

"The combination of the firms represents an unusual opportunity to bring together, at a time of some competitive dislocation in the industry, two leading asset managers with complementary capabilities and complementary geographical footprints," Barclays CEO John Varley said in a media teleconference.

BlackRock says BGI's record of product innovation, risk analytics and leadership in quantitative investing, indexing, and retirement solutions will complement BlackRock's expertise in active fund management, tailored solutions, innovative culture and risk management via BlackRock Solutions. iShares is the industry-leading ETF platform, with more than $300 billion of AUM in more than 350 funds worldwide. iShares is a rapidly growing business, ranking among the top three selling mutual fund and ETF families for the last three years.

BlackRock Global Investors' products will include equities, fixed income, cash management and alternatives, and will offer clients diversified access to global markets through separate accounts, common trust funds, mutual funds, ETFs, hedge funds, and closed-end funds.

For Barclays, the deal will bring in new capital and allow it to have a broad and ongoing relationship with the new BlackRock Global Investors.

"When the financial crisis began in the summer of 2007, we had two very important objectives in managing our investment banking and investment management business through this period" says Barclays president Bob Diamond.

The first was to manage the businesses profitably and the second was to come out of the crisis in a stronger strategic position.

"I believe the announcement today to combine BGI and BlackRock meets the second strategic test for both (investment banking and investment management)," says Diamond.

Diamond notes that the structure of asset management companies worldwide, especially in the US, is evolving. The focus on the separation of investment banking and investment management businesses is intensifying in the US, he says, as a result of the consolidation of both industries and increasing regulatory burdens.

"The demand from clients for independence and open architecture is becoming clearer," Diamond says.

In fact, Diamond says having BGI has become a "bit of a nuisance for Barclays" because of the parent company's inability to conduct business with certain entities due to third-party issues relating to BGI. It has become increasingly difficult for a bank like Barclays to have a top tier position in both investment banking and investment management, he adds.

"We believe that in the future, the benefits of relations between broad banking groups like Barclays and asset management businesses will best be achieved through strong partnerships and not full ownership," Diamond says. "That's exactly the thinking that drives the proposed combination (of BGI and BlackRock) in the proposed transaction."

Significant impact for Asia's asset management industry

The whole deal -- while most beneficial to Barclays and BlackRock in the US -- will have a significant impact on the asset management industry in Asia.

In AsianInvestor's annual report on the top 100 fund houses in Asia in terms of assets sourced from this region, BGI ranked third with $204.5 billion in AUM as of end-September 2008 while BlackRock ranked eleventh with $105.4 billion also in end-September 2008.

BlackRock president Rob Kapito says Asia is a key region for both BlackRock and BGI at the moment, and will continue to be an important market for the combined company. He doesn't foresee any major restructuring of operations of the two fund houses as the businesses are complementary. He notes that 18% of the combined company's assets will be in Asia (a figure that a Hong Kong spokesman says should only be 9%, however).

"We have offices in many locations we believe it is a growth area for BlackRock and we are going to continue to add people in the offices and add products as the market continues to grow. It's a very significant, very important market for us, currently and going forward," Kapito says.

Responding to a query on possible layoffs in Asia, Kapito's response was an unequivocal no.

"This is an area where we have been both growing and will both continue to grow," he says.

In Asia, Peter Swarbreck is BlackRock's Hong Kong-based CEO. He is also responsible for retail distribution in the region. The BlackRock portfolios managed in Asia include the China Fund, India Fund, Asian Dragon Fund, Japan Value Fund, and Japan Opportunities Fund. BlackRock has a staff of around 500 in Asia.

Over at BGI, Mark Talbot is the Hong Kong-based Asia ex-Japan CEO. Nick Good is the Hong Kong-based Asia-Pacific CEO of iShares, which has been aggressively expanding its presence in the region in recent months with more than 50 staff (double last year's figures) working at four offices in the region. BGI has a staff of around 500 in Asia, including aroun 277 in Japan.

Transaction Details

At the closing of this transaction, which is expected to occur in the fourth quarter, Barclays will hold a 19.9% economic interest in BlackRock. The two firms will seek to expand their relationships in investment banking and wealth management.

Also at the closing, BlackRock will have more than 9,000 employees in 24 countries and have a meaningful presence in all major markets around the world. The addition of the BGI San Francisco office will expand the firm's US footprint.

"The combination of active and passive investment products will be unsurpassed, and will enhance our ability to offer comprehensive solutions and tailored portfolios to institutional and retail clients," says Laurence Fink, BlackRock chairman and CEO.

Blake Grossman, CEO of BGI, will serve as a vice chairman of the combined firm, head of scientific Investing, and a member of the office of the chairman.

Under the terms of the transaction, BlackRock would acquire BGI in exchange for 37.8 million shares of common and common equivalents in BlackRock and $6.6 billion of cash. The shares will represent a 4.9% voting interest and an aggregate 19.9% economic interest in the combined firm.

Barclays will have certain restrictions on the sale or acquisition of shares in BlackRock, but will have the right to maintain its ownership percentage if BlackRock issues additional shares in the future.

The cash portion of the purchase price will be funded through a mix of existing cash, committed debt facilities and proceeds from the issuance of equity securities to a group of institutional investors. The cash portion of the purchase price is 100% committed.

A group of banks, including Barclays, Citi and Credit Suisse, has committed to provide BlackRock with a new 364-day revolving credit facility of up to $2 billion. The facility would be drawn at closing to the extent necessary and repaid during the term from the proceeds of any capital raising transactions. It is BlackRock's intent to refinance any draw down under this facility with the proceeds of term debt financings.

BlackRock has received commitments from a group of institutional investors to purchase 19.9 million shares at the closing of the transaction for a total of $2.8 billion.

In addition to the conclusion of the go-shop arrangement, the transaction is subject to approval by Barclays shareholders, regulatory approvals, client consents and customary conditions.

Citi and Credit Suisse served as lead financial advisors to BlackRock. Banc of America Merrill Lynch Securities, Morgan Stanley, and Perella Weinberg Partners provided additional financial advisory support. Skadden, Arps, Slate, Meagher & Flom served as legal counsel to BlackRock.