State Street is set to acquire their competitor, Brown Brothers Harriman, making them the largest custodian in the world at roughly $37,000,000,000,000 in client assets.
But why are they doing this, why is it important and what does it mean for the stock price? Let's jump into it below:
State Street Acquisition Overview:
State Street is set to acquire, BBH (Brown Brothers Harriman) Investor Services for $3.5B. BBH hold's ~$5T in client assets, thereby pushing STT's AUC (assets under custody) to ~$37T. The transaction with BBH is expected to close at year end. One the main reason STT is looking to acquire BBH is because BBH has significant exposure to EMEA, Asia, Latin America and other markets that SST is "light in". The reason this is important is two fold:
- The first is because in the Non-US geographies, the fee's and margins are higher. As we always preach here at Moby, margins are key to understanding the scalability of any companies business model. By unlocking higher margin geographies, STT can make their business more efficient, productive, and profitable.
- The second is because STTwill be able to unlock better margins and growth than BBH was able to in those same regions. This is because of the synergies (see below for definition 👇) their acquisition will present. With BBH, STT can use those synergies to force higher margins, and metrics associated with increases in overall growth.
If you're unfamiliar with the term, synergy is essentially the output of a partnership where 1+1 is greater than 2. What we mean is that in isolation companies often have ceilings on their growth. But by partnering or acquiring other companies, the thought is that they'll be able to unlock new products, growth or financials that were previously impossible to attain.
For example if Tesla wanted to build an electric airplane it would likely be a massive undertaking. The same would go for Boeing if they wanted to build an automobile. But if Tesla and Boeing were to join forces they'd likely be able to use each other's resources to create a product that neither would be able to do easily without the other.
Significance Of The Acquisition:
So while you now understand why STT wants to do this, what we haven't yet discussed is the implications on their business going forward. With this acquisition, STT now expects to raise their margins to ~31% by the end of next year. In a few years they also hope to net $250M of expense synergies and $38M of net revenue synergies. If they're able to achieve these 3 metrics, or close to it, we know it will warrant a much higher valuation. What we need to see however, is that the path to getting there starts to materialize early to mid next year. Our initial analysis shows that this path is extremely realistic for STT. This is because STT has shown their ability to increase margins in their existing locations. By using BHH's new clients, STT should be able to leverage their scale.
If this does happen, we think STT's stock can start to generate serious outperformance over the next year or two.
State Street's Outlook:
We think STT's performance should stay in line with the S&P for the remainder for the year. Once the acquisition starts to materialize next year, we should start to see the outperformance relative to the market.
However STT could appreciate before then if one of two following scenarios happen:
- The FED raises interest rates faster than expected. STT is somewhat sensitive to interest rates and should the FED do this faster than anticipated, we estimate STT's stock price to be affected.
- STT's synergies with BBH become more apparent/clear to other investors. Right now the market is unsure of the expected synergies, but should these start to become mainstream, we would likely expect the stock price to start outperforming sooner rather than later.
How To Play It:
The key takeaway is that we're initiating an overweight position on STT now should these events occur sooner than we think. In any case, STT should yield some income in the short term, track the S&P on a nice risk/reward basis and provide potential upside this year, if not next!
Price Target: $110 (26% upside)
Today's Price: (September 8, 2021): $87
Target Date: Q2-Q3 2022
Dividend Yield: 2.59%
Rating: Overweight
Ticker: STT