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Matthew Martos

GHL AT A GLANCE

P/E ► 35.5 AVG EV/EBITDA ► 21.0 AVG ROA ► 23.8% VERY HIGH ROE ► 35.6% VERY HIGH Debt to Equity ► 0.357 LOW Interest Coverage Ratio ► 69.3 VERY HIGH

 

 

 

 

 

 

Greenhill & Co. (GHL) is an independent boutique investment bank that specializes in providing medium and large-cap companies with corporate advisory services, including mergers and acquisitions, recapitalizations, and distressed sales. It charges clients fees based on the value of the transaction or restructuring. It also manages and invests its own capital in a family of private equity funds that target small, non-public companies, earning revenue primarily through management fees and net gains on their investments.

In FY 2007, Greenhill's total revenue was $400.4 million, with its financial advisory revenue witnessing a 241% jump from FY2003. Notably in 2007, the company presided over the acquisition of ABN Amro by Fortis (FORB-BT), the largest-valued transaction ever in the financial services industry at $99.1 billion^[1]. Greenhill has accomplished high profit margins the past three years through industry-leading revenue per employee ($1.9 million in FY2007), successful geographic and managerial expansion (43 managing directors in 2007, a 40% increase over the prior year), and a strict adherence to low, performance-based compensation costs (below 50% in FY2005-FY2007)^[2].

As a result of the 2008 financial crisis, many of Greenhill's competitors have either been acquired, declared bankruptcy, or re-chartered to become bank holding companies. Although in 3Q08 saw quarterly losses of $51.9 million in its merchant banking funds and a 68% decrease in financial advisory from 3Q07, Greenhill has largely resisted the economic turmoil thanks to modest leverage in its merchant banking investments^[3]and a lack of exposure to the ill-fated securitized home loans that plagued so many of its competitors during the subprime mortgage crisis^[4]. Greenhill was thus able to increase its global presence in 2008 by establishing offices in Chicago and Tokyo, while struggling banking firms were forced to substantially reduce staff domestically and abroad^[5].

Total Revenue and Net Income have Risen Steadily Since 2004^[6]

Company Overview

Despite having gone public in 2004, Greenhill's managing directors still owned 58% of the company at the end of FY2007, thus following a business model close to that of a private firm^[7]. It stands out from its competitors in its status as an independent firm, not acting as the subsidiary of a larger bank and thus never at a conflict of interests in servicing larger financial institutions. Lacking services such as research, deposit-taking and trading, it is able to focus solely in its conflict-free advisory work and merchant banking funds. Its advisory wing overlooks financial restructuring for its clients, mediating on matters such as mergers and acquisitions (M&A) , divestitures, or recapitalizations, and receiving a commission based on the value of the transaction. It places much less emphasis on its merchant banking, which manages four private equity funds for unaffiliated large-scale investors and also injects direct equity investments into those funds.

Business and Financial Metrics

Since its inception in 1996, Greenhill has witnessed consistent revenue growth at a compounded annual rate of 27%, reaching $400.4 million in revenue for FY2007^[8]. A growing geographic presence, with the percentage of offshore financial advisory revenue growing 139% from FY2004 to FY2007, and the continuous acquisition of experienced managing directors has fueled this growth by facilitating the expansion of its customer base. Being a small banking firm, it relies on advising a limited number of clients (in FY2007, 56% of its advisory revenue could be traced to its top ten clients)^[9]. A discipline in containing employee compensation costs as a percentage of total revenue have been integral to Greenhill's edge in profit margins over the rest of the industry, especially during the 2008 Financial Crisis when it hast led the industry in (46% in 3Q08)^[10].

Because its merchant banking is contingent upon the performance of its portfolio companies, it bears volatile returns and is a riskier source of revenue than its financial advisory segment. It feeds off of the management fees from outside capital invested in its funds, net gains from its own direct equity investments, and profit overrides when returns surpass certain benchmarks. Poor performance in 7 of its 19 portfolio companies in FY2007 resulted in decreased yields of 65% in net gains and 87% in profit overrides over the prior year.

Business Segments

Financial Advisory Constitutes the Majority of the Firm's Earnings^[11]

Financial Advisory (92% of revenue in FY2007)

Greenhill's financial advisory division focuses on mergers, acquisitions, restructurings, and other complex corporate financial matters. Financial advisory revenues increased 241% from FY2002 to FY2007, edging out the four largest investment banks' average revenue increases of only 175% during that period. Their advisory fees also totaled $366.7 million in FY2007, a 75% increase over the prior year^[12]. In FY2007, it advised and oversaw several prominent transactions, including the acquisition of ABN AMRO Holding NV by Fortis SA/NV, and the acquisition of BCE Inc. by Teacher’s Private Capital, valued at $99.1 billion and $52.1 billion, respectively ^[13]. This boost allowed it to withstand the economic downturn in 2008 and expand into Japan and Chicago in late 2008, where it hopes to expand its clientele and establish relationships with industrial-leading midwest clients^[14].

Merchant Banking (8% of revenue in FY2007)

Returns on its merchant banking division align heavily with fluctuating economic conditions and the performance of its funds. Because Greenhill incurred losses in 7 of its 19 portfolio companies in FY2007, revenue stood at a meager $33.7 million (8% total), a decrease of 65% over the prior year. Greenhill's merchant banking has also struggled in FY2008, incurring losses of $51.9 million in 3Q08^[15]. As of September 30, 2008, 32% of their total principal investments were related to the energy sector, a stake that has proven unfavorable to Greenhill because of the 3Q08 dive in Oil Prices ^[16]

Trends and Forces

A Decline in Investment Banking Participants Leaves Greenhill with an Opportunity to Build Market Share

Advisory in Europe Instrumental to Greenhill's Success^[17]

Because of the 2008 financial crisis, the financial landscape is in a state of flux where credit is inaccessible and players seek ways to overcome heavy losses and re-establish solvency. Greenhill has not needed restructuring or capital infusions from the U.S. governments, but others have not been as fortunate. Lehman Brothers (LEH) and Bear Stearns Companies (BSC) filed for bankruptcy, Merrill Lynch (MER) was fire-sold to Bank of America (BAC), and Goldman Sachs Group (GS) and Morgan Stanley (MS) declared they would deleverage and begin retail banking activity.

To Greenhill this market upheaval is a double-edged sword. Because many of its competitors have merged or disappeared, roughly 22% of the M&A market is now open for Greenhill to build tremendous market share^[18]. A clean track record during this crisis can also help Greenhill emerge from the ruckus with a competitive advantage in financial advisory because of its status as an independent firm. In FY2000, 19% of all completed global M&A volume could be traced back to independent banking firms; in FY2007, 36% of M&A volume was attributed to independents^[19].. With the changing financial arena, many of Greenhill's competitors have no choice but to consolidate into larger banking entities, creating a conflict of interests when servicing clients. However, some of Greenhill’s joint rivals now have at their disposal multi-functional services, such as deposit-taking, that provide clients with a wider range of products than those offered by Greenhill.

An Unavailability of Credit Reduces M&A Activity

The tightening of credit after the 2007 Credit Crunch has decreased global M&A activity, particularly in the United States and Europe. As of December 22, 2008, global M&A deals had decreased 31% in volume from a year before, according to Reuters. Over 1,100 deals were canceled in 2008 as unfavorable worldwide market conditions are undermining firms' abilities to make acquisitions.^[20]. Greenhill is not impervious to the frozen credit markets, suffering 68% drop in financial advisory revenue in 3Q08 from 3Q07.

Boutique Status and Merchant Banking Strategy are Heavily Affected by Fluctuations in U.S. Economic Cycles

With 94% of its four merchant funds invested in U.S. equities at the beginning of 2008, Greenhill is prone to suffer the detrimental effects of recessionary periods in the U.S^[21]. Historically, it has followed an investment strategy in which it holds the companies in its merchant funds for three to five years, regardless of economic conditions^[22]. In the 3Q08, this cost Greenhill a loss of $51.9 million and poses threats for the future of its merchant banking division.

The international exposure of its financial advisory branch has helped hedge against domestic risks, with 58% of the financial advisory revenue of 2007 coming from Europe ^[23]. Additionally, the opening of an office in Tokyo in October of 2008 is indicative of its desire to establish a more global perspective and diversify its clientele ^[24].

Because of its status as a boutique investment bank, Greenhill’s relatively small clientele is a liability. Its top ten clients accounted for 56% of the firm’s total revenue in 2007, something that leaves Greenhill's senior management constantly looking out for new clients and gives Greenhill’s present clients tremendous leverage^[25].

Capital-Rich Japanese Companies Seeking Buyouts Presents Opportunity for GHL

With record profits accruing year after year, Japanese companies have been making large strategic buyouts abroad since 2007, singling out distressed firms. Through October 2008, they have executed transactions totaling roughly $57 billion for the year, exceeding previous national highs, and are likely to continue as worldwide valuations are relatively cheap ^[26]. In seeking tactical acquisitions around the world, these companies will need financial advisory in sorting through all the possibilities. In 2008, Greenhill's made a strategic expansion to Tokyo.

Competition

Greenhill's revenue per employee of $1.9 million in FY2007 led the industry, closely followed by Goldman's revenue per employee of $1.6 million. This high productivity provides downsize protection, and along with consistently low compensation costs, results in sizable profits for Greenhill^[27]. It competes in securing mergers and acquisitions and restructuring advisory engagements against other prominent boutique investment banks, including:

• Lazard (LAZ): Lazard is a leading international financial advisory and asset management firm. Like Greenhill, it advises clients on financial matters such as mergers and acquisitions, restructurings and other complex transactions.
• Jefferies Group (JEF):Jefferies Group is a full-service investment bank and asset management firm. Jefferies and Greenhill often contend for the same middle-market companies, those ranging from $25 million to $1 billion, although Greenhill does also target companies of larger valuations.

Greenhill also competes against its bulge bracket rivals for clients in M&A transactions. Examples of bulge bracket rivals include:

• Goldman Sachs Group (GS): Goldman Sachs is now a bank holding company. Mergers and acquisitions is its specialty, leading the pack in 2007 with over $1.2 trillion in completed M&A volume.
• Morgan Stanley (MS): Morgan Stanley is also a bank holding company. Alongside Goldman Sachs Group (GS), it is an annual leader in financial advisory and restructuring.

With the Disappearance of Many of its Competitors, Greenhill is Looking to Build Market Share ^[28]

Market Share

According to Bloomberg, Greenhill & Co. ranked #19 globally in M&A advising in 2007. Because of the aforementioned structural changes in the financial industry, Greenhill looks to become a more important player in the future demand for corporate advisory services^[29].

References

1. ↑ Greenhill 2007 Annual Report
2. ↑ 4th 2008 ghl kbw 11 5 08 vfinal.pdf Keefe, Bruyette & Woods Securities Brokerage Conference, 11/05/08
3. ↑ GHL 3Q08 10-Q, Item 2, pg. 24
4. ↑ Adelson & Jacob Consulting, The Subprime Problem:Causes and Lessons, 1/8/08
5. ↑ PR Newswire, "Greenhill & Co. Reports Third Quarter Net Loss Per Share of $0.42" 10/24/08
6. ↑ GHL 2007, 10-K Item 6, pg. 21
7. ↑ GHL 2007, 10-K Item 6, pg. 10
8. ↑ Greenhill 2007 Annual Report
9. ↑ GHL 2007, 10-K, Item 1, pg. 6
10. ↑ 4th 2008 ghl kbw 11 5 08 vfinal.pdf Keefe, Bruyette & Woods Securities Brokerage Conference, 11/05/08
11. ↑ GHL 2007, 10-K Item 7, pg. 24
12. ↑ GHL 2007, 10-K Item 7, pg. 24
13. ↑ Greenhill, "Selected Transactions"
14. ↑ Newswire&docDate=November 3, 2008&press_symbol=US;GH The New York Times, "Greenhill & Co. Expands to Chicago to Cover Industrial Sector and Midwest Clients," 11/03/08
15. ↑ GHL 3Q08 10-Q, Item 2, pg. 24
16. ↑ GHL 3Q08 10-Q, Item 2, pg. 26
17. ↑ GHL 2007, 10-K Item 7, pg. 25
18. ↑ Bloomberg Terminal, MOST function, M&A Worldwide Completed Deals, 2007
19. ↑ 4th 2008 ghl kbw 11 5 08 vfinal.pdf Keefe, Bruyette & Woods Securities Brokerage Conference, 11/05/08
20. ↑ Reuters, "WRAUP 1-Global M&A Falls in 2008, Ends Five Year Growth," 11/22/08
21. ↑ GHL 2007, 10-K, Item 4, pg. 14
22. ↑ GHL 2007, 10-K, Item 4, pg. 16
23. ↑ GHL 2007 10-K, Item 7, pg. 25
24. ↑ The Deal, "Greenhill hires M&A bankers, opens Japan office," 10/15/08
25. ↑ GHL 2007, 10-K, Item I, pg. 6
26. ↑ The Economist, "Japan's Overseas M&A Spree" 10/02/08
27. ↑ 4th 2008 ghl kbw 11 5 08 vfinal.pdf Keefe, Bruyette & Woods Securities Brokerage Conference, 11/05/08
28. ↑ Reuters, "Global Ranking of Top M&A Advisers" 9/15/08
29. ↑ Bloomberg Terminal, MOST function, M&A Worldwide Completed Deals, 2007