Cashing in on the New Frenzy
Companies focusing on steady growth face a real challenge: recent massive cost-cutting may have boosted bottom-line results, but as economic growth is likely to remain tepid in coming years, it will be hard to keep showing impressive year-over-year gains. At this point in previous economic cycles, management teams have historically sought to keep sales and profits rising by pulling out their checkbooks. Good old-fashioned M&A (mergers and acquisitions) is a tried-and-true method to maintain growth rates.
Increasingly, potential buyers are turning to Greenhill & Co. (NYSE: GHL). While bigger rivals try to focus on all aspects of financial services, Greenhill sticks to its core business: M&A advisory. Greenhill was founded back in 1996 by Robert Greenhill, a former top banker with the now defunct Salomon Brothers. He took the firm public in 2004.
That pure-play focus on M&A advisory has paid off, as sales and profits grew sharply every year – that is until the stock market and economy seized up 18 months ago. In 2008 and the first half of 2009, very few companies were willing to take the chance that an acquired company might suffer an even deeper sales plunge. Notably, Greenhill’s advisory-related fees fell -1% overall last year (offset by gains in merchant banking), while industry-wide M&A fees declined -23%, according to data tracker Dealogic. (The value of announced deals fell a sharper -36%). The second half of 2009 represented a thawing out for deal-makers, which led Greenhill to post a sharp turnaround in sales and profits.
Now, Greenhill is entering the sweet spot of the M&A cycle, and if history is any guide, the deal-making spigot should open wide for the next few years. As a point of reference, Greenhill posted $400 million in sales back in 2007, more than $4.00 a share in profits, and generated more than $100 million in free cash flow. Since then, the company has been plucking away top talent from beleaguered rivals, and opening offices in countries that are poised for an M&A boom – especially in Asia. Greenhill has opened an office in Tokyo, and has just acquired Caliburn, one of Australia’s leading M&A advisory firms. The deal led several analysts to sharply boost profit estimates for 2010 and 2011. The beefed-up operations should enable Greenhill to exceed those stellar 2007 results when the M&A cycle is in full bloom.
Providing deal-making advice can be quite profitable. Operating margins hit 38% in 2009, and return on equity approached 30%. Those metrics have been fairly constant in the ups and downs of the economic cycle, and are due to more reasonable compensation practices than found at peers. At some of the top M&A banks, employee compensation, as a percentage of sales, is usually in the 55% to 60% range. Greenhill typically maintains compensation around 45% of sales. Management can still lure top talent, as the firm is not bogged down by bloated expenses from other less-profitable divisions, so banking advisors still take home a similar amount of money as they would at the biggest firms.
So what should you expect from the next few years? Barring a massive economic meltdown, deal-making should keep building – regardless of whether the economy limps along at a turtle’s pace, or becomes more robust. (As noted earlier, the main risk to deal-making is a recession, which few analysts and economists anticipate at this time).
Greenhill’s revenues are expected to rise at a +20% clip this year, and at an even faster clip in 2011, using past economic cycle M&A volumes as a guide. As previously noted, per-share profits hit $4.00 in 2007, and there’s no reason to believe they can’t exceed $5.00 this time around, as the company now has greater market share and an expanded global footprint. Shares may be pricey on trailing results, but trade for a more reasonable 16 times that 2011 or 2012 outlook. When the M&A cycle has really heated up in the past, Greenhill traded for 25 to 30 times projected profits. By my math, this stock should hit $125 – some +50% above current levels – or 25 times that 2011 or 2012 outlook.