Greenhill is an independent M&A advisor, often referred to as an M&A boutique along with public peers Lazard (LAZ), Evercore (EVR), and recent IPO Moelis (MC). The business model is very straight forward, M&A advisors are generally paid when deals close and are paid based upon a % of the deal value. So when M&A activity spikes, advisor revenue spikes along with deal closings.

Greenhill is in an odd position of sitting in an industry with accelerating activity (2014 YTD industrywide announced M&A activity highest since financial crisis), yet Greenhill is reporting deteriorating results. According to Bernstein research, 97% of M&A activity is explained by the level of global financial assets and given levels of globlal financial assets, M&A activity is running at 'normalized' levels. Yet, when we look at Greenhill's valuation, it seems investors believe GHL's earnings are at cyclically depressed levels with GHL shares at more than 2x teh S&P P/E multiple and at least a 50% P/E premium to closest peers. Going forward, Bernstein expects M&A activity to grow at 7 to 8% annually (and Greenhill's marketshare has been flat for several years), thus it seems investors are paying over 30x P/E for a business that grows 7 to 8%, has a balance sheet that's experiencing significant deterioration and is maxed out against debt covenants, meanwhile shares trade at a significant premium to peers despite the company's underperformance relative to peers.

1) Deteriorating Balance Sheet

Greenhill has significantly drained its balance sheet in order to buyback shares and maintain its dividend, yet despite the huge buybacks, the share count has not meaningful declined because so many shares are issued as compensation.

Net Cash & Investments 

1Q13:  $49.7m

2Q13:    40.4

3Q13:    16.3

4Q13:    23.6

1Q14:      6.5

 *Note: Cash flow and balances are seasonal due to bonus cycle

2) Debt Covenants Maxed Out - Buybacks Will Be Difficult to Execute

Greenhill's debt agreement with First Republic has four covenants: 1) Debt / (Tangible + Subdebt) not to exceed 2.0, 2) Debt / LTM EBITDA not to exceed 1.25, 3) Liquidity of cash and cash equivalents must be at least 1.0x debt, and 4) tangible net worth must be at least $90m. GHL is at risk of exceeding two of these covenants (#3 and #4) if they execute on their current buyback and dividend 

Liquidity Ratio Trend (Bank Covenant has 1.00 Max)

1Q13:  2.25

2Q13:  1.85

3Q13:  1.14 

4Q13:  1.38

1Q14:  1.01

Tangible Equity Trend (Bank Covenant $90m Min)

1Q13:  $131m

2Q13:    124

3Q13:    118

4Q13:    134

1Q14:    104

Another data point that GHL's balance sheet is stretched is that to start 2013, GHL approved a $100m buyback, but only completed $55m. 

3) Without Buyback, Stock Supply/Demand Becomes Imbalanced and Share count Will Grow

Since its IPO, Greenhill has had a high short interest. Pre-crisis, short interest average about 20 days. More recently, short interest has been about 10 to 15 days of trading volume. However, since mid-2013, the short interest has dropped to lows, running more in a range of 5 to 10 days. I believe the high short interest combined with a very active share buyback program has led to an elevated share price. In the last three years, GHL has averaged just under $70m in buybacks per year. So if we combine minimal buybacks with a much lower short interest, supply/demand of GHL shares this year could dramatically change.

Despite the hundreds of millions spent on share buybacks in recent years (and highlighted numerous times in GHL's investor presentation), what isn't mentioned is that it has not resulted in a lower share count. In 1Q11, GHL's diluted share count was 31.1m. Three years later after spending 13% of their market cap on buybacks, the share count was 30.2m in 1Q14 or only 3% lower. 

4) Lack of Deal Announcements (Deals Announced but Not Closed - Leading Revenue Indicator)

Lazard:    $199 billion

Evercore: $145

Moelis:     $25

Greenhill: $38

5) Employee Departures, While Bad for the Firm, Benefitted 1Q Results by an unreported 17c

When employees depart Greenhill with unvested stock, there is a reversal to restricted stock amortization. Despite this happening on more than one occasion, the company will not disclose the amount of the benefit nor call it out as 1-time. However, we can see the benefit in the cash flow statement. In 1Q14, restricted stock amortization was only $5m compared to the $13 to $15m run-rate in 2013 so it appears compensation had a 1-time $8.5m benefit or 17c per share. We saw a similar impact in 3Q 11.

What is more concerning is why key producers are leaving Greenhill in spite of leaving so much on the table.

6) Greenhill's Growth & Productivity Gains (or for GHL Losses) Lag Peers 

On every major metric, Greenhill's growth has lagged peers (Lazard is excluded from this analysis because half its business is asset management which skews comparisons)

Revenue CAGR from 2008 to 2013

MC:  45%

EVR: 28%

GHL:   5%

Comp Ratio Since 2008

MC: 10 points lower

EVR: 6 points lower

GHL: 7 points higher

# of Employee CAGR Since 2008

MC:  84%

EVR: 24%

GHL: 7%

Revenue / Employee CAGR Since 2008

MC:  5%

EVR  3%

GHL -2%

7) Missing Out on the Trend to Boutiques

GHL's market share has been stagnant in recent years and down YTD while peer boutiques have been gaining share. YTD GHL's market share is 0.5%, below their 0.8% recent average and recent year's don't show much of a trend (1.1%, 1.0%, 0.7%, 0.9%, 1.1% in the last five full years). Meanwhile boutique peers are seeing big increases. EVR's share has increased very year since 2010 and MC's share has increased 4 of the last 6 years from 0.2% in 2008 to 1.5% YTD.

8) A Lower Share Price Directly Impacts the Business

While many other companyies can tell their employees that the near-term share price does not matter, this is not true at Greenhill. A lower share price makes it cheaper for competitors to poach talent because the targeted producers will be walking away from less stock value. For example, walking away from 100,000 shares when the stock is at $40 is much cheaper than waking away from 100,000 shares when the stock is at $60. Usually the recruiting firm needs to compensate for the lost restricted stock so the lower price directly makes recruits cheaper. Additionally, because Greenhill so heavily compensates their employees with restricted shares, a lower share price means more shares will need to be issued to effect the same dollar amount of compensation.

Risks to the Thesis:

Significant increase in M&A activity with GHL participating. This would benefit reported results, but also allow the company to maintain its dividend and execute its buyback.