Description

For a formatted version see here: https://www.dropbox.com/s/7owoy7a31z2lwp8/GHL%20Short%20Thesis.pdf?dl=0. This was originally submitted a week ago for membership entrance when GHL was at ~$20.

Situation Overview

Recently, Greenhill (“GHL”) did a leveraged recap to take advantage of what mgmt. believes is a temporarily depressed stock price. In Oct. 2017, GHL raised $350mm TLB at L+375 to repay the existing bank debt and repurchase up to $285mm of shares. Bob Greenhill (Chairman) and Scott Bok (CEO) also pledged to purchase $10mm each in newly issued common stock. On 10/30/17, GHL completed its previously announced tender offer for 3.4mm shares / 12% of shares outstanding (out of an announced 12mm share tender offer) at $17.25. This alignment of interests with mgmt. and share prop-up from the recap has driven the stock up to ~$20 today.

Greenhill has been written up twice on VIC: a short in 2014 by chaney943 and a long in Nov. 2017 by piggybanker. We believe many of the points that chaney943 brought up about the structural issues of the business are still valid and have become even more prevalent. We disagree with piggybanker’s view that GHL’s issues are short-term. However, we agree that the technical components he discusses have merit. These have somewhat manifested in the run up to ~$20 and we believe may provide for future attractive entrypoints. .

Investment Thesis

We believe GHL is a business in secular decline and that the recent recap presents an entry point to short the business. While management believes that 2017 is a trough year in earnings (thus the leveraged recap), we believe that the issues GHL faces are long-term and that results will either trend sideways or potentially get materially worse. Below are what we believe to be the key points that support the secular decline thesis:

• Increasing revenue amongst boutique M&A peers (Moelis, Lazard, Evercore, PJT), while GHL revenue have been stagnant from 2012 – YTD 2017 (particularly if backing out ~$40-50mm of fees from Teva / Allergan)
• Historical failure to win “large transactions” (>$1bn), but mgmt. says that is GHL’s primary focus
• Least productive (revenue per MD) of the boutique banks
• Significant concentration in deals with a small set of MDs
• Significant MD turnover in recent years, with high-profile ones occurring post leveraged recap
• New MD hires in past years haven’t visibly contributed to deal announcements & lack of prestigious hires

We believe GHL’s glory days are behind it and the declining revenue / transaction count will continue. As the CEO says, “the nature of our business is such that if somebody asks us to forecast our revenue 4 quarters out, I mean, it doesn't matter whether you sign a confidentiality agreement or not, that's a hard thing to do other than just in a very, very directional sense. We look at the above points to get a directional sense of where the business is heading, which we believe is not in a good direction. We believe GHL’s fair value price is between $12-13 in the next 12-24 months with significant potential for more decline.

Current Bull Case

The bull case is predicated around 2017 revenue weakness being one-off / a temporary lull & doesn’t signify franchise deterioration. Also, increased buyback capacity provides meaningful share support and a declining share count by ~50% will reduce float / liquidity increasing risk / borrow costs to shorts. This technical prop-up should be enough for the M&A market to recover & any policy uncertainty to subside so when the M&A tide rises it’ll lift all boats including GHL.

Business Overview

GHL has a very simple business model as a pure advisory boutique investment bank. It generates revenue by advising companies on M&A or RX, and is paid the vast majority of the fees upon completion of an M&A transaction (for RX, the fee model is a monthly retainer usually around $100K-200K and a success fee upon completed RX or refinancing). This is different from lawyer fees that are billed hourly and are paid even in a failed transaction. As such, time spent on trying to win new business / client opportunities and failed transactions receive $0 in revenue. This is a highly competitive business with a large number of bulge brackets (GS, JP, MS, BAML, CS, Citi, DB) and pure advisory boutiques (LAZ, EVR, MC, PJT, Centerview, Perella, etc.) all vying for clients. GHL does not do the other things associated with bulge bracket IBs (trading, underwriting, lending etc.). This could be problematic when competing for M&A business, as many companies will choose to have a bulge bracket also provide M&A advice if they need financing as part of the transaction.

GHL also does not have an asset mgmt. business like LAZ (~50% of revenue) or an equity research arm like EVR (~20% of revenue) to smooth out the inherent lumpiness of M&A advisory. It did acquire Cogent, a secondaries advisory business (advising endowments / pensions on selling their PE assets), in Feb. 2015 for $98mm (30% payable as earn-outs). We believe this business is contributing a little less than $40mm of revenue today (~15% of revenue), discussed further below. However, Cogent is also an inherently lumpy business as it’s also a transaction business (albeit not tied to the same macro factors as M&A). GHL has a real estate capital advisory segment, but only currently has 3 MDs so we don’t ascribe much value to it being a significant buffer to the lumpiness of M&A.

Stagnant / Declining Revenue from 2012 – 2017

A look at historical revenues indicate 2017 isn’t actually a trough year, but that 2015 was as well with $230mm of revenue (when backing out Cogent revenue). GHL revenue has been declining every year from 2012 – 2015 and 2017 YTD. While we recognize, global / US M&A has been decreasing in recent years, every other boutique peer has been growing (some significantly) in those years.

2012-2014 declines are concerning, but one of the main indicators of a deteriorating franchise is the low in 2015 of ~$230mm, excluding ~$30mm of revenue from Cogent that year (calculated as ¾ contribution of ~$40mm of revenue; $9.6mm reported for Q1 2015, run-rate of $38mm, FY 2014 of $45mm), followed up with YTD 2017 also at $233mm (when extrapolating out $40mm for Cogent). FY 2017 will be much lower due to the significant outperformance in Q4 2016 and is projected to be $228mm of total revenue (incl. Cogent), which implies M&A / RX revenue of ~$200mm. We believe this ~$200–230mm is the new revenue base for the advisory business (ex. Cogent) with strong potential for further deterioration going forward.

We also believe that the Teva/Allergan and subsequent divestitures that generated an estimated $40-50mm of revenue were an outlier, which makes 2016 an outlier (when the deals closed). Since 2012, GHL has completed 4 deals that were >$10bn (Teva / Allergan Generics, Safeway / Albertsons, Forest / Actavis, AvalonBay / Archstone). 2 of them were barely above $10bn (Safeway & AvalonBay) and Forest / Actavis was ~$25bn. One thing specific to the Teva transaction was the multitude of divestitures that GHL did for them afterwards that generated significant revenue. Also, GHL appears to have lost the Teva account with MS advising Teva on its recent ~$1.4bn divestiture of its Women’s Health business. It’s also replaced its Head of Generics and CEO since the GHL transaction. GHL also appears to have lost the Actavis account when Paul Bisaro was replaced as CEO of the company post-Forest Lab by Forest Lab CEO, Brent Saunders. When Actavis bough Allergan for $66bn, JPM was Actavis’ sole adviser. Even less promising for GHL, when Bisaro became CEO of Impax and sold it to Amneal ($6bn deal, Oct. 2017) he used MS as his adviser.

Significant Recent MD Turnover

“We've obviously not have a problem with retention. We've really lost pretty much nobody in a very long period of time”

–         Scott Bok Q3 2017 Conference Call

However, an analysis of GHL’s website historically shows otherwise. MD turnover is important as they’re the key revenue generators and have a book of clients that usually follow the MD as they trust the person for the advice not the broader institution they’re at. Below is the data on the recent MD turnover (we equate transition to “sr. adviser” as a departure in terms of revenue generation as they are not day-to-day expected to go out and win clients / mandates).

(1)   3 transitions to sr. adviser

(2)   5 transitions to sr. adviser

On an absolute basis, the numbers seem small, but GHL already has a small MD base. At the beginning of 2015, we estimate that GHL had 63 M&A MDs. This results in a turnover of ~33% when excluding sr. adviser transition and ~45% when including. When increasing the timeframe to 5 years, it becomes roughly 50% turnover when excluding sr. adviser transition. This implies that since 2015, 1 out of every 3 MD is a new person. This is problematic due to the loss of clients and industry expertise when MDs leave, particularly exacerbated as GHL has many industries covered by only 1-2 MDs. We did not benchmark against the other boutiques, but believe that these are very high numbers.

In fact, the first risk factor stated in the 10K is “Our ability to retain our managing directors and other professionals is critical to the success of our business

Many of the MDs who have left were also “rainmakers” who came from prestigious banks and were heads of groups at GHL. Some departures have resulted in a loss of coverage of an industry or severe decline in transactions in that industry. Many of these MDs have been with GHL for over 5+ years so their recent departures are alarming for what they may be seeing internally in terms of pipeline / future performance. Below are some highlights of departures:

• Brad Robins (Joined in 2001 & left in Jul. 2016) – Was head of Restructuring at GHL and left for Ducera
• Steven Friedman (Joined in 2009 & left in Mar. 2015) – Was head of Financial Services at GHL (covered insurance companies) and left for Guggenheim as Sr. MD in FIG
  • Also took Ashutosh Rathore (Principal covering Insurance) with him to Guggenheim and as a result no one now covers insurance at GHL, which is a significant sector for M&A
• Dhiren Shah (Joined in 2005 & left in Jul. 2015) – Was head of Communications, Media and Tech at GHL & left to be Head of Sponsors at CS
  • Have seen a significant lack of technology deals since his departure
• Luca Ferrari (Joined in 2012 & left in Oct. 2015) – poached from GS where he was Head of Northern Europe M&A; was Co-Head of European Corporate Advisory at GHL; now is Head of M&A EMEA for BAML
• Christopher Mize / Aaron Hoover (Joined in 2009 & left in Oct. 2014) – started the GHL Houston office and responsible for the Energy practice; poached by MS to be Chairman of Energy America and Co-Head of Energy America, respectively
  • Had multiple >$1bn energy deals in their tenure; 0 since departure
    • Replaced with 3 new MDs but have seen essentially 0 transactions in energy space since
    • Essentially resulted in the loss of all energy deals

The recent departures can be correlated to the recent decline in stock price as a good portion of MD bonuses are in GHL RSUs. For example, at the start of 2014 GHL traded at ~$60 and at the start of 2015 it had declined by 33% to ~$40 and now trades at ~$20. These RSUs have vesting periods, which means when issued $1mm of RSUs at year end 2013 they’d be worth $660K by 2015 and you’d just now be able to begin to cash out. Per FT article published Jan. 2017, “We were like, [expletive] it. We are producing all the revenue and subsidizing everybody that’s here. And on top of that, all our past [share-based] compensation is getting killed because other MDs are missing their revenue targets and the stock price is falling. It became a vicious cycle,” says one managing director, who left recently.”

Much more alarming is the recent departures of 4 MDs since the announcement of the leveraged recap (5% of existing MD base at time). Based on analysis of archived GHL web pages, it has seen the departures of Ashish Contractor, Nate Stulman and Anthony Parsons since the recap. We believe this is an indicator that there are a number of MDs who do not believe in the company’s future post-recap and this could just be the beginning of the departures. Particularly revealing is that both Ashish and Stulman joined GHL as associates out of HBS and climbed the ladder, only to leave shortly thereafter the recap. These MDs should be the most incentivized to win new deal flow and have many, many years remaining in their career. The others are an MD who was Head of European Corporate Advisory at the time and the Head of Forest Products who had been at GHL for a decade. Below is an overview of the exits:

• Ashish Contractor (Joined in 2005 as an associate & promoted to MD in 2012)
  • Worked with Rupert Hill on many of the largest Pharma transactions of their respective years (and largest transactions in GHL history)
    • Failed Concordia Sellside – would have been ~$5bn
    • Teva / Allergan Generics - $41 bn
    • Actavis / Forest Lab - $25bn
    • Actavis / Warner Chilcott - $8.5bn
  • Worked with Rich Jacobsen on many large HC Services transactions
    • Emdeon / Altegra - $910mm
    • Cerner / Siemens - $1.3bn
    • Aetna / Coventry - $7.3bn
  • The # of large deals across 2 disparate sectors of HC indicates he was responsible for the M&A execution, while Rupert Hill and Rich Jacobsen were more your classic “industry” bankers. With his departure, these 2 MDs may find it harder to generate large M&A transactions without him. Conversations with former employees about Rupert Hill have  generated comments like "wouldn't know what to do with a DCF if you gave it to him"
  • Recently, he was solely responsible for many of the deals from NY. While they were the smaller, it appears he made up for it in volume. He was responsible for 2 out of 6 deals done from NY in 2017 and 6 out of 16 deals from NY in 2016 (2 in conjunction with Rupert in 2016). Below are from 2016 and 2017.
    • Integra / Derma Sciences
    • AMAG / Palatin
    • Aralez / Toporol
    • BioD / Derma Sciences
    • QLT / Aegerion
    • Ligand / Cormatrix
  • Discussions with former employees indicate he was extremely close with Bob Greenhill and was a rising star in the firm with 1 of the 4 corner offices in NY (the other 3 belonging to Kevin Costantino, President, Scott Bok, CEO and Eric Mendelsohn, head of RX). This can be partially discerned from his promotion to MD in 6.5 years (similar to Costantino) while the typical timeline can take ~10 years (can be seen below with Stulman’s track)
• Nate Stulman (joined in 2006 as an associate and promoted to MD in 2016)
  • Was named co-head of Financial Technology shortly after being promoted to MD
  • Responsible for many of the credit card transactions
  • GHL has retained significant market share of these transactions and the knowledge in credit card transactions is particularly nuanced and not like usual M&A. Based on our discussions with industry experts there are a small number of banks competing for these transactions with Guggenheim and GS being the other 2 main players
    • Nordstrom / TD Bank - $2.2bn
    • Dillard’s / Wells Fargo
    • Target / TD Bank - $5.7bn
• Anthony Parsons (joined in May 2012 from DB where he was Vice Chairman of UK M&A)
  • Left post-recap to be Vice Chairman of Global Banking at HSBC
  • With his departure both Co-Heads of European Corporate Advisory left in a 2-year span of each other (Ferrari left in Oct. 2015)
  • Significant leadership turnover in Europe, which historically has generated between 25-30% of revenues cannot bode well
• James Flicker (joined in 2008 from Citi where he led Global Paper & Forest Products)
  • Left post-recap to join Sagent Advisors
  • Been at GHL for over a decade and one of longest tenured MDs in NY

We believe that the significant # of MDs who have left in recent years indicate a lack of confidence in GHL’s ability to right-size the ship. These MDs have also taken clients / business with them resulting in a vicious cycle of declining business for GHL. Especially concerning are the departures of 4 MDs shortly after the leveraged recap.

Historical failure to win marquee transactions (>$1bn) even with mgmt. “emphasis” on it

“Apart from this unfavorable mix of business by region, the fact that our work is historically more skewed to large transactions than of many of our closest peers has also been a headwind. As the data shows, the deal activity has shown most weakness at larger deal sizes”

-          Scott Bok Q2 2017 Conference Call

GHL mgmt. has repeatedly these past few quarters of underperformance blamed the lack of larger deals in the general M&A market since they’ve historically focused on them. Large transactions are meaningful as the fees / margins are higher. There are a few things we believe the data shows:

• Historically GHL has not won a significant # of large transactions as compared to peers
• Boutiques have increased the # of large transactions in recent years while GHL has decreased

As seen above, GHL is by far the worst performers amongst boutique peers in getting large M&A transactions. Even with the market for large transactions not performing well as of late (per Scott’s ad nauseam mentions), the other boutiques have managed to capture more share of those transactions. Particularly concerning is that the # of large transactions, which we define very liberally as >$1bn, for GHL has been declining from an already low base.

We also analyze it on a per MD basis to account for the different size of the MD base (# of large transactions / # of MDs.

GHL is woefully underperforming its peers. We believe GHL going forward will continue to struggle to win these large transactions and due to the mgmt. emphasis on them will be reluctant to shift towards a business model of volume with middle market transactions (e.g. Houlihan Lokey).

Least Productive (and Declining Productivity) MDs of Boutique Banks

Note:Excludes revenue contribution and MD count for non-M&A & RX advisory businesses; Centerview data is estimated for 2017 per various news articles

As seen above, GHL has by far the lowest productivity per MD of its boutique peers. We believe this is due to the lack of wins in marquee transactions of >$1bn (discussed above) and multiple MDs producing little to no revenue (discussed below). Even more concerning, is the declining productivity over time.

GHL is consistently the worst performer with declining growth in productivity as well. While we recognize M&A ebbs and flows, the continuous decline and lack of signs of a rebound (2016 notwithstanding as discussed above) further show that GHL is a deteriorating franchise whose current MD base will have a hard time turning around the business.

Concentration of Deals with Small # of MDs

“I'm just trying to get a sense of whether it's a core group of bankers that are doing most of the things or whether you have a new kind of wave of talent that's coming in and significantly contributing to the bottom line, too”

–BAML Equity Research, Q2 Conference Call

We believe it is a core group of bankers that have been responsible for the bulk of the transactions. We’ve analyzed the deals listed on the “Transactions” portion of the GHL website and have attributed deals to specific MDs. This can be readily done as GHL many times has 1 MD covering an entire sector. We would like to note that we believe every transaction GHL is a part of is on the website. This is based on discussions with former employees and the fact that they include transactions that are sub-$100mm on it (literally no smaller deals could be excluded).

There were only 31 transactions announced in 2017 and the New York office was responsible for only 6 deals (M&A only) with 2 MDs responsible for 4 of them. This statistic is alarming as the NY office is primarily the most productive office.  Also, our conservative estimate is that ~20 MDs produced zero transactions in 2017. Below is the breakdown by MD / office (where can’t discern specific MD).

• RX – 7 deals (3 MDs, 23%)
• Chicago – 3 deals (3 MDs, 10%)
• Australia – 3 deals (6 MDs, 10%)
• Greg Miller (NY / Media) – 2 deals (6%)
• Brazil – 2 deals (3 MDs, 6%)
• Contractor (NY / HC) – 2 deals (6%)
• Pieter-Jan Bouten (London / TMT) – 2 deals (6%)

These trends are repeated in 2016 with 48 transactions and 16 transactions out of NY with the same 2 MDs responsible for 12 of them. Note that the two lists are remarkably similar.

• Greg Miller (NY / Media) – 6 deals (13%)
• Contractor (NY / HC) – 6 deals (13%)
• Brazil – 5 deals  (10%)
• Chicago – 4 deals (8%)
• Australia – 4 deals (8%)
• RX – 3 deals (3 MDs, 6%)

While we realize deal count is not an exact proxy for revenue (one large transaction’s fees may be more than multiple small transaction fees combined), we believe this is a broader indicator that the productivity of the firm is concentrated amongst a very small core group of MDs. This leads to a significant risk of departures severely affecting GHL’s revenue. Already we’ve seen departure of one of the above MDs leave (Ashish, discussed above) and if Greg Miller or the Chicago office were to be poached (similarly to the Houston office) that would have a significant impact on GHL revenues.

Inability to hire Marquee MDs & Lack of Transactions from Recently Hired MDs

“And then on your new hires and maybe also internal promotes, have new hires been productive? And not just the people this year but maybe the last 2 or 3 years, people you've hired, people you've promoted”

-          BAML Research, Q2 2017 Conference Call

GHL has recently been on a hiring spree and has stressed it as a driver of growth. Below is the recent MD hire count.

*All 4 have departed since

Even with all these hires, GHL hasn’t been really able to grow its total base due to the multiple departures. Below is our analysis of the MD count for the M&A / RX business

We also believe that a good number of recent hires haven’t panned out and aren’t marquee hires that will drive growth. Below is a list of former banks / leadership positions (if any) of the new hires (hires from 2015 onwards)

• Jefferies
• Perella Weinberg
• UBS / Head of Capital Goods
• RBC
• BTG Pactual / Head of LatAm ex Brazil
• UBS / Head of LatAm ex Brazil
• Barclays / Head of RX
• BBVA / Head of European M&A
• Rothschild / Co-Head of Business Services
• Raymond James / Co-Head of Energy
• TD Securities / Head of Houston office
• JP Morgan / Head of Applied & Communication Tech.
• GCA Savvian
• GS / Co-Head of Nat Res for APAC
• Nomura / Global Head of Mining
• GS / Head of Canada Diversified IB
• GS / Head of Canada Mining and P&U
• JPM / Vice Chairman of Australia

A quick glance at the list shows that only 8 of the 18 above candidates came from one of the top bulge brackets or boutique banks (GS, JP, Barclays, UBS, which can be argued if still a top bank). However, 2 of them were in Australia and 2 were in Canada, which as regions don’t have significant deal flow. As Evercore’s CEO says, he’d rather not hire anyone than hire a B+ banker (https://www.bloomberg.com/news/articles/2017-07-27/evercore-says-damn-frustrating-as-potential-hires-rank-only-b). We believe GHL is hiring B+ bankers that will have a hard time driving growth.

This response on an earnings call from Bok regarding recruiting is especially telling.

“But I'm just curious what exactly your pitch is to the very best bankers? I guess from a very high, very simple level, if you're a top banker at a bulge bracket and you look at Greenhill's share price, revenue growth, accomplished over the last 5 years, my guess is you would've -- you would probably assume other boutiques are more attractive destinations, just my guess here. So maybe just help me understand what exactly is the unique or -- the unique selling points you are -- you offer to these banks as you pitch them?” – CS Research Analyst

“I think a few things. I think one is kind of the point I just made, which is that we tend to focus more on larger transactions. And there are a lot of bankers out there, particularly at some bulge bracket firms that, that's their history. They'd rather focus on a few home runs than a lot of singles and they prefer a firm that has that strategy. I think, secondly, I would still argue that we're the most global of the independent firms. Putting aside Lazard, which is 150 years older than us, but I would still say we're actually very, very similar to Lazard in terms of if you look at how much revenue comes from clients outside the U.S. besides us and Lazard, the other firms are all really quite significantly lower, so if you're in a sector where cross-border, global activity is critical to what you do, I think you're going to be drawn to us. Third, I think we're known to have a really collegial team-oriented culture, so it's important for you to work in teams to do complex cross-border things. I think that's a positive for joining us. And fourthly, I think frankly a big one, is that we're smaller. I mean some other firms have grown really dramatically in the last few years, so they've just got less white space. And people who kind of have had a 20-year career somewhere and they look at Greenhill, and depending on what their niche is, what their focus is with the clients, they might see an awful lot of white space here where it becomes quite interesting, whereas slotting into be the fifth MD covering your space at a firm that's built out a lot more, on a personal level it's not nearly that interesting, so that's fundamentally my pitch, and I hope some -- a few recruits are listening to that and they'll give me a call tomorrow.” – Bok

First, we think it’s hilarious that a research analyst uses a conference call to specifically ask how GHL is able to recruit. We agree with him and think the factors he lists (share price, revenue growth, historical accomplishments) make the other boutiques more attractive for the top bankers.

The CEO essentially cites the below reasons to join GHL, which we believe aren’t very compelling:

• Focus on large transactions – discussed above why other boutiques are arguably better at large transactions
• International focus
• The other boutiques have more than sufficient coverage in Europe, Australia and South America
• These first two reasons are also what he is always touting as why Greenhill is lagging behind in deal flow
• Some soft answer regarding “culture”
• GHL is smaller – There are many firms that are just as small (and arguably perform better), e.g. Centerview

An analysis of the most recent MD hires at the other boutique firms (LAZ, EVR, MC, PJT, Centerview) can confirm GHL’s lack of ability to attract top bankers. We’d particularly like to highlight Centerivew’s strong track record recently.

Catalyst

• Earnings releases showing lack of a recovery
• Lack of deal announcements, which can be tracked on their website