Laughing Water Capital, a long-biased investment partnership, presented Greenhill & Co. Inc. (GHL) at the recent MOI Global Best Ideas conference and demonstrated why they think this company could more than double in the years to come. Recently, we came across this presentation, so let’s see why boutique investment bank such as GHL appeared on LWC’s radar.
Since they are dealing with businesses that are struggling with operational, structural and/or optical problems, it’s no wonder that GHL (which tried really hard to keep pace with the competition lately) entered their portfolio. Moreover, in LWC, they are focusing on the fundamental value of businesses while having patient and small size approach. Something its founder Matt Sweeney is not just emphasizing in his work, but in his life as well. After all, he invested almost his entire net worth in the strategy. Sixteen years of experience in trading, sales, banking, covering mutual and hedge funds (with focus on small/mid-cap names) were enough for him to learn not to over-diversify, trade frequently and focus on short term.
And now, to get back to unveiling why GHL is LWC’s cup of tea. If we skim-through stock basics, we can see that last year, the heads of GHL had attempted to recapitalize the company (leveraged recap) by raising $350 million in debt so that they can “repurchase more than 50% of their outstanding stock.” The price of the stock at the time of Best Ideas 2018 conference was $18.50 a share.
Moreover, with offices in Americas, Asia, Europe and Australia, GHL covers a huge territory, while dealing with mergers and acquisitions primarily, and also with capital raising, PE liquidity, and restructuring, the last one being significantly intensified lately. So, they provide specialized services for a specific segment of the market, what LWC is doing, as well.
But, let’s review GHL within the LWC’s 5-part framework.
Firstly, is it a good business? Investment banks are almost always needed when a major company has to do some financial decision-making, plus boutique banks are in high demand when it comes to representing sellers in M&A transactions. Therefore, GHL meets a need.
However, some downsides of this industry are that investment banking is generally competitive field, thus having low barriers to entry. Also, a huge number of new boutiques appeared lately. The whole industry is like a net where revenue, reputation (experience and success), and relationships (a function of quality MDs) are intertwined, with assets holding them together. So, according to some, GHL is “too frugal with MDs,” and its brand “brand has slipped.”
On the other side, compared to bulge brackets, losses have less impact on businesses, and payout is generally better in this industry, thus attracting top-performing MD’s. Moreover, LWC reported strong cash flow through a cycle and improvement of company’s revenue profile, pinpointing that some of the reasons are strong MD recruiting and recent hires.
After discussion on capital returns, next in line are answers on why does the opportunity even exist? In this section they propose there’s no reason for GHL to fears the peaking cycle and also explains the reason for GHL brand to slip – it was in the wrong niche at the wrong time. Finally the company’s “special situation” is explained step by step, starting with the announcement of the plan for a levered recap in September 2017.
They also wondered are management’s interests aligned, and the fact that decision makers are willing to pay almost $40 million in dividends and salary in case debt isn’t paid until maturity, says it all. Even when it comes to reversing of previous public statements (in the period of 6 years, the management came a long way from giving the dividend the highest priority and refusing to lever up as the way to accelerate returns, to the announcement of recapitalization plan) the management is on the same wavelength.
But, what happens when something goes wrong, like GHL’s brand declining? The thing is that sometimes, weakness is tied to the market, not the brand. The good news is that GHL is more global than its competition, thus having more opportunities and “more markets”. Also, there’s the fear that global M&A has already peaked. However, it seems that this doesn’t even matter because boutiques like GHL, that have conflict-free status are preferred partners when it comes to sell-side engagements. Knowing that M&A cyclical bottom will probably be short-lived, GHL could expect increased M&A revenue.
Valuations are that 2018 will be a good year for GHL, while there is an assumption that 2022 will be a “normal” one. Meaning, it’s when the real money could be made; when the dividend is resumed, debt paid down and when the stock prices start to rise again.
The bottom line is that LWC’s capital base can fully benefit from “seesaw” situations. Meaning, the best move would be to repurchase shares as soon as possible, thus turning the GHL’s stock into a true “stub stock,” because, “the lower the stock price goes in the near term, the higher it will go in the long term.” Stub stocks are truly tempting investments with significant positive return potential, but what makes them risky is whether market participants will perceive opportunities the recapitalized company has to offer.