Glenn Rogers writes:
Let's not mince words. Looking back at the events of the past 18 months, we have witnessed the end of a financial system that had operated successfully for generations. Bear Stearns, Lehman Brothers, AIG, and Merrill Lynch were just a few of many casualties. By the time it was over, the financial landscape was strewn with the remains of failed companies. Finally, however, the carnage seems to be over and we are witnessing the long, slow stabilization of the financial universe and the emergence of the companies that will drive new world order.
Among them are survivors like Goldman Sachs (NYSE: GS) which is now at the top of the pyramid in terms of asset management and mergers and acquisition advisory services. But even Goldman Sachs almost went down and had to become a bank and accept government bail-out money to survive. Although it has repaid all the TARP money loaned to it, the company has been pilloried in the press and on Capitol Hill in recent months, as have the leaders of JPMorgan Chase, Bank of America, Citigroup, and Morgan Stanley. All of these institutions took TARP money and most have repaid it, with the exception of Citigroup and AIG. But still there lingers in the public mind, and in the minds of Congressional members, much bitterness and mistrust of these former masters of the universe.
But flying just under the radar of all this chaos and recrimination are two smaller firms which never took TARP money and now find themselves in the enviable position of being pure plays in the historically lucrative and important financial advisory areas of restructuring and mergers and acquisitions (M&A).
Anyone who has paid attention to the market action during the past few weeks will have noticed that M&A activity has picked up significantly. When a company like Prudential announces that they have acquired AIG's Asian business for over $35 billion, you can be sure that they will be paying huge fees to advisory firms. In this particular case, Lazard Ltd. advised them on the transaction and to help raise funds to pay for the deal.
These transactions are highly complex and require experienced personnel who are highly sought-after and expensive to keep. In the past, smaller firms like Lazard might have had a tough time competing with the big merchant banks for that talent. Now, with the large banks under considerable scrutiny about their pay policies, the smaller companies have been able to attract high-priced talent among people looking for a less regulated place to work.
Similarly, perspective clients are attracted to smaller firms that don't come with the high-profile antagonism that leads to the kind of unwanted publicity that can become a major distraction during large transactions. So these days it's a virtue to be small, agile, and under the radar. There are two companies that fit this profile very well.
Lazard Ltd. (LAZ)
Lazard has been in business since 1848 when it was founded in New Orleans to provision miners heading west to the California gold rush. The company now has offices in 40 cities across 25 countries with over 2,200 employees. Lazard generated revenues of $376.7 million in 2009 compared to $119.3 million for 2008 (figures in U.S. dollars). Recently, they announced blowout fourth-quarter revenues. Operating revenue was $514.4 million for the quarter, compared to $402.5 million for the fourth quarter of 2008 and $431.5 million for the third quarter of 2009. That made it the third best quarter in terms of revenue in the company's history. M&A and strategic advisory operating revenue was $170.2 million in the fourth quarter, an increase of 37% over the 2009 third quarter. Restructuring operating revenue was $103.4 million for the fourth quarter and a record $376.7 million for the full year. Net inflows were $4.6 billion and $10.3 billion for the fourth quarter and full year, respectively.
The company reported a net loss for the quarter and the year, due to "significant special charges and changes in compensation policies to enhance our competitiveness and drive shareholder value".
Note how much revenue was generated by corporate restructuring. In fact Lazard acted as advisers on more than 450 restructuring deals last year. But recently the majority of their assignments have been non-bankruptcy related, which may indicate we are entering a more stable period of corporate life.
In addition to the advisory business, the company has a significant and growing asset management operation. Assets under management increased 42% to $129.5 billion in 2009, from $91.1 billion at the end of 2008.
The stock took a hit last year Lazard lost its chairman and CEO, the legendary Bruce Wasserstein, who died suddenly in October. Subsequently, the firm named Kenneth Jacobs to replace him but Wasserstein was so highly regarded as one of the leading deal makers of the last three decades that it has taken a few months for the stock to rebound. But rebound it has, closing on Friday at $37.22, well up from its 52-week low of $20.55.
Recently, the company announced a share buy-back program of up to $200 million. It also declared that would be paying large bonuses to its staff. In my mind, they are excessive but as long as Lazard can perform and make money for investors, we'll give them the benefit of a doubt. The stock pays a quarterly dividend of 12.5c a share (50 annualized).
Action now: Buy with a target of $48.
Greenhill & Company (GHL)
Greenhill is less well known than Lazard and has only been in business since 1996. It is also a much smaller company than Lazard with only 250 employees and revenues of $298.6 million in 2009. But, like Lazard, the company is clearly focused on its advisory business, which has been growing rapidly. Their profit margins of 35% and the return on equity of 29% are the highest in the industry.
In a recent letter to shareholders, chairman Robert F. Greenhill emphasized that the company has been able to fuel its growth through "an ongoing recruiting effort for senior bankers that is clearly bearing fruit". He said the company is hiring "senior recruits from nearly all major competitors and as we enter the New Year, the steady flow senior bankers wanting to join Greenhill continues unabated."
This past year they recruited 14 managing directors and four senior advisers from their competitors. To say that this is a people business is an understatement and in the current environment this company has the unusual opportunity of being able to attract the best.
As a result, the fourth-quarter revenues were up 26% year-over-year while net income was up 39%. For the full 2009 fiscal year, annual revenue was up 35% and net income was up 47%. The outlook for 2010 looks even more bullish as the company continues open new offices globally thereby expanding its international footprint.
Recently, Greenhill advised on a number of large transactions for such companies as Coca-Cola, SAS Group, Terex, and Prudential Financial. Currently, the majority of the business comes from Europe and the United States but as the company continues to expand that will change. For example, they recently opened an office in Tokyo and I expect we'll see announcements of further office openings in the Asia-Pacific region this year.
I think Greenhill offers an opportunity to not only buy into a focused advisory firm at the right time in the cycle but also to buy a firm that is rapidly expanding at a time when their major competitors are experiencing unusual pressure from U.S. government and from governments around the world.
Currently the stock trades at $80.97, off its 52-week high of $96.09 but well above its low of $55.41.