Evercore: Underfollowed Firm Has Great Potential
Aug. 8, 2017 2:53 PM ET|5 comments| About: Evercore Partners Inc. (EVR)
Michael Boyd
Michael Boyd
Long/short equity, contrarian, medium-term horizon, mid-cap
MARKETPLACEIndustrial Insights
(5,822 followers)
Summary
Evercore doesnt get much press, and the firm has been quietly snapping up investment banking market share for years.
In a market dominated by massive bulge bracket investment banks, management has proved nimble in winning big deals traditionally reserved for large players.
Top talent continues to flow to Evercore. I expect the company to continue to steal market share and build its reputation in the coming years.
Even adjusting for stock-based compensation, the company prints money and has a solid shareholder return program.
This idea was discussed in more depth with members of my private investing community, Industrial Insights.
I’ve struggled to find attractive buys in the traditional brick and mortar retail banking space, but there are pockets of great value sprinkled throughout other areas of the financial sector. I’ve pointed out areas of value in the asset manager space in the past (see my research on Legg Mason (LM) as an example), but that also exists in the investment banking space as well. I’ve got several favorites in that space, but Evercore (EVR) remains my top pick in the space. Perhaps slightly under the radar to many, Evercore has quickly taken the independent investment banking space by storm over the past several years, and the firm’s reputation has quickly grown. In a world dominated by massive bulge bracket investment banks with sprawling operations, the firm has quickly carved out a solid niche for itself across many key banking verticals. It also remains pretty cheap, even after a strong rally late year. For anyone that is bullish on public market activity (mergers and acquisitions, restructuring, initial and secondary equity offerings), I don’t think there is a better company to put your money behind today.
Business Overview, Fundamentals of the Investment Banking Market
Evercore has quickly become one of the leading independent investment banking advisory firms in the world, helping clients complete merger and acquisition (“M&A”) deals, providing restructuring and capital markets advice on debt/equity issuance, institutional equities research, and also securities underwriting. For all those investors who are highly skeptical of conflicts of interest within investment banks (I know there are quite a few of you), this is a true independent firm. Evercore does not engage in commercial banking nor does it engage in significant proprietary trading activity. Confidentially and impartiality are key tenants of the business, and it is something management adheres to. For instance, the Institutional Trust and Fiduciary business was recently sold to Stone Point Capital for this reason. Potential conflicts began to arise with the core business. In short, Evercore is a research and advise shop, through and through. To provide further context, well-known deals that the company has advised on that investors might know include EMC’s sale to Dell and the associated consortium (Michael Dell, MSD Capital, and Silver Lake), Abbot Laboratories (NYSE:ABT) on its acquisition of St. Jude Medical, or Medivation (NASDAQ:MDVN) on its defense from a hostile takeover by Sanofi (NYSE:SNY) and subsequent sale to Pfizer (NYSE:PFE).
This business is all about talent, and talent tends to flow to where the growth and other top talent is currently. So while overall staff headcount is low: just 1,475 individuals worldwide, this is high quality talent, and since Evercore has been winning substantial market share, the company has had no problems pulling in or poaching staff from bigger firms. To put its size in context, while still a small player, Evercore expects to be well up from the 6% market share that it had at the end of 2016 (by my estimates, somewhere in the 7.5% range), and expects to be ranked just outside the top five globally among all firms that publicly report advisory revenues (competition here would be Bank of America (BAC), Deutsche Bank (DB), Goldman Sachs (GS), JPMorgan (JPM), Lazard (LAZ), and UBS (UBS), among others).
Despite the stock markets being at all-time highs, as well as plenty of deal-making occurring, overall M&A activity remains at right around historical norms when measured as a percentage of global market cap or by global GDP. Coupled with low volatility and a healthy economy, and this isn’t a bull market for investment banks by any stretch. Overall M&A activity thus far is up incrementally this year, with a slight bias toward the upper and lower ends of the scale. There have been a few blockbuster deals (which Evercore still isn’t going to be winning most of the time), but also a lot of smaller deals, say <$2,500M, that the company has had no problems winning. I think its important to note that despite nominal dollar M&A growth ballooning 2010 to 2016 (up 53%), Evercore has more than tripled its advisory revenue from $292M to $1,074M over the same timeframe. That has come from substantial wins when it comes to market share (2.3% to 6.0%), and that’s a testament to how well the company has been performing. Management loves this statistic, and highlights often that Evercore’s three-year advisory revenue growth rate has exceeded every member of its peer group.
While M&A activity is by far the most core source of revenue, restructuring and equity capital activity also play an important role. Market activity in this business has come off the lows found in the middle of 2015, but remains slightly muted. Restructuring is highly reliant on distressed companies running into issues, and leveraged loan defaults peaked in 2014 (high point for Evercore in this market), but are still at moderately high levels compared to most other time periods over the past five years. A good chunk of this remains energy sector driven, however – once that dries up, defaults will be fairly low and business might be harder to come by. Until then, energy deals will likely be the bread-and-butter, see the company’s involvement in the Energy Future Holdings bankruptcy, or all the moving pieces that were involved in Chesapeake Energy’s (NYSE:CHK) senior note exchange. Investors should think of this business as a hopeful counterweight to M&A market weakness. Higher interest rates and weaker global macroeconomics tend to negatively impact deal-making, but likely would also pressure more companies into needing help on the restructuring side.
On the equity capital side, investors can’t knock company performance here either despite a tepid market for equity issuance since 2014 (IPOs are down, and corporate paper is so cheap most companies outside of MLPs/REITs are not issuing equity). Perhaps most importantly here, Evercore has evolved from co-managing deals to being leading bookrunner. This is another indication of the company’s growing strength in the market, moving from a supportive role to being the lead underwriter, coordinating efforts among other banks. More and more companies entering the public markets for the first time have come to Evercore to fulfill that role: the company led deals on Athene (ATH), the largest IPO that took place last year, as well as other high-profile IPOs like MGM Growth Properties (MGP) and Myovant (MYOV).
Financials, Valuation
Management target has been to sustain operating margins of 25% or better, a target the company is attaining as long as amortization of LP unit awards associated with the ISI acquisition are excluded. This is in line with the independent investment advisory peer group (much larger Lazard, smaller peer group of Moelis & Company (MC), Greenhill & Company (GHL), PJT Partners (PJT) which have <$1.5B market caps). While some of these smaller peers are more cheaply valued on some metrics, earnings there are also much more lumpy - a handful of deals going their way or not can make or break a quarter or even a year. These firms also have not experienced the growth that Evercore has had over the past several years, and in this space I’d much rather put my investment dollars behind a company riding high if the premium is not outlandish.
Most readers know my penchant for investing based on cash flow, so I’ll mention you do have to be careful on the free cash flow side here. For cash flow driven investors, financials can make great investments given limited capital expenditure needs (this is a people business, as asset light as you can get), but there are caveats. Stock-based compensation can get a little aggressive, particularly in this market where professionals look for stock compensation, much like in technology. Equity-based and other deferred compensation totaled $258M in 2016, which gets added back on the cash flow statement as its non-cash. I generally re-include stock-based compensation in free cash flow calculations as if that was paid as cash, otherwise you can get a very distorted picture. While Evercore, and most other publicly-traded managers, devote a substantial amount of capital to share repurchases, it is rarely enough to offset dilution (although Evercore did manage this over the past twelve months). Getting a little off track but worth a mention, complicating matters here is the substantial amount of acquisition-related limited partnership (“LP”) units that were issued as part of the purchase of ISI in 2014, which become exchangeable for common stock only upon satisfaction of multi-year performance conditions. Evercore recently fixed the exchange ratio between those LP interests and the common stock at 47%, which likely means another 2.5M shares of dilution hitting the books over the next several years until they all expire. Analysts were a bit critical of the decision to fix the exchange rate, given ISI has been running a touch below expectations, but management believes this is the right move to eliminate some internal issues. Overall, this will result in total aggregate consideration being issued in connection with the ISI acquisition at 5.3M shares, substantially below the 8.2M share maximum that was part of the agreement, but still a great multiple on the operating income this business has thrown out.
Little divergence there aside, operating cash flow this year should come in at $500M, with $25M or so in capital expenditures. Dinging Evercore for $275M in stock compensation as well puts free cash flow if dilution was fully offset at around $225M, a 6.5% yield. That’s a strong number in a vacuum, but is also one that should moderate as the ISI deal impact fades in the coming years and Evercore isn’t essentially getting dinged twice (once for equity tied to performance on the acquisition, again for paying those same individuals for work today). If market share continues to expand and corporate action activity continues to be as healthy as I expect it to be, this could be a big winner over the next several years for shareholders. Risks to the recommendation here are obvious: a downturn in global economic activity hurting the firm’s business, a reversal in market share gains (likely tied to weak performance by bankers and analysts), or the usual regulatory risks that persist throughout the financials space. These risks are balanced to some extent by the company’s balance sheet ($314M net cash position).
Disclosure: I am/we are long EVR.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Evercore: Underfollowed Firm Has Great Potential - Evercore Partners Inc. (NYSE:EVR) | Seeking Alpha
