The View From Greenhill

I don't need to belabor the point that private-equity buyout transactions are the rage right now. Every day seems to bring a new deal, and as the sizes of the buyouts grow, it seems as if a billion-dollar transaction can get pushed down in the headlines. Not to be totally outdone, some of the world's largest companies are making waves of their own in this area and pulling off some massive acquisitions.

Among all of the beneficiaries of these huge transactions, the lawyers and bankers who act as advisors on the deals are smiling for sure. The bulge bracket investment-banking firms such as Lehman Brothers (NYSE: LEH  ) and Morgan Stanley (NYSE: MS  ) tend to hog much of the spotlight, but there are a handful of boutique advisory firms that have been turning some heads, too. That's why I decided to dig in a bit on Greenhill (NYSE: GHL  ) , an advisory up-and-comer.

At a glance
Greenhill was founded in 1996 by Robert Greenhill, a former president of Morgan Stanley and chairman and CEO of Smith Barney (now a unit of Citigroup (NYSE: C  ) ). Greenhill's bread and butter is its advisory business, which helps clients with mergers and acquisitions, restructurings, and other financing issues.

To augment its advisory services, in 2000 the firm founded its merchant-banking arm, Greenhill Capital Partners (GCP). Since then, GCP has raised more than $1 billion in three private equity funds (two in the U.S. and one in Europe) and $102 million in one venture-capital fund. Though advisory remains the firm's larger revenue generator, GCP has ramped quickly. It provided 36% of the firm's revenue in 2005 and 28% in 2006.

Fueling the firm: the economy
Not unlike its bulge-bracket brethren, Greenhill's business is driven in large part by economic conditions and its people.

As a smaller firm without a capital-markets arm, Greenhill has somewhat less exposure to the economy than some of its full-service investment-banking counterparts do. While the firm certainly benefits from the increased M&A activity that often accompanies a strong economy, it also has strong practices in divestitures, restructurings, and other strategic advising that can help smooth out revenue during downturns in the economy. In the major downturn in 2001, Greenhill showed considerable resilience -- revenue dropped just 10% in '01 and was back up 13% in 2002.

Greenhill's merchant-banking arm, on the other hand, has a much stronger tie to the economy. The funds are much more likely to find receptive capital markets or strategic buyers for its portfolio companies during good economic times. It will also be significantly easier for the firm to find investors willing to bankroll new P/E and venture-capital funds during go-go times than during a downturn.

Also fueling the firm: the people
People, while a much more difficult area to analyze, are perhaps even more crucial to the success of Greenhill. On the advisory side, the firm brings in clients based on its senior professionals' relationship networks, the clients' ability to sell Greenhill's capabilities, and the historic success that the firm has had working on various advisory assignments. While you can't find a "managing directors" line item on the balance sheet under assets, a few rainmakers can have a significant impact in this business.

Greenhill continues to bring in top talent and recently announced the addition of Martin Lewis, a well-connected banker who was the former head of restructuring at Rhone Group, as well as a founder of the boutique banking firm Miller Buckfire Lewis and a managing director at Blackstone. On the flip side, the firm hasn't been immune from defections -- it recently lost highly regarded bankruptcy and restructuring specialist Harvey Miller to his old law firm, Weil Gotshal.

With the importance of the firm's people comes Greenhill's largest expense -- the familiar and hefty compensation line. In 2006, compensation and benefits came in at 46% of revenue -- about the middle of the road compared with the rest of the Street. Though compensation expenses are somewhat flexible downward when tough times hit, they are likewise flexible upward when the firm does well. So as with other investment banks, compensation is not particularly amenable to leverage as the firm reaches a larger scale.

The lumps of advisory revenue
Though Greenhill has shown a pretty steady top-line growth rate on an annual basis, quarterly trends reveal how lumpy the realization of advisory and private-equity revenue can be. A case in point was the firm's first quarter of 2007. Advisory revenue dropped off 26% year over year, and merchant-banking revenue fell off a cliff from $52 million in Q1 2006 to $7 million in Q1 2007.

The drop of more than 50% in total revenue is steep, but it was a particularly difficult comparison to go up against $47 million in gains on merchant-banking investments in the year-ago quarter. In a period of high M&A activity, the drop in advisory fees is notable, though in its earnings release, Greenhill said it had already booked advisory revenue of $50.2 million through the first few weeks of April.

On deck
Moving past the tough first quarter, Greenhill has recently been tapped as an advisor on a handful of blockbuster deals that could translate to some nice revenue if even a couple of them close.

Acquirer

Target

Deal Size

Informa*

Datamonitor

$1 billion

SSAB Svenskt*

IPSCO (NYSE: IPS  )

$8.5 billion

JC Flowers, Friedman Fleischer, Bank of America, and JPMorgan

SLM (NYSE: SLM  ) *

$25 billion

Fortis*, The Royal Bank of Scotland, Banco Santander

ABN Amro (NYSE: ABN  )

$98.1 billion

Kohlberg Kravis Roberts and Stefano Pessina

Alliance Boots*

$24.4 billion

Source: Greenhill website. * Denotes a Greenhill client.

Fees for advisory services in M&A transactions are typically determined as a percentage of the deal value. Though some of these transactions may not close -- the ABN Amro deal in particular jumps out at me -- Greenhill certainly seems to have itself positioned to cash in on the continued wave of M&A activity.

So ... that view from Greenhill? For now, at least, it looks pretty sunny.

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Fool contributor Matt Koppenheffer is currently ranked 11,069 out of 28,939 rated Fools participating in The Motley Fool's CAPS service, and he encourages everyone to get heard. He owns shares of Bank of America, which, along with JPMorgan Chase, is a Motley Fool Income Investor pick. The Fool's disclosure policy doesn't fear the reaper.


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