Description

We believe that shares of Greenhill (GHL) have the potential to more than double from current levels in the next 12-18 months

SUMMARY THESIS

We believe GHLs recently announced recapitalization (debt raise, share repurchase, insider buying) is a strong signal from management in the future of the firm. The lack of selling interest in the tender offer, coupled with the large amount of buying power from the repurchase, and massive short interest, set the stock up for the potential for significant upside in the event that company performance rebounds to historical average levels.

BUSINESS OVERVIEW

GHL is an investment bank, whose exclusive focus is on advisory. GHL does not engage in any of the other businesses typically associated with investment banking (trading, underwriting, research, etc). As such, GHLs business model is heavily reliant upon earning deal fees on M&A transactions.

REVENUE MODEL

GHL employs ~75 Managing Directors (MDs), who are the key revenue-generators of the firm. Since 2010, annual revenues (deal fees) per MD have averaged $4.3mm, with a range of $3.7mm to $4.7mm.

The majority of the costs of GHL are compensation-related costs, consistently averaging 55% of revenues. Other (non-compensation) costs historically have been more fixed in nature, and have averaged in the low $60mm range since 2010.

GHL has been consistently profitable since its IPO thirteen years ago, with PBT averaging ~85mm annually since 2005.

It is important to note, however, that given the small number of revenue-producing employees, and the episodic nature of the large, complex transactions that GHL advises on, PBT can be volatile in the short-run.

RECENT RESULTS

Financial results at GHL have hit a rough patch recently. The stock has declined from the $30s down to $15, corresponding with disappointing earnings in Q1-Q3 2017. Revs YTD (through 9/30) are down over 25%, PBT has virtually dried up, and revenues Per MD have dropped beneath the low-end of their historical range.

GHL management’s view is that recent results are just a bump in the road, and there are idiosyncratic reasons for the slowdown. They state that their current book of assignments gives them confidence about their future.

Unfortunately, the lack of disclosure by GHL on their pipeline, and the fact that GHL has now had three straight quarters of disappointing results, has led investors to discount management’s comments and fear that there are more structural issues impacting GHL.

RECAPITALIZATION AND TENDER OFFER

In September, GHL announced a levered recapitalization, consisting of a debt raise, and a tender offer/share repurchase.

They announced they would raise $350mm of debt, and repurchase up to $285mm of stock (through a tender offer for ~$200mm, and subsequent open market purchases).

Concurrently, GHL also announced that insiders would be purchasing stock. Specifically, the CEO and Chairman would purchase a combined $20mm of stock at the tender price, and the CEO would forgo 90% of base comp for 5 years (2018-2022), in exchange for $2.75mm of RSUs (at a five year cliff vest)

On October 26^th, GHL announced the results of the tender offer. ~3.5mm of the 12mm shares offered were tendered at a price of $17.25

WHY WE CARE

We became interested in GHL after the announcement of the recap. We viewed the large debt raise, as well as share repurchase as a very tangible signal of management’s constructive view of the future. Why would management invest $20mm into their own stock, the CEO forgo compensation, and the Board agree to lever up the company if there was not a strong belief in the future prospects of the firm?

We became even more interested in GHL after the results of the tender offer. The fact that only ~30% of the shares offered were tendered means to us that those shareholders who own the stock also believe in the value of the franchise (ie they are not sellers at $17.25).

This coupled with a short interest that is 27% of the float, and a pending buyback that is equivalent to nearly 40 days of volume, we believe could set the stock up really well for any potential upside surprise.

VALUATION

Below we outline the valuation framework for GHL. We believe that the risk/reward is heavily skewed to the upside in GHL shares.

Our upside case assumes that GHL return to the middle-upper range of their historical MD productivity, and can effectively buy in the shares from the recap at $24/share (~40% premium to current). In this case, we believe that GHL stock could be worth close to $40 per share, or more than double current levels.

Our downside case assumes that MD productivity remains significantly depressed versus historical levels. We assume that GHL can buy in its stock at a price of $14 (20% discount to current). Importantly, we believe that our downside case is buffered by the sheer amount of stock that management is able to purchase. In the near term, we believe there is a firm put at $17.25 (the tender price), as GHL would have acquired 12mm shares (30 days volume) at that price just a few weeks ago, if there had been willing sellers. Importantly, after a 10 day blackout post the tender, GHL will be able to start repurchasing shares in the open market late this week.

RISKS

The key risk here is that management is completely wrong about the issues at GHL being short-term and idiosyncratic in nature. They execute on the stock repurchase, and lever up the company, and results go sideways from here, or get even worse.

CATALYSTS

• Mgmt executes on share repurchase near current levels
• Results return to historical average levels

DISCLAIMER

The author of this posting and related persons or entities ("Author") currently holds a long position in the securities mentioned above. The Author makes no representation that it will continue to hold positions in these securities. The Author is likely to buy or sell long or short securities of this issuer and makes no representation or undertaking that Author will inform Value Investors Club, the reader or anyone else prior to or after making such transactions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note. The views expressed in this note are the only the opinion of the Author.  The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in securities of this issuer. Reader agrees to hold Author harmless and hereby waives any causes of action against Author related to the above note.

Catalyst

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