Greenhill & CO (NYSE:GHL): Upgraded to Outperform at JMP Securities; Pure-Play M&A Advisory Focus Poised for Growth

JMP Securities is upgrading Greenhill & CO (NYSE:GHL) to Outperform from Market Perform and is establishing a $100 price target.

Firm notes that while the shares have been impacted by depressed M&A activity in 2009 and YTD’10, Greenhill has seen continued market share gains in its advisory business given a solid restructuring practice and focus on providing still highly valued un-conflicted advice. Given GHL is the lone publicly traded “pure-play” M&A boutique as peers look to further dilute their focus on pure M&A advisory, the firm believes GHL is the best levered play to a turn in the M&A cycle we envisage in 2010. Given the recent selloff in the stock, they find the valuation highly attractive at 15.0x their 2011 EPS forecast vs. a long-term average of 21.1x.

Boutique business model intact as advisory remains core focus. As many of GHL’s peers continue to diversify their business models and by definition dilute their core focus in M&A advisory (for example, Evercore’s cash equities/capital markets build-out) and larger competitors struggle with legislative/regulatory changes (like GS, MS and JPM), GHL has done the complete opposite, having recently exited the Merchant Banking business, positioning the firm as one of the few firms with a pure-play, core M&A advisory focus.

Challenging 2009 for M&A, but continued share gains and resilient revenues keep us bullish. In a challenged year for M&A, with fees down 23% on average for the group, GHL core M&A advisory fees were quite resilient, declining only 1% yr/yr, as the boutiques continue to take share following dislocation at some of the bulges. This reflects strong growth in market share of 28%, as the firm has benefitted from participation in some of the largest deals in 2009 including advising Roche on its acquisition of Genentech, BJ Services on its merger with Baker Hughes, and Wells Fargo’s acquisition of Prudential Financial. Since the end of 2009, 2010 EPS visibility has improved with a current M&A backlog of $34B. In addition, JMP notes GHL managed to earn higher than expected M&A fees consistently despite a mixed M&A backlog of public deals, given a steady stream of restructuring deals and private transactions.

In 2009, announced M&A volume in the US was down 32% following the 36% decline seen in 2008. Since the peak in 2007, this represents a 57% decline, which compares to the average 64% decline seen in M&A activity in the last 3 major downturns in the M&A cycle (1982, 1988 to 1991, and 2000 to 2002). With the recovery in the equity markets in 2009 (with the S&P 500 up 23.5%) and signs that an economic recovery is underway, JMP expects 2009 to represent the bottom of the current M&A cycle. Assuming 8% growth in equity market cap from 2010 to 2012 and a gradual normalization in the ratio of M&A activity to market cap implies 68% growth in M&A activity in 2010, 37% growth in 2011, and 31% growth in 2012.

Productivity per MD metrics suggest $8.00 EPS power next cycle peak. During the last cyclical M&A peak in 2007 GHL earned $4.04, generated by 30 M&A MDs (with less than 10% of ’07 revenues from merchant banking). Since then, Greenhill has opportunistically grown their stable of top M&A rainmakers to 55 MDs, given the instability at some of the larger firms allowing GHL to add additional high-quality people at more rational prices. Given the high caliber of rainmakers at GHL, JMP expects the firm to generate $10-12 million per MD in peak years versus $5-6 million each at the trough (note: the firm generated $5.3mm per MD in 2009, which they believe will be the trough year for M&A). This suggests GHL can achieve $8.00 per share at the top of the next M&A cycle based on 55-60 MD rainmakers (2x the number they had in 2007). Firm's 2011 EPS of $4.75 reflects $7.2mm in revenues per MD (assuming a more normalized M&A environment, which they would characterize as mid-cycle EPS power for GHL, not peak), and when applied to GHL’s long-term average valuation of 21.1x translates into $100 fair valuation, or 40% upside versus the current price.

Notablecalls: JMP Securities highlights an interesting pure-play M&A player that may end up being in the sweet spot of the business cycle here. The stock does not look cheap by any measure (trading 15x 2011E EPS), so some of that coming upside must already be priced in.

Yet, with the variety of deals being announced today and over the past couple of weeks, the stock could really get some play here.

It's a thin name so getting decent fills requires paying up, possibly a lot. With a little help from the market this one can do $73-$74 today, with $75 not out of the question.