Description

Summary

Buy EVR with upside to $87.5 (currently at $62) or ~40% return

Evercore is a boutique investment bank.

I think of EVR as an attractive GARP-y stock over a longer term horizon, given:   

-     Tailwinds: They have good cyclical tailwinds (and some secular tailwinds with the shift in deals to boutiques from universal banks)

        o   M&A deal volume still remains at low levels and hasn't bounced back yet,  which has kept a lid on MD productivity.  The environment for M&A remains as supportive, and whenever CEO confidence picks up (which will probably happen after another 3-6 months of calm and clear skies), the M&A boom should bounce back as well 

-   Best in class: They are by far best in class at what they do and have executed extremely well

        o   Grew M&A revenues up 28% through Q3 2013 (vs. the industry roughly flat)

-    High ROI: They make smart and high IRR (50-100%) hires – while always being careful not to over-invest or depress margins

        o   They have a desire to double investment banking headcount from (from 62 to 100-120)

        o   Been able to hire the top tier talent partly because success breeds success,  and people get compensated based on their performance

        o   Very low capital intensity and capex  (around $10-12mm of capex a year) 

-   Organic growth:  Have been prudently and intelligently growing their intuitional equities business and investment management business (all organic so far)

        o   Both are just starting to turn profitable and grow. 

        o   Plenty of operational leverage there as they keep growing it – should make then meaningful contributors to earnings

        o   The 3 businesses are now synergizing well

              §  In particular, the institutional equities business is getting them into more equity deals, and helping banker’s pitch

              §  Should really show more incremental contribution in 2014

        o   Adds $4-7/share in value each year (stock at $62.40)

-     Secular winner / share gainer

        o   They continue to take share and talent (independent boutiques have generally been taking share from the money center banks)

               §  Conflicts of interest and poor compensation at the large banks has been part of the reason

               §  Since 2008 through Q3 2013, EVR's advisory fee growth has grown 240%, while most banks have experienced -20-24% declines

        o   They hire MDs consistently and cautiously.  I’ve run through the hiring and payout process with them before, details below

              §  They've grown MD headccount from 26 to 66 over the last 7 years.  Plus, their MD productivity has consistently improved over time

        o   They’ve grown advisory revenues by 30% CAGR since 2008

-    Executes the best by far in the boutique space and amongst the large banks as well (in what is usually a very lumpy business)

           o   They’ve done well practically every quarter (in the past 4 years, they’ve only had 3 negative YoY revenue decline quarters). 

Relative / versus comps – EVR still best in class

Out of all the other banks, this is the best way to bet on increased M&A

-    GHL – Greenhill doesn’t execute well and has lagged a lot.  They’ve put up a bunch of poor quarters recently.  I think they just don’t have (and can’t hire) the right talent

      o   Trades 29x 2014 EPS cons.  (this stock has already traded in an odd manner)

-    Lazard is largely asset management and has a lot of EM AUM exposure

       o   Trades at 19x 2014 EPS cons.

-     The large banks have too much stuff going on in the rest of their businesses (Dodd Frank, etc.)

-     EVR trades at 22x 2014 EPS (about 0.73x PEG),  reasonable multiple given the organic growth, high ROIC, low capital intensity, management quality, and track record) 

EVR stock has vastly outperformed LAZ, GHL, GS, MS stocks over the last year - and for good reason

Risks

-   It’s a lumpy business and quarters can be volatile here on a QoQ or YoY basis

       o   However, EVR has continue to pick up share and do very well

       o   But management always cautions that they could have a weak quarter just due to timing or luck

       o   Has generally outperformed and put up positive growth YoY in 12 of the past 15 quarters  (while the industry has been flattish)

-    Some key man risk with Roger Altman

       o   But they’ve developed a pretty deep bench now.  Roger is just another MD these days

Capital allocation

-    Hiring MDs is very high ROI.  Here’s the math:

        o   Basically costs EVR ~$6mm to bring on an MD, with those costs spread over 2.5 years

        o   Expects no revenues in year 1

        o   In year 2 that MD should start contributing.

        o   The MD should be able to generate $10mm+ in revenues,  at 55% comp ratio

        o   Basically you can get to a ~100% IRR (pre tax, not risk adjusted)

        o   Over 70% of their hires work out

                §  So roughly a 55% IRR per hire on a probability-adjusted, tax adjusted basis

-    Capital allocation goals

        o   Wants increase dividend every year (as they’ve done historically)

             §  div yield is at 1.5% now

             §  Grown it 13.6% over the last 5 years

          o   Offset dilutive effect from equity bonus (which they’ve done)

Valuation

-    EVR should do about $2.20 in EPS for 2013  (+23% YoY)

          o   People have that going up another 25% in 2014 to $2.75, which is reasonable.  Why?:

          o   Just through their normal hiring of 6-7 MDs a year, they usually organically gain another ~$0.20-$0.35 in EPS a year (hiring MDs is basically a 50-100%+ IRR investment for them if you work through the math). 

              §  They have 62 MDs now

          o   With their continued growth in asset management and intuitional equities (from a small base), they could put up another $0.10-0.15 in EPS in 2014

          o   So that gets you to ~$2.60 in 2014 EPS

          o   The other $0.15 in EPS to get to $2.75 consensus  only requires modest contribution from their advisory business to make up for 7% EPS growth delta.  Given how well they execute and their top talent, that's been extremely easy for them to do

-     The stock is trading at 22.5x 2014 EPS,  which around it's longer term average multiple of 22x P/E (20x median)

          o   Historical PE multiple for EVR has ranged between 15x and 25-30x on the high side.  Given  the secular and consistent organic growth,  plus the low capital intensity, high ROIC, and high margins of this business,  these multiples makes sense 

-     I think EVR will continue to grow organically through hiring and methodically building out their nascent asset management and institutional equities business,  which drives ~11-15% EPS growth by itself (through organic growth without a M&A bounceback)

-    If they also keep taking share from the competition (as they have done consistently) and ride the M&A upswing, you could see more EPS growth on top of that

I can see EPS much higher this cycle, because they’ve been growing their business (they’ve tripled MD headcount since 2006)

The previous EPS peak was $1.56 in 2007.  Now they have 3 times the # of MDs, and an institutional equities business plus wealth management

I could see $3.50-$5.00 in EPS in the next 2 years

EPS Detail

In terms of EPS upside

-   I can see them growing EPS by ~25% this year (like they have in previous years)  and in future years without a significant bounceback in M&A

        o   They’ve done 32% EPS CAGR since 2010 – which is during a time when the M&A market has been pretty much flat

-    Organic EPS growth decomposition:

        o   Hiring:

              §  About 10-15% of that EPS growth is just from organic hiring of around 6 MDs a year

              §  The IRRs on their hiring investments are about 55%  (probability adjusted)

        o   Market share gains / good execution:

             §  About another ~10-15% of that EPS growth is from their simply winning share and doing better

             §  They have steadily increasing and better MD and firm productivity, plus leveraging of fixed costs

                                Their MDs are ~2x more productive than bankers at GHL and LAZ, and that productivity has been increasing

             §  Their market share is about 5.6%,  up from 2.5% in 2010

          o   Institutional equities and wealth management finally a positive contributor (more of a future EPS growth contributor)

                 §  Contributes 5-10% EPS growth is from the organic build out of their intuitional equities and wealth management division (which are just turning profitable in 2013 and 2012 respectively)

                 §  That division is still growing slowly off a small base as they pick up clients and AUM

                §  Plus they’re providing cross sell opportunities & synergies for the bankers

          o   So to sum up, I can see steady 25-35% EPS growth even amid a pretty static M&A environment

                   §  Their secret sauce is just their focus on hiring top talent, and growing the business prudently while being careful about margins. It is a business where success  breeds more success, as top talent wants to go there because they want to be with other top talent and the stock performance helps attract talent as well 

          o   Management is targeting 25-30% EBIT margins (vs. the 22.9% they are at currently) - I think it's a fairly easy target for them to hit just from organic growth 

 So it’s not so much just a cyclical company,  EVR has plenty of consistent organic growth (without a big M&A rebound)

My EPS targets

-   In 2015, $3.50 in EPS is pretty achievable (just with organic growth)

            o   Put a static 22x EPS multiple on it gets you to $77 (24% upside in a year)

            o   Coincidentally, that gets you to 27% EBIT margins (mid-point of mgmt’s target range)

-     With a bounceback in M&A to $15mm/MD (back to 06/07 levels), you could see $5 in EPS in 2015

            o   Put a 17.5x EPS multiple on that more peakish number,  you could get to $87.5 stock price,  or about 41% upside

           o   Also, that coincidentally gets me to 30% EBIT margins (high end of mgmt’s range)

-    For 2013, they’re on track to do $2.20 in EPS

            o   For 2014, $3

 Meanwhile, I think they can continue growing EPS at ~30%,  so trading at 0.73PEGratio, with the potential for a cyclical M&A upswing in the next year or 2.

Evercore EPS history

2006

Back in late 2006 when the stock hit $35,  that was obviously near the peak in M&A ahead of the credit issues that eventually hit

They ended up doing $1.5 in 2007, so 22.5x 2007 actual

 People had projected 2007 EPS to be $1.22 i.e. 28.7x EPS

 2010

They ended up doing $1.00 EPS in 2010 and $1.50 in 2011

 In mid 2010 when it hit $35,  people thought they could do $1.30-1.50 in EPS in 2010 (~25x 2010 EPS),  but were aiming for ~$2.00 in EPS in 2011 (17.5x)

 2011 

They actually earned around $1.50 in 2011 and are on track to earn $1.50ish in 2012

 In early 2011, people were pricing in around $1.80 in EPS for 2011 (19.4x)

And ~$2.25 in 2012 EPS  (15.5x 2012 EPS)

2012

The setup seems similar with people projecting EPS going from $1.50 in 2012 (18.6x EPS) to $1.90 in 2013 (14.75x EPS)

 So seems like stock will really start moving if they’re actually on track to hitting ~$2.00 in EPS from this $1.5 area that they’ve been in

Financials

EVR's business segments (advisory, investment management, equities)

-   Advisory

           o   revenues have been up 27% YoY (with good surprisingly good performance & consistent performance in each quarter, vs. choppy quarters at most competitors)

           o   EBIT has been up 58% YoY to $111.7mm through Q3 2013

-    Investment Management

           o   This business started contributing positive EBIT in 2012 and has been slowing growing organically and becoming a bigger contributor

           o   Put up $11.9mm of EBIT through Q3 2013, vs $4.3mm in 2012 through Q3

           o   They only manage $13.8bn in AUM. 

           o   Still small and growing

-     Institutional Equities

            o   They've also started up (organically) a small equity division with research and hope to build out an equity platform to complement their advisory business

            o   This business turned slightly profitable at $1mm of EBIT YTD 2013, vs. -$5.1mm of EBIT in 2012

             o   This business is starting to compliment and add to the investment banking side,  plus it helps their investment management platform

  -  EBIT margins have been steadily rising from 17.2% in 2010, to 23% in 2013.  Management expects to be able to achieve 25-30% EBIT margins as they continue growing

   - Evercore's MD productivity is 2.5x that of Greenhill and 1.7x that of Lazard.  Greenhill's productivity has been stagnant, while Lazard's has been falling.   Meanwhile, EVR's MD productivity is up 60% since 2010 due to better talent, increased firm reputation, building out an equity business, in addition to more international alliances

 Business background

- Evercore's asset management business is small and nascent but has turned profitable and is growing slowly (organically and through small bolt-on acquisitions of wealth management firms)

- Their advisory business continues to crush it simply by outperforming the space and executing better.  And through consistent and cautious hiring

- They also have a small institutional equities business that just got in the black this year

 I like EVR as a longer term play since they just keep executing well and have solid organic growth as well

Lazard (in comparison)

Overall, the investment banking business has been weak The money management business has been OK,  and better bears have feared (given that 26% of their AUM is EM equities)

 LAZ's investment banking business has been choppy / weak

     - total advisory revenues YTD are down 10% YoY with weakness in M&A (-7.8% YoY YTD, $516mm of revenues),  and even more weakness in restructuring advisory (-27% YoY YTD,  $45mm of revenues)

     - similarly, Greenhill has had a choppy 2013 so far. EVR has been outperforming

     - advisory is 14% of total EBIT (asset management is 86% of total EBIT)

 Money Management - pretty good

      - Q3 AUM is up 10% YoY to $176.5bn

      - their mix is 83% equities, 14% fixed income, 2.8% alternatives

      - 80% of their equity AUM is in non-US equities (a even mix of EM, international and global equities),  20% US stocks

          - not surprisingly,USequity AUM is up ~50% YoY, the rest is up 8% YoY

      - EM equities is 26% of their total AUM

Catalyst