Description

PJT Partners (PJT) is a short because:

• PTJ is benefiting from an exceptionally favorable operating environment that is unlikely to persist
• PJT’s partnership structure creates a significant tax drag on free cash flow making valuation more expensive than implied by the EBITDA multiple. Even so, shares trade at well above peer multiples despite lower than expected growth
• Assuming normalized earnings are above prior peak numbers, PJT shares are worth >40% less than current prices

Business overview

PJT Partners is a global investment bank that provides strategic and restructuring advisory. The company’s Park Hill group offers private capital advisory and fund raising services. PJT has 120 partners, 75 of whom are on the strategic advisory side, 19 are in restructuring, 20 at Park Hill are and 6 are in corporate. PTJ went public in 2015 and has since grown significantly with LTM revenue up 219% over 2015 and partner count increasing 161% over this period.

PJT has an exceptionally strong restructuring franchise. According to reorg.com, PJT was the highest earning restructuring banker for 2023 and 1h 2024. By comparison FactSet ranks PJT 14th in 2024 July YTD M&A value. The company only provides revenue breakdown between advisory and placement with advisory accounting for 89% of the total. Within advisory, restructuring likely comprises ≈40-50% of LTM revenue.

The current environment is extremely favorable for PJT

Normally when the economy and markets are strong M&A and capital raising deal volumes are also strong, but restructuring work is scare. In a weak / recessionary economy the inverse is true. The last 12 months however have been an a truly unique peorid when economic growth and M&A activity has been ok, but at the same time higher interest rates have created an abundance of restructuring engagements.

In 2023, US chapter 11 filings were the highest in many years, even exceeding the 2020 pandemic. A similar level of bankruptcy activity continued into the first half of 2024.  While 2023 was a bit of a slow year for M&A, transaction value the first half of 2024. increased 17% vs. 2023.

Figure 1: U.S. M&A and Restructuring Market

This is the perfect environment for PJT as all parts of the business benefit from a favorable operating environment. This situation is unlikely to persist and either the M&A / capital raising business or the restructuring side will likely face a more challenging market going forward.

Partnership structure creates a significant tax drag on free cash flow

About 15% of diluted shares are in the form of partnership units which are convertible into class A shares. PJT is required to make cash distributions equal to 50% of the taxable income due to partnership units. These payments are reported as ‘Tax Distributions’ in the financing section of the cash flow statement.  As a result, PJT’s true, overall cash tax rate is around 32% and actual free cash flow to equity is much lower than it initially appears.

Figure 2: PJT Historical Cash Flow

Shares are expensive on both an absolute and relative basis

On consensus numbers looking out the next 3 years PJT trades at a high absolute valuation and a high valuation relative to peers.  Even assuming EBITDA well in excess of out year consensus and 50% higher than the company’s 2020 peak earnings (the ‘Max’ column in Figure 3 below), shares appear only fairly valued.

Figure 3: PJT Trading Multiples

In addition, PJT trades at the highest EBITDA multiple in its peer group. This is despite the company’s higher tax burden vs. peers (not captured in the EBITDA multiple) and the lowest expected revenue growth over the next two years.

Figure 4: PJT Trading Multiples vs. Peers

Fair value is >40% below today’s price

Despite the unusually favorable operating environment PJT’s normalized earnings should continue to grow. The company continues to hire more bankers and gain share. In addition, many of the PJT’s recently hired bankers have yet to reach full productivity leading to below normal margins. We assume that share gains increase earnings 15%, normalized margins are 220bps higher than 2024 which is offset by a $35m decrease from less favorable end markets. This yields normalized EBITDA of $295m.

Normalized EBITDA of $295m translates to free cash flow after stock comp of roughly $198m. We value PJT at 16x FCF or an implied EV/EBITDA of 9.6x. On a absolute basis, this multiple feels right as earnings should continue to grow overtime, but this growth will likely be volatile due to changing markets and fluctuations in share in this competitive market. 9.6x EBITDA also is roughly equal to where peers trade after adjusting for PJT’s higher tax burden. This yields a valuation of approximately $72 /share or 42% below the current price.

Figure 5: PJT Valuation

Key risk

The key risk here is that PJT’s market share growth overwhelms a less favorable operating environment such that normalized future earnings are much higher than prior peaks. Not only are banking markets volatile but share among advisors can swing significantly. PJT has executed well over the last several years and now boasts an enterprise value comparable to more established firms like Lazard, Moelis and Piper Sandler.

While our valuation assumes continued share gains, share gains could be even more than we’ve modeled. However, this risk appears acceptable for two reasons; First, even if we’re wrong and normalized EBITDA is 50% higher than the 2020 peak, shares only appear fairly valued (see figure 3). Second, this is a competitive industry and no one bank grows forever - as WEB said about Solomon “the assets go home every night” and many once hot advisors no longer exist today (when I was coming out of undergrad, everyone wanted to work for Gleacher). As such, it seems unlikely that share gains will be enough to cause significant losses. 

Catalyst

Estimates coming down