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As I have reflected on the last week, one news item really sticks out in my mind. JP Morgan raised $10 billion in debt the day they announced earnings, but they did it without the FDIC backing that is available for large financial institutions right now. I don't follow the debt markets closely enough to know if other firms have raised similar amounts without a government backstop for investors, but I don't remember hearing about it. I think this is yet another very good datapoint. The debt markets are starting to function without the need for government help. The cynics will argue that I shouldn't be excited about the strongest bank in the country being able to raise some debt financing; of course they should be able to. They would say that my excitement only proves how bad things are. My point is simply that I don't expect JPM to be the last bank to be able to do this. The trend is bullish.
There were also a string of better than expected earnings from Wells Fargo, Goldman, JP Morgan and Citigroup. As I have said before, things get less bad before they really get better. Despite my bullishness, I as still a skeptic on Goldman Sachs. Don't misunderstand me, I admire their culture and the caliber of the the people they attract. These are very good things. But as an investor I am staying away. At the end of the day, this is still a highly leveraged company that makes money in a very opaque way. People who buy this stock (I fell into this mindset in the past so this is also a confession) will shrug their shoulders and say "Yes, but these guys are REALLY smart and will figure out how to make money like they always have." That's right; very highly paid investment professionals will use this as their investment thesis.
I have learned quite a few things over the last three years and here is one; if the business model is flawed, whole industries can be wiped out. It wasn't that long ago that mortgage originators were darlings of the investment community. They are simply gone now. The leveraged investment bank industry almost followed suite; we lost Bear and Lehman, Merrill was forced to sell, UBS is still in trouble, Goldman and Morgan had to convert to bank holding companies so the Fed could keep them from the same fate. My point is that Goldman may be full of smart people, but I can't even begin to predict how much money they will make next year and I no longer think the business model is attractive. And yet the stock was at $130 the other day. This is a cult stock and I'm going to find better models to invest my money in. For the sake of the broader market, I hope Goldman does very well but I'm willing to miss that gain.
Sunday, April 19, 2009
Wednesday, April 15, 2009
Market in Transition and Equity Raises
I have been thinking and realizing over the last week that the market is at a tough spot. For some perspective, I remember hearing a lot of investors say things like the following: "I can't call the bottom so I won't try. I'm willing to miss the first 15-20% of the next bull market so that I have confirmation that it IS a bull market." My conversations with people lead me to believe that these same people are now very uncertain about what to do. They had the 20% rally off a bottom, but they are still hesitant. I have noticed my own tendencies are to want to buy on a pull-back when the markets are going up, but being afraid to buy when the pull-back is actually occurring. If I am bold enough to extrapolate my tendencies on the market, it implies that there are still a lot of potential buyers that are still waiting to buy. All this to say, we just had a rally but I don't think investors are convinced we are in a bull market, despite their comments prior to the rally. And for those who bought on the way up, or are just still holding old positions, it is tempting to lock in some of the recent gains. I still think we are in a new bull market, but these pauses make sense to me.
What I was really excited to see was some equity raises. Everyone saw that Goldman Sachs raised $5 billion yesterday, but unless you cover the financial sector you may easily have missed three other equity raises (First Niagara and Fidelity National yesterday and Chimera today). Seeing four financial sector equity raises in two days was a bit of a surprise; in the pleasant sense. The capital markets are normalizing under our noses. I'm still leery of Goldman's business model, but from a broader perspective, I'm very happy that other investors are willing to give them more capital.
And finally, I little aside. I was thinking about one of my favorite internet ideas again yesterday; Prosper.com. They are currently in a quiet period while they go through a registration process to sell promissory notes, but this is fine because I wouldn't lend money through Prosper.com quite yet. This website allows people to borrow and lend from each other through Prosper.com. As a lender, you are making an unsecured loan to a stranger based on their write up and some standardized data they have to provide. When the US economy loses less than 75k jobs in a month, I think it will be time to put some money to work here, based on the assumption that the most likely reason the loans won't be repaid is loss of income. At about -75k jobs, I expect loan performance going forward to be good, but interest rates still attractive.
What I was really excited to see was some equity raises. Everyone saw that Goldman Sachs raised $5 billion yesterday, but unless you cover the financial sector you may easily have missed three other equity raises (First Niagara and Fidelity National yesterday and Chimera today). Seeing four financial sector equity raises in two days was a bit of a surprise; in the pleasant sense. The capital markets are normalizing under our noses. I'm still leery of Goldman's business model, but from a broader perspective, I'm very happy that other investors are willing to give them more capital.
And finally, I little aside. I was thinking about one of my favorite internet ideas again yesterday; Prosper.com. They are currently in a quiet period while they go through a registration process to sell promissory notes, but this is fine because I wouldn't lend money through Prosper.com quite yet. This website allows people to borrow and lend from each other through Prosper.com. As a lender, you are making an unsecured loan to a stranger based on their write up and some standardized data they have to provide. When the US economy loses less than 75k jobs in a month, I think it will be time to put some money to work here, based on the assumption that the most likely reason the loans won't be repaid is loss of income. At about -75k jobs, I expect loan performance going forward to be good, but interest rates still attractive.
Thursday, March 26, 2009
Greenhill on a roll
Greenhill (Ticker GHL) announced another MD hire today, bringing the YTD number to five. My projections were for them to hire ten in 2009 so they are already half way there. For those that own it, I would start to think of the position as a source of funds if it goes above $85 within the next month or two. The stock can go higher, but I think you can find better risk/rewards in other stocks at that point. I wouldn't initiate a new position at these prices, but I am sticking with my position for now.
Monday, March 23, 2009
Toxic Assets, Expectations and an Anecdote
If you have read my prior posts, you know that I am bullish on stocks and consider this a good time to be allocating into equities. There are four things I want to highlight today to bolster that argument. Namely, the Treasuries Toxic Asset Plan announced this morning, Tiffany reported better than expected results, and a conversation I had last week that startled me.
First the Toxic Asset Plan. Treasury Secretary Geithner announced a plan to partner with private investors to to create investment entities that will bid on pools of toxic assets with financing assistance from the government. There is a factsheet on the Treasury's website so I won't rehash it here. In a prior post I mentioned that I was optimistic because I thought the government was finally trying to address all five of the key issues needed to return to a more normal financial and economic footing. They were to: recapitalize the banks, remove toxic asset overhang, find a bottom in housing prices, slow consumer deleveraging, and try to create jobs. Whether this toxic asset plan will work is still debatable, but we have a concrete plan of action from the government and I think that is a positive step. There is real movement on all five areas now.
Second, Tiffany & Co reported bad Q4 results, but they were better than analyst estimates and the stock was up about 5% at the open. I don't cover consumer stocks very closely, but I feel like I am seeing more headlines where things were not as bad as projected. Before things get better, they get less bad, and I think that is what we are starting to see.
Third, and I think most interesting, I talked to a friend of mine last week who told be that they were still being swamped with requests from wealthy households to sell stocks and buy bonds. I found it shocking that investors that have lost so much in equities would now decide to lock in low interest rates and effectively give up the opportunity for capital gains from here. I asked my friend if he was serious. He said that investors were not thinking about how to regain some of the money they lost, they were just trying to prevent further loss. I knew this reallocation had been happening, but I guess I thought it had mostly run its course. There continues to be selling pressure on equities from this type of activity, yet the market has bounced about 18% off its March 9th low. The fear remains, but I think we are running out of sellers.
First the Toxic Asset Plan. Treasury Secretary Geithner announced a plan to partner with private investors to to create investment entities that will bid on pools of toxic assets with financing assistance from the government. There is a factsheet on the Treasury's website so I won't rehash it here. In a prior post I mentioned that I was optimistic because I thought the government was finally trying to address all five of the key issues needed to return to a more normal financial and economic footing. They were to: recapitalize the banks, remove toxic asset overhang, find a bottom in housing prices, slow consumer deleveraging, and try to create jobs. Whether this toxic asset plan will work is still debatable, but we have a concrete plan of action from the government and I think that is a positive step. There is real movement on all five areas now.
Second, Tiffany & Co reported bad Q4 results, but they were better than analyst estimates and the stock was up about 5% at the open. I don't cover consumer stocks very closely, but I feel like I am seeing more headlines where things were not as bad as projected. Before things get better, they get less bad, and I think that is what we are starting to see.
Third, and I think most interesting, I talked to a friend of mine last week who told be that they were still being swamped with requests from wealthy households to sell stocks and buy bonds. I found it shocking that investors that have lost so much in equities would now decide to lock in low interest rates and effectively give up the opportunity for capital gains from here. I asked my friend if he was serious. He said that investors were not thinking about how to regain some of the money they lost, they were just trying to prevent further loss. I knew this reallocation had been happening, but I guess I thought it had mostly run its course. There continues to be selling pressure on equities from this type of activity, yet the market has bounced about 18% off its March 9th low. The fear remains, but I think we are running out of sellers.
Tuesday, March 17, 2009
Greenhill - a great franchise, buy at $60
Greenhill (Ticker: GHL)
Who they are: Greenhill is a NYC-based investment bank that focuses on Corporate Advisory (both M&A and restructuring), Merchant Banking and a newer Funds Placement business. As of 3/17/2009, they have 52 managing directors around the world.
Investment Thesis:
-M&A is cyclical and will return in the future, at which point investors will pay 20x estimates for this high quality pure-play.
-Unlike bulge bracket rivals, Greenhill has remained a low-capital-intensive business. Advisory has almost no capital requirements, and merchant banking has low capital requirements (which are not levered up).
-Greenhill's boutique business model is in favor and will gain prominence given the tarnished image of the bulge brackets and fewer conflicts of interest when working with Greenhill.
-They are attracting the best and brightest amid the market turmoil.
-They have won some very high profile assignments that bolster their industry standing among corporate chieftains.
-I have tremendous respect for Bob Greenhill and Scott Bok, and think they have built a differentiated culture that will serve clients, employees and shareholders well.
-I like this stock under $60 per share.
Catalysts/Risks:
-Need to hire about 10 top-notch MDs in 2009 or investors will be disappointed.
-Merchant Banking will try to raise GCP III this year and was hoping for $1b; +/- will be noted.
-GCP II is 80% invested since being raised in 2005. While it appears they were more prudent with leverage than the industry, there is mark-to-market risk at a minimum.
-Additional high profile assignments in advisory. Getting the lead role to Roche on its Genentech merger was a big deal. Investors will be looking for signs it wasn't a one-timer.
-Can their culture survive and thrive as they grow? I think so, but this is a risk.
Math/Assumptions:
-I assume that at the end of 2010, investors will pay 20x for a normalized earnings power estimate because the M&A cycle will be re-accelerating and Greenhill is a high quality way to get pure-play exposure to that cycle.
-I assume they will start 2011 with 63 managing directors which can each generate $8 million in revenue, and that on a normalized basis, merchant banking will contribute 15% of total revenue. (I assume no interest income for conservatism sake)
-I assume compensation expense ratio of 46% and a non-comp expense ratio of 15%, for an operating margin of 39%.
-With a 35% tax rate, that gives me $150 million in net income for normalized 2011 ($5 in EPS with a 30m sharecount)
-That implies the market will pay right around $100 per share at the end of 2010 and I want a 30% CAGR to that price. Discounting back to today means I like this stock at about $60 per share.
A note on culture:
Culture is a tricky thing to analyze because it is inherently subjective, but it is often very important. I think Greenhill is an example of a company where they have been very deliberate about their culture and where I think it is a competitive advantage. Most i-banks have cut-throat environments where the MDs bring in the business and operate at a very high level, but leave most of the execution and detail to their subordinates. Compensation is often opaque and there is very little collaboration among MDs.
Greenhill has built a culture of collaboration, execution and meritocracy. MDs at Greenhill routinely help each other find contacts in the course of completing and sourcing deals. As Scott Bok said, if an MD turns out not to be a team player, they will be drummed out of the firm. Additionally, a rival firm might send ten people to a board meeting, each of which is competing for air time to demonstrate their sliver of knowledge on the deal. Greenhill sends a couple people with the MD knowing the whole story because they have been involved in the execution. Greenhill looks for MDs that want to be involved with completing deals, not just golfing with CEOs to source deals. Finally, every MD knows the compensation for every other MD. This creates a culture of meritocracy where the new hires know they can be paid for their performance and the veterans know they have to justify their compensation in the eyes of their peers. Maybe I'm drinking the corporate cool-aid, but I can see why a CEO would prefer to work with Greenhill.
Word of caution:
I think buying GHL at $60 or less will provide a nice return by the end of 2010, but recognize that the fundamentals in the M&A and Merchant Banking business are at the bad part of their cycle right now. It is probable that there will be bad news between now and the end of 2010. I guess I'm trying to warn investors that the fundamentals could be extremely volatile on this stock and therefore the stock price may be extremely volatile as well. When I try to model this company I don't even bother to forecast an EPS number for 2009 or 2010 for the reasons I just mentioned. Just understand the type of investment this is before you buy it.
Who they are: Greenhill is a NYC-based investment bank that focuses on Corporate Advisory (both M&A and restructuring), Merchant Banking and a newer Funds Placement business. As of 3/17/2009, they have 52 managing directors around the world.
Investment Thesis:
-M&A is cyclical and will return in the future, at which point investors will pay 20x estimates for this high quality pure-play.
-Unlike bulge bracket rivals, Greenhill has remained a low-capital-intensive business. Advisory has almost no capital requirements, and merchant banking has low capital requirements (which are not levered up).
-Greenhill's boutique business model is in favor and will gain prominence given the tarnished image of the bulge brackets and fewer conflicts of interest when working with Greenhill.
-They are attracting the best and brightest amid the market turmoil.
-They have won some very high profile assignments that bolster their industry standing among corporate chieftains.
-I have tremendous respect for Bob Greenhill and Scott Bok, and think they have built a differentiated culture that will serve clients, employees and shareholders well.
-I like this stock under $60 per share.
Catalysts/Risks:
-Need to hire about 10 top-notch MDs in 2009 or investors will be disappointed.
-Merchant Banking will try to raise GCP III this year and was hoping for $1b; +/- will be noted.
-GCP II is 80% invested since being raised in 2005. While it appears they were more prudent with leverage than the industry, there is mark-to-market risk at a minimum.
-Additional high profile assignments in advisory. Getting the lead role to Roche on its Genentech merger was a big deal. Investors will be looking for signs it wasn't a one-timer.
-Can their culture survive and thrive as they grow? I think so, but this is a risk.
Math/Assumptions:
-I assume that at the end of 2010, investors will pay 20x for a normalized earnings power estimate because the M&A cycle will be re-accelerating and Greenhill is a high quality way to get pure-play exposure to that cycle.
-I assume they will start 2011 with 63 managing directors which can each generate $8 million in revenue, and that on a normalized basis, merchant banking will contribute 15% of total revenue. (I assume no interest income for conservatism sake)
-I assume compensation expense ratio of 46% and a non-comp expense ratio of 15%, for an operating margin of 39%.
-With a 35% tax rate, that gives me $150 million in net income for normalized 2011 ($5 in EPS with a 30m sharecount)
-That implies the market will pay right around $100 per share at the end of 2010 and I want a 30% CAGR to that price. Discounting back to today means I like this stock at about $60 per share.
A note on culture:
Culture is a tricky thing to analyze because it is inherently subjective, but it is often very important. I think Greenhill is an example of a company where they have been very deliberate about their culture and where I think it is a competitive advantage. Most i-banks have cut-throat environments where the MDs bring in the business and operate at a very high level, but leave most of the execution and detail to their subordinates. Compensation is often opaque and there is very little collaboration among MDs.
Greenhill has built a culture of collaboration, execution and meritocracy. MDs at Greenhill routinely help each other find contacts in the course of completing and sourcing deals. As Scott Bok said, if an MD turns out not to be a team player, they will be drummed out of the firm. Additionally, a rival firm might send ten people to a board meeting, each of which is competing for air time to demonstrate their sliver of knowledge on the deal. Greenhill sends a couple people with the MD knowing the whole story because they have been involved in the execution. Greenhill looks for MDs that want to be involved with completing deals, not just golfing with CEOs to source deals. Finally, every MD knows the compensation for every other MD. This creates a culture of meritocracy where the new hires know they can be paid for their performance and the veterans know they have to justify their compensation in the eyes of their peers. Maybe I'm drinking the corporate cool-aid, but I can see why a CEO would prefer to work with Greenhill.
Word of caution:
I think buying GHL at $60 or less will provide a nice return by the end of 2010, but recognize that the fundamentals in the M&A and Merchant Banking business are at the bad part of their cycle right now. It is probable that there will be bad news between now and the end of 2010. I guess I'm trying to warn investors that the fundamentals could be extremely volatile on this stock and therefore the stock price may be extremely volatile as well. When I try to model this company I don't even bother to forecast an EPS number for 2009 or 2010 for the reasons I just mentioned. Just understand the type of investment this is before you buy it.
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