Yesterday Matthew wrote that the importance of big Wall Street banks may be on the decline. The financial services giants were tarnished by the 2008 crisis and now face the threat of new, technology-driven alternatives to traditional banking. This trend is playing out across the industry from retail banking to mergers and acquisitions.
Partly in response to this theme, earlier this year we bought shares of Evercore Partners (EVR), a boutique investment bank with a market cap of $1.7 billion, in our small cap fund. The company was founded by industry veteran and former deputy Treasury secretary Roger Altman and has been steadily taking market share from the larger players. We thought that the company would benefit from the increasing wave of mergers and acquisitions as well as the rise of smaller, more specialized banks that are free from the conflicts of interest of giants such as J.P. Morgan, Goldman Sachs and Citigroup.
From 2005-2013 Evercore’s market share of U.S. M&A grew from 1% to 5.5%. The company has been involved in some of the largest deals in recent history including Berkshire Hathaway’s acquisition of Burlington Northern, Sanofi’s acquisition of Genzyme and Kraft’s split that created Modelez.
But at the beginning of August Evercore announced it was acquiring International Strategy & Investment Group LLC (ISI) in an all-stock deal for $406 million, and the stock fell 8%. It seemed somewhat ironic that a highly successful investment bank that specializes in advising companies on mergers and acquisitions would have a deal of its own that was so poorly received by the market.
Why was the market so upset by this news? First of all, issuing new shares to pay for the all-stock deal could significantly dilute the value of outstanding shares. Also, the limited scope of Evercore’s business was a kind of competitive advantage. Client’s like that the company specializes in M&A because “full service” banks are plagued with conflicts of interest. When Evercore announced the ISI deal, the company seemed it was giving up its specialized status in order to grow and expand and compete with the “full service” giants. Also, to make things worse, the equity research business has for a long time appeared to be on the decline.
I thought there must be more to the story though. So what did the company itself and other commentators say about the deal?
In response to the charge of dilution, the company has said that it will embark on a major share-buyback program to offset any loss of value. In a discussion on Bloomberg TV, the CEO Roger Schlossstein went further into the company’s thinking behind the deal. Schlosstein insists that the deal does not compromise Evercore’s independence, and the company does not plan to ever become a “full service” investment bank. He says that the company’s increased presence in equity research and trading will enhance its core fee-only M&A advisory business. They will be able to provide better service and attract more new bankers from other firms. What causes conflicts of interest, Schlosstein says, is when the giant investment banks own a stake in the company that they are advising, a practice Evercore always avoids.
Another detail that emerged in a separate Bloomberg article was that the deal with ISI contained significant incentives attached to ISI’s future performance. If ISI does not contribute as much as expected to future revenue, Evercore will not have to pay as much. This protects Evercore from some of the downside risk of the deal.
Bloomberg also notes that ISI is a highly successful and well known firm, founded by industry legend Ed Hymen. The company has managed to continue to grow despite the wider decline in the equity research industry. According to an industry recruiter who is quoted by Bloomberg, “Ed Hyman is an industry unto himself. ISI is one of the most successful research boutiques.”
Evercore’s stock never bounced back after the news of the deal. It remains down 11% this year. The ISI acquisition is a contrarian move, but it could help Evercore in its mission to be the most elite investment bank, as Schlosstein says. For now we will take the company at its word and trust that the leading M&A experts did not badly botch their acquisition of ISI. But we will continue to monitor the news and see how the ISI deal pans out in the coming quarters.