Admiration for the regional boutiques

IDD had a nice article on the rise of the regional boutique investment bank. See article pasted below.

Burgeoning Boutiques
Paul Sweeney
September 25, 2006
IDD

In 2001, when Douglas Brockway and a couple of partners formed Innovation Advisors, a New York-based advisory boutique focused on the technology industry, friends in the investment banking world were incredulous.

Back then, the US economy was in the doldrums and the technology industry was licking its wounds. But not quite five years later, Brockway and his firm have won a measure of respect from old colleagues.

"A lot of people scratched their heads and asked why we were starting an investment bank," says Brockway, a managing director at the firm with 15 years of experience dealing with emerging growth companies at SG Cowen and Alex. Brown. "Now those same people are saying, You're smart -- and a little lucky.'"

Indeed, what began as a three-person operation in New York that was long on energy and experience but short on actual business clients has morphed into a firm with Boston and Chicago offices and a staff of 18. Brockway, moreover, boasts that the upstart firm has closed 30 transactions since its inception, the bulk of them M&A deals. And Innovation Advisors is not alone.

Every profession that services mergers and acquisitions - lawyers, accountants, insurance firms -- have seen its fortunes rise of late. But few have benefited more handsomely than the 25 to 30 regional and boutique investment banks around the country that focus on advisory work and private equity investments in the middle market. Ironically, the explosion of opportunity, thanks in varying parts to pricing, generational changes and the ubiquitous private equity pressure, has caused these little fish to grow quickly and stretch the definition of boutique.

Time to Get In on the Auction

It's no surprise that the M&A boom, and concomitant private equity explosion, have been the primary drivers of this success. The effects these two engines have had on middle-market banks have caused them to mushroom.

The best known of these firms, which largely eschew the capital- and risk-intensive world of sales and trading, include Houlihan Lokey Howard & Zukin in New York, Harris Williams in Richmond, Va., Goldsmith Agio Helms in Minneapolis, Lincoln International in Chicago, GulfStar Group in Houston, George Baum in Kansas City and Edgeview Partners in Charlotte, N.C.

Their success over the last decade has completely altered the landscape of M&A deals, particularly in the middle market, defined broadly as deals under $700 million.

The rising prominence of regional boutiques is occurring as all areas of the investment banking industry are flourishing.

Investment banking activity is at some of its highest levels in years, says a recent Goldman Sachs report on the securities industry. By all accounts, M&A work - where fees generally run 1.5% to 2% of the sale price - is rapidly becoming Job One at the regional boutiques.

A host of factors are fueling the M&A fervor. Not only are private equity firms hungry for acquisitions, but there are more of them, and they are awash in capital, with US funds having raised $446 billion in the last eight years, according to Thomson. Pension funds, foundations, university endowments and wealthy individuals looking to put their cash hoards to work, increasingly disdain the public markets in favor of less liquid - but more profitable - private equity investments. The total capital raised in 2006 is expected to break all records, with $78 billion raised as of Sept. 12.

As the attached table shows (page 19), the increasing competition from private equity is remarkable. Already, there have been more funds closed in 2006 than were raised in all of 2002, and the dollars committed has been trebled. And the 92 funds closed thus far this year have raised more money than the 225 funds raised in 2003 and 2004. While 2006 still technically lags the fundraising numbers put up last year, simple math suggests that the year-end total may well dwarf 2005.

"Within our investment banking group, M&A is about 80% of our business," says Bill Tyson, co-head of investment banking at BB&T Capital. "And two-thirds of our M&A business pertains to private equity." Innovation's Brockway says about 70% of his firm's business involves M&A situations, and the balance stems from capital raisings.

Once, private equity firms targeting a middle-market opportunity could strike a deal directly with an entrepreneurial company, but now they almost always go through an intermediary - the regional boutique. And that often means participating in an auction.

"In the mid-1980s, you could just find a company and negotiate with them," says Paul Rossetti, managing director of American Securities Capital Partners, a New York private equity firm with a $900 million war chest looking for action. "A lot of guys back then didn't know what their company was worth. But now everybody pretty much knows how it's done, or they know somebody who did [an LBO]."

So spirited is the auction process that the effect is to intensify activity around a particular situation, says Dom DeChiara, the head of private equity and investment funds practice at King & Spalding, a New York law firm. "It's not unusual to send the book out to 100 different people," he adds, referring to the first stage of the auction process.

Other forces pushing public companies into the arms of private equity firms - especially those in the middle market - include the groaning weight of both Sarbanes-Oxley regulations, which some analysts say adds $2 million a year in compliance costs, and the demands of regulators like the Securities & Exchange Commission. In addition, many businesses are relishing the freedom of being closely held and having the luxury of thinking about long-term success, rather than the quarter-to-quarter performance concerns that dominate the thinking of Wall Street.

In a massive generational change, a multitude of family-owned businesses are going on the auction block. "Baby boomers are beginning to turn illiquid assets into liquid investments and diversify their net worth," says Colt Luedde, managing director at GulfStar Group, a regional boutique in Houston. "The owner of a $50 million company usually doesn't have that much in cash, despite the value. But by selling all or a portion of it, the owner can convert it to cash and invest in all sorts of things."

In addition, banks have been loosening their lending requirements and vying for deals. In Houston, says Jeff Geuther, a private equity lender at LaSalle Bank/ABN AMRO, a bevy of new lenders are jostling for a place in private equity deals and ratcheting down prices. "Pricing on senior and junior debt has been compressed," he says. "We're seeing spreads come down to 150 basis points over Libor from 250 basis points just two years ago."

To the list of market drivers propelling the middle market, Innovation's Brockway adds the fact that strategic buyers - Corporate America as well as non-US companies - "have fixed the internal problems that they had in 2001 and now want to have 15% organic growth, plus they want to fill in the extra 5% [with an acquisition] to get to 20%."

And with improving stock values, many public companies are not shying away from using shares as currency, Brockway says. "So strategic buyers are more active and driven to be more aggressive. From the sellers' perspective, it's a perfect world."

Prices at which companies are selling are at historical highs, as much as eight times Ebitda, compared with roughly six times Ebitda just five years ago, says David Lobel, a managing partner and co-founder of Sentinel Capital Partners, a New York-based private equity firm that invests mainly in middle-market companies.

And for the right business, GulfStar's Luedde says multiples can go higher. He cites the recent example of a $330 million sale in which the price was 10.4 times Ebitda. "Most private equity people will tell you that they're paying more than they ever have," says Richard Stowell, managing director of Fairway Capital, a Houston-based $150-million mezzanine fund.

Houlihan Lokey managing director Justin Abelow contends that the regional boutiques are not the only ones pushing up the prices. "In situations where we've auctioned broadly, it's often because private equity firms insist that they get to see every deal," he says. "The pressure isn't always coming from the seller - or the agent."

Some industry observers say that prices might have reached their peak; should they sail any higher, there will be little room to produce the requisite internal rate of return on deals. However, all things being equal, sellers may insist on terms in addition to price that can force a private equity firm to make concessions. In the sale of a manufacturing company, for example, "someone may want to be sure that Earl, who used to run the plant, keeps his job," says Fairway Capital's Stowell. "For a price, all things are possible."

The Boutique Advantage

To distinguish themselves among both sellers and purchasers in such a competitive environment, the regional boutiques are relying more on industry knowledge than geographic expertise. Indeed, territorial boundaries are breaking down, especially as firms expand beyond their traditional preserve and even begin forming alliances overseas.

Harris Williams, for example, is no longer confined to Richmond. "We've grown consistently every year that we've been in existence," says managing director Giles Tucker, noting that the company has added offices in San Francisco, Boston, Philadelphia and, most recently, Minneapolis, where the firm recently hired a top M&A banker from Piper Jaffray.

But even when there is no actual office, GulfStar's Luedde says out-of-state regional boutiques, as well as other distant bankers, are regularly crowding the locals. "We see more firms from around the country sending their representatives to Texas, calling on people in the market here," he says. "So you're competing on deals way more than you used to."

More often than not, he says, two or three other investment banks can be counted on to woo the same client. And it isn't just the regional boutiques, Luedde adds. "We just lost a deal to Lehman Brothers and Goldman Sachs - although it's unusual to see them."

For its part, GulfStar, which also has a Dallas office and has built a reputation as a premier energy boutique, is now venturing outside Texas and the oil patch, representing companies in other industries, such as business services.

It is often the key contacts and strong relationships with private equity firms that specialize in particular industries that can separate the boutique bank from its brethren, says Fred Wainwright, executive director at the Tuck School of Business' center for private equity and entrepreneurship. "A lot of the boutiques have particular niches and that adds value to the marketplace."

At Goldsmith Agio, says managing director Michael McFarland, the firm's reputation for advising consumer companies helped win the assignment representing Allen-Edmonds Shoe, maker of men's dress shoes. Its sale to private equity firm Goldner Hawn, also of Minneapolis, marked Goldsmith Agio's 10th sale of a consumer company in 2006.

Tyson at BB&T Capital in Richmond says that his firm has several areas of expertise, including handling M&A assignments for companies in industrial services, logistics and transportation, financial services and healthcare. But one of BB&T's more active areas has been the firm's service to government services companies, including handling M&A assignments for information technology, aerospace and defense contractors in its Reston, Va., office. Near Washington, DC, the office sports a staff of 25 and is the firm's largest location outside Richmond. "There's been a huge increase in government spending," Tyson says.

Here Come the Big Boys

BB&T also is indicative of another trend in the industry: the purchase of regional boutiques by large, superregional commercial banks that, in the wake of the demise of the Glass-Steagall Act, have piled into investment banking. GulfStar is owned by Lardo-based International Bank of Commerce, and in the last year, Harris Williams was purchased by PNC Bank, a Pittsburgh bank holding company, ORIX, a Japanese financial firm, purchased a majority share of Houlihan Lokey, and Wells Fargo bought Barrington Associates in August.

Having a commercial bank as a partner can add to a regional boutique's ability to provide more lending and financing options, say investment bankers. But at least one private equity executive voices skepticism.

"The theory is that, by buying these boutiques, banks will provide financing," says American Securities Capital Partners' Rossetti. "But guys like us already have our lending sources lined up. I don't think that, because they're affiliated with a bank, it makes somebody a better shop."

But sources at the private equity firms are applauding another trend attending boutique banks: their rapid expansion into overseas markets, either by opening offices, partnering with foreign financial firms or selling off part of their company to offshore players, as Houlihan Lokey has done with ORIX.

"We hadn't figured out Asia, and we had issues like the language barrier," says Houlihan Lokey's Abelow. "And frankly, it's harder to get paid there for pure advice as opposed to capital financings."

Steve Brown, a partner at Code Hennessy & Simmons in Chicago, also hails the trend. He cites in particular working with Chicago's Lincoln Partners, which merged with Frankfurt's Peters Associates this past January. "As globalization continues to bring business communities together," Brown says, "they have a greater capability to find international buyers in Europe and Asia."

And that creates only one problem: No one has coined a good name for a regional boutique bank that has gone global. IDD

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