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On November 12, Bill Simpson wrote an analysis of Keefe, Bruyette Woods (NYSE:KBW). The text of Mr. Simpson's original writeup follows:

KBW - KBW Inc. (Keefe, Bruyette Woods) plans to offer 7.5 million shares (assuming over-allotment is exercised) at a range of $19-$21. Insiders are selling 3.75 million shares in this offering. KBW will be self-underwriting their own offering. Merril Lynch will joint lead the offering with 6 other houses co-managing. Post-offering KBW will have 30.4 million shares outstanding for a market cap of $608 million on a $20 pricing. IPO proceeds will be used for general corporate purposes.

Directors and Executive Officers of KBW will own 23% of shares outstanding post-IPO, all employees as a whole, 80%. Pre-IPO, entire firm is employee/director owned with no single individual owning more 4.2% of outstanding shares.

From the prospectus:

'We are a leading full service investment bank specializing in the financial services industry. Since our founding in 1962, our commitment to this large and growing industry, our long-term relationships with clients and our recognized industry expertise have made us a trusted advisor to our corporate clients and a valuable resource for our institutional investor customers.'

We've seen a number of boutique investment banking ipos the past few years including Lazard, Greenhill, Evercore, Cowen and Weisel. They've broken down into two types: 1) The M&A (mergers & acquisitions) based group that has ridden the wave of consolidation the past few years, showing strong operating results and robust stock market appreciation. This includes Lazard, Greenhill, and Evercore. 2) The underwriting based group that has struggled to show revenue growth the previous 2-3 years, Cowen and Weisel.

Group one IPOs have been 3 of the best performing ipos of the past few years, while group 2 has struggled.

The key to this deal is the following line from the prospectus: 'Number one ranking as U.S. M&A advisor to financial services companies in each of the years 2005, 2004 and 2003, ranked by number of deals.' Bingo. Note though that KBW focuses on smaller capitalization companies, so was #3 in M&A in the financial services sector in 2005 (and #9 in 2004) based on value of the deals. Still a strong player in this sector though.

KBW's operations break into 3 segments:

1) Investment banking. This includes the M&A component as well as IPO and secondary offering underwriting. KBW has been a solid underwriter of financial related IPOs the past few years, carving out a nice little niche for themselves there. In fact they've been #1 in managing U.S. IPOs and follow-on equity offerings for financial services companies in both 2005 and 2004(again based on number of offerings). We've noted above they're also the #1 financials services M&A advisor on deals getting done.. A few recent M&A deals: pending sale of North Fork Bancorporation to Capital One Financial Corporation; the acquisition by Bank of America Corporation of MBNA Corporation; the sale of Household International to HSBC; and the pending sale of Texas Regional Bancshares to BBVA.

Of the 190 clients for whom KBW executed investment banking transactions in 2005, approximately 45% were companies for which they'd executed other transactions during the previous five years.

KBW is a strong player in the small and mid-cap financial services niche. In fact they dominate that niche in both M&A and equity deals. Deals involving financial services companies accounted for 31% of all M&A fees and 21% of all underwriting fees in 2005. If the earnings/expenses for KBW look solid, this is enough here to recommend this deal. M&A has boomed the past few years driven by record corporate cash levels and billions in private equity being put to work. Those trends look to continue going forward. To stress again though: KBW plays in the smaller company space, this far they've not really broken into the large M&A deals. Their specialty is regional bank mergers and buyouts.

KBW in 2006 has seen a sharp increase in structured finance private placement deals.

Investment banking historically has accounted for 50% of revenues.

2) Trading. KBW focuses trading efforts on the sector they know: banking. they've the #1 ranking by trading volume as trader of U.S. bank stocks with less than $5 billion market Also one of the leading traders in the Nasdaq 100 financial index stocks. Commissions have historically accounted for 30% of annual revenues, proprietary trading 10%.

3) Research. Number one in five of the seven categories of their research coverage, and second place in the other two categories. Named "Best of the Boutiques" in a survey by Institutional Investor. KBW's research analysts currently cover 489 companies.

Strategies going forward are to expand the European business and expand the asset management business. Currently KBW manges/advises two related hedge funds.

Compensation Expense: Overall compensation is always the largest expense line with these type operations and one needs to make certain that the investment banking entity is not funneling all the profits to management/employees but also growing shareholder value. KBW plans to limit total annual compensation and benefit expense to 55%-60% of total revenues. This is in line with similar firms, although should note it is higher then EVR's 50% target.

History - KBW was founded in 1962 with a focus on the financial services sector. Headquartered in the World Trade Center, 67 employees died on 9/11, approximately 1/2 of KBW's New york staff. Included in this number were five of 9 board members including the co-CEO and Chairman of the Board. KBW planned an IPO in 1999 but that was set-aside after an insider dealing scandal involving the then CEO and a porn star. The ceo resigned and the IPO was scrapped. Not surprisingly there is no mention of this latter event in the prospectus --- if there is they buried it well enough that I didn't find it.

Financials

$1.75 X's book value on a $20 pricing.

Revenues in 2005 at $307 were flat coming off a strong 2004. Revenues in 2006 however have really picked up thanks to strong increases across the board in investment banking, commission trades and proprietary trading. Of note the strong gains in investment banking for 2006 are due to underwriting and private placements. M&A is actually down substantially in 2006 from 2005 for KBW.

Based on first 6 months of the year, revenues for full year 2006 appear to be on track for $400-$425 million, a 34% increase.

2005 - Employee compensation expense was 61%, slightly above the post-IPO target. Non-compensation expenses were 29%. Operating margins were 10%, net margins 6%. KBW earned $0.58 a share in 2005. On a $20 pricing, KBW would be trading 34 X's trailing earnings. As a point of comparison, EVR's earnings per share for 2005 were $0.63.

2006 - Earnings will be much stronger due to the anticipated 34% revenue growth to $400-$425 for the year. Employee compensation expense of 58%, well within target. Non-compensation expenses on pace for 24% of revenues. Operating margins anticipated at 17%, net margins 10%. Anticipated earnings per share for 2006, $1.20 - $1.25. No matter how you slice it, KBW is having a great 2006 through the first 6 months. On a pricing of $20, KBW would be trading 16 X's 2006 earnings.

Comparisons. At the top of the piece, we looked at two different types of investment banking IPOs. The M&A focused group has fared much better in the market and also carry a much hefty valuation. A quick look at GHL/EVR two M&A focused firms and COWN/TWPG, two underwriting focused firms.

(NYSE:GHL) - $1.95 billion market cap, trading 6 1/2 X's revenues and 16 X's book. Trading 27 X's 2006 earnings with an expected 10% revenue growth rate.

(NYSE:EVR) - $1.05 billion market cap, trading 5 X's revenues and 6 X's book. Trading 37 X's 2006 earnings with an expected 30% revenue growth rate.

(NASDAQ:COWN) - $217 million market cap, trading. 0.6X's revenues and below book value. Trading 14 X's 2006 earnings. with a 10% revenue growth rate.

(TWPG) - $420 million market cap, trading 1.5 X's revenues and 1.6 X's book value. Trading 19 X's 2006 earnings with a 10% revenue growth rate.

(KBW) - $608 million market cap on a $20 pricing. Trading 1.5 X's revenues and 1.75 book value. Trading 16 X's 2006 earnings with a 30%+ revenue growth rate.

So should KBW be valued with the M&A focused firms or the others? I submit it is somewhere in between. KBW has a strong M&A business, historically accounting for 15% of annual revenues. Part of KBW also resemble TWPG. I would define KBW as resembling TWPG but focused on the financial services sector with a much stronger M&A component. KBW is also having a strong 2006, even though the M&A segment has lagged a bit this year. While I don't believe KBW should valued as dearly as EVR, there is definitely room for appreciation here from IPO range. I would value KBW somewhere between TWPG and EVR.

Conclusion - Solid deal. KBW with their strong financial sector M&A operation (#3 in dollar value in 2005), resembles two of the strongest IPOs of recent years GHL/EVR. While I don't see this deal quite as strong as those two, they have built a solid niche for themselves in the investment banking sector. Recommending this deal strongly in range.

Related Articles: Energy Investment Bank IPO: Highlights from Petrie Parkman's S-1 Filing; Evercore Partners: Unlikely To Sustain Its Inflated Valuation -- Barron's

Source: An In-Depth Look At The KBW IPO