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HFF Holdings (NYSE:HF) floated its IPO this morning -- here's our writeup sent to subscribers last week (disclosure: we own a position with average price of $18.20):

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HFF Holdings plans on offering 16.5 million shares (assuming over-allotment) at a range of $15-$17. Goldman Sachs and Morgan Stanly are lead managing with BofA, Wachovia, JP Morgan and Lehman co-managing. Post-offering HF will have 39 million shares outstanding for a market cap of $624 million on a $16 pricing. Approximately 3/4 of the IPO proceeds will go to pay partnership holders as HF converts from a partnership to a publicly traded company. 1/4 of the IPO proceeds will go to repay debt.

As HF was structured as a partnership prior to IPO, management, board and employees will own essentially all outstanding shares not sold on IPO. Assuming over-allotment is exercised that equals 55%-60% of ownership in HF. Note that these shares will still be listed as partnership units post-IPO, much as the Evercore IPO was structured.

From the prospectus:

We are a leading provider of commercial real estate and capital markets services to the U.S. commercial real estate industry based on transaction volume and are one of the largest private full-service commercial real estate financial intermediaries in the country.

HF is an expertise operation. Expertise IPOs rely heavily on their employees/management, one reason why HF was structured as a partnership pre-IPO. Expertise IPOs tend to do rather well overall. We've seen a number of successful 'expertise' IPOs the past few years including GFIG/EVR/GHL/LAZ and HF's direct comparable CBG. Note that CBG is up approximately 500% since the 2004 IPO, reason enough to take this HF offering seriously.

HF operates out of 18 offices in the US staffed by 130 transaction professionals. In 2005, HF advised clients in transactions covering 44 states and 500 cities. Revenues are derived from client fees on a transaction by transaction basis.

HF operates as 'one stop shop' for commercial real estate including debt placement, investment sales, structured finance, investment banking/advisory, private equity, note sales and commercial loan servicing.

Note what HF does not do: They are not involved in leasing or property management nor does HF engage in principal commercial property investing. HF feels this allows them to provide objective advice to clients and to act as impartial broker to both sides of their deals.

A quick look at HF's services:

Debt placement - Construction loans, adjustable and fixed rate mortgages, entity level debt, mezzanine debt, forward delivery loans, tax exempt financing, and sale/leaseback financing. Clients are owners of various types of property, including, office, retail, industrial, hotel, multi-family etc... Debt is placed with every imaginable possible debt placement client including life insurance companies, investment banks, commercial banks, thrifts, agency lenders, pension funds etc.... Keep in mind HF is transacting and placing the debt, not carrying the mortgages on their own books. HF makes money from the deal flow, not the appreciation or depreciation of the assets in the future. In 2005 HF's value in debt placements was approximately $22 billion, an approximately 11% share of the entire US commercial debt placement market.

Investment Sales - HF provides investment sales services to commercial real estate owners who are seeking to sell one or more properties. Essentially HF acts as a commercial real estate agent. In 2005 HF was the agent for $7.6 billion in investment sales, which was approximately a 3% US market share.

Structured Finance - Alternative investment expertise in mezzanine, preferred equity, participating and/or convertible debt structures, bridge loans. HF will participate in structuring these alternative financing options to fit the clients needs. In 2005 HF acted as broker/dealer in approximately $2.1 billion of structured finance

Private equity, Investment banking, and Advisory services - HF serves as a real estate investment banker/adviser for clients desiring to access the private equity investment market as well as advising clients in financial transactions. Services include commercial real estate investment banking/advising services for direct private equity investments, joint ventures, private placements, management buyouts,and mergers and acquisitions(M&A). HF really just kicked off their real estate investment banking/advisory services in 2005. HS was involved in $100 million in total transactions in this niche in 2005 and over $1 billion through the first 9 months of 2006. It appears this niche will be a prime growth driver for HF going forward as they grab commercial real estate M&A market share.

Typical clients for HF's services include both users of capital, such as property owners, and providers of capital, such as lenders and equity investors.Clients will often act as both users and providers of capital in different transactions. Over the past three years no single client represented more then 4% of overall revenues.

Growth plan - Expand geographic penetration, increase market share and capitalize on cross-selling opportunities. HF's growth focus will be to locate and bring on board commercial real estate transaction professionals in smaller US market not currently covered by HF. Also note that HF has quickly grown their commercial real estate M&A arm in 2006, from essentially start-up stage in 2005.

Risks - HF is heavily leveraged to overall commercial real estate activities. To make money, HF needs to see sustained interest in commercial real estate transactions. As HF notes in the prospectus, 'Historically, commercial real estate markets, and in particular the U.S. commercial real estate market, have tended to be cyclical and related to the condition of the economy as a whole and to the perceptions of the market participants as to the relevant economic outlook.' Overall the commercial real estate market has been in a cyclical upswing for most of the US after a 2002/2203 trough.

Financials

No substantial cash or debt on the books post-offering.

No dividends planned.

Revenues - HF has grown revenues annually throughout the decade, with strong growth of 40%-55% coming in 2004-2005. For full year 2005, HF booked revenues of $206 million. As with most expertise companies, compensation to producing partners is the greatest expense line. HF's transaction professional are primarily paid in commissions, salary and bonus. The direct expense line for all employee compensation appears to be approximately 65% of revenues the past 18 months. Expect this % to remain fairly robust as is common with this type of operation.

In 2005 HF had operating margins of 23%, fully taxed net margins of 16% and earnings per share of $0.82.

2006 - Through the first 9 months of 2006, HF appears as if they will grow revenues 15% for the full year to $235-$240 million. Operating and net margins will be in the same ballpark as 2005. Full year 2006, HF should earn approximately $1 per share. On a $16 pricing, HF would be trading 16 X's 2006 earnings.

2007 - As long as the commercial real estate market remains active, HF is positioned to have a very good year. With their burgeoning private equity placement and M&A arm to go with their strong debt placement and commercial agent segments, another 10%-20% revenue growth year should be achievable. The largest expense item, employee compensation, does not look to drop as a % of revenues so there will not be a significant margin increase as revenues increase. At a 15% 2007 revenue increase that would mirror 2006's % increase, HFF should earn $1.15-$1.20. This number is a ballpark number only at this point and could change each way depending on HF's success in garnering a larger slice of the pie and general commercial real estate activity. I would surmise that the earnings per share would not be a whole lot lower then this forecast unless the US economy ran into a recessionary climate the back half of 2007. At those estimate, HFF would be trading 13-14 X's 2007 earnings on a $16 pricing.

Concern - I would prefer to see a smaller employee related expense % here. 65% total appears rather steep and it doesn't appear as if HF has any plans on lowering that number going forward. Many of the broker/dealer and investment banking IPOs we've seen the past 3-4 years have committed to capping employee compensation going forward at 55%-60%. HF's 65% is a bit above there.

CBG is HF's closest publicly traded comparable. Keep in mind that CBG is a behemoth in the sector, much larger, more diverse and covers a larger geographic area then HF. A quick glance at each:

CBG, $8 billion market cap. Currently trades 24 X's 2006 earnings and 19 X's 2007 estimates with a projected 25% 2007 revenue growth, fueled in part from acquisitions.

HF, $624 million market cap on a $16 pricing. At $16 would trade 16 X's 2006 earnings and 13-14 X's conservative 2007 estimate with a projected revenue growth in 2007 of approximately 15%.

CBG is up 500% since IPO late in 2004. If the commercial real estate market just remains stable, HF is a solid IPO coming at a very reasonable multiple. Really I would only be concerned in pricing range if the US economy slows in a recession like climate. Otherwise the multiple is reasonable enough in range that HF should do quite well. Whenever an IPO's closest comparable is up 500% from offer, you've got to take notice. Factor in also that 'expertise' IPOs have as a rule done very well this decade and HF should work quite well. I like this deal quite a bit.

HF is not a direct play on the valuation and strength of the real estate market. They're a play on the transaction growth this decade of structured finance and debt placement in the commercial real estate market. In a fashion this is similar to the growth of derivatives and the resultant effect on the broker/dealer and exchange sector. For HF, the underlying price does not matter so much as long as there is sustained demand for transactions, refinancings, alternative debt structuring, debt placement etc...This is a big reason that CBG's chart looks a lot like those of the derivatives exchanges and derivatives broker/dealer GFIG since IPO. They've all benefited from the heavy growth in transaction flow in their markets, not the overall valuation of the underlying assets. This is a key difference to a business linked directly to the underlying prices involved in said transactions.

Yes, a sustained downturn in the commercial real estate market would have an impact on these activities. However it would most likely take a pretty severe overall economic downturn to curtail HF's core revenue streams. HF stands to do well as long as commercial real estate transaction activity overall remains fairly strong, regardless of the underlying pricing fluctuations. In very simple terms, if the US economy avoids recession, HF should do quite well.

Source: A Close Look At The HFF Holdings IPO