On September 23, Bill Simpson wrote an analysis of Duff & Phelps (DUF). In its debut September 27, the company's offering of 8.3 million Class A shares sold for $16 apiece, compared with a forecast range of $16.50 to $18.50. Friday the stock closed at $20.35.
The text of Mr. Simpson's original writeup follows:
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Duff & Phelps plans on offering 9.5 million shares (assuming over-allotments) at a range of $16.50-$18.50. Goldman Sachs and UBS are lead managing the deal. Lehman, William Blair, KBW, and Fox-Pitt Kelton will be co-managing. Post-ipo DUF will have 33.8 million shares outstanding for a market cap of $592 million on a $17.50 pricing. Approximately 20% of the ipo proceeds will be used to repay debt, the remainder will go to insiders.
Vestar Capital will own 20% of DUF post-ipo, Lovell Minnick 16%. Both are private equity entities that came on board DUF to help fund the 2005 purchase of Corporate Value Consulting from Standard & Poors. In addition on 9/1/07, Shinsei Bank (Japanese) purchased a 10% post-ipo stake in DUF at $16.07 per share.
From the prospectus:
We are a leading provider of independent financial advisory and investment banking services. Our mission is to help our clients protect, maximize and recover value. The foundation of our services is our ability to provide independent advice on issues involving highly technical and complex assessments of value.
DUF's valuation advisory services are focused on four core areas:
1) financial and tax valuation;We've seen a number of financial advisory and/or investment banks come public the past few years. DUF is a bit of a different animal than the rest as they focus on the unique niche of valuation advisory services specializing in complex financial, accounting, tax, regulatory and legal issues.
2) mergers & acquisitions;
3) restructuring; and
4) litigation & dispute.
DUF breaks down their business into Financial Advisory and Investment Banking segments. Financial Advisory segment provides valuation advisory, corporate finance consulting, specialty tax and dispute and legal management consulting services. Investment Banking Segment provides M&A advisory services, transaction opinions and restructuring advisory services.
This is a good spot to make an important point. With the slowdown in M&A activities over the past two months, this might not be an ideal time for a financial operation with an Investment Banking M&A component to come public. DUF however derives 75%-80% of annual revenues from their Financial Advisory segment (valuation advice) and 20%-25% from their Investment Banking segment. It should be noted that a chunk of those Financial Advisory segment revenues have come from valuation advisory services for newly acquired/merged operations. DUF believes the past 18 months that 45%-50% of their overall revenues were in some aspect related to M&A. This alone should be enough to proceed with a bit of caution on this DUF ipo.
DUF does not fall neatly into either of the financial advisory/IB ipos of the past two years in that they do not rely primarily on either direct M&A advisory services nor capital raising (IPO/secondary) activities.
DUF (with 21 offices, 6 being international) had approximately 400 clients in 2006. 36% of the S&P were a client sometime over the past 18 months and during that period 60%+ of revenues were derived from repeat customers. DUF is the industry's leading independent practice providing purchase price allocation services. Additionally, DUF is the number two independent provider of fairness opinions and a top ten global provider of restructuring services based on number of assignments.
Sarbanes Oxley - In 2002 the Sarbanes-Oxley Act, among other things, has conflict of interest restraints preventing accounting firms from providing other non-audit advice. The Enron scandal was the primary driver behind this aspect of Sarbanes-Oxley. This has led to an increase in demand for independent non-audit accounting related services. DUF believes that Sarbanes-Oxley gives them a competitive advantage over the auditing focused accounting firms in securing valuation advisory clients as DUF has no audit related segment and thus no potential conflicts of interest that would run up against the constraints of Sarbanes-Oxley.
Fair Value Accounting - DUF believes they benefit from the shift towards Fair Value Accounting [FVA]. FVA seeks to measure the current market value of a company's assets and liabilities as an alternative to the traditional historical cost method of accounting. Simplified for our purposes, FVA is an accounting snapshot of a company as it looks on current assessment of value, not historical. As DUF specializes in valuation, this shift to FVA standards and away from historical accounting standards plays into their favor.
Global M&A boom - This is the big question mark with this ipo. While DUF's direct M&A advisory arm is small when compared to their Financial Advisory segment, a huge chunk of their organic growth the past few years has been from giving financial advisory valuation services to newly acquired and merged companies. As M&A activity, particularly levered buyout M&A activity has slowed significantly the past few months, it remains to be seen what sort of impact this slowdown will have on DUF's advisory services. I would think the third quarter of 2007 will see a rather significant slowdown in DUF's direct and indirect M&A related revenues. Whether M&A activity resumes strength over the next twelve months will go a long way in determining the success of this DUF ipo.
Restructuring - On the flip side, if the economy slows, DUF hopes that their restructuring and financial distress advisory services will grow in demand. I do like that DUF is playing both sides of the fence here with merger financial valuation advisory services as well as bankruptcy valuation services. On some level, valuation experts will be in demand no matter the economic climate.
Note - In the prospectus, DUF stresses quite a bit their non M&A related strengths. They do have that, however the transaction boom the past few years has been very good to DUF. It stands to reason that if the number of transactions in the global marketplace slows from 2006 and first half 2007 levels, DUF's revenue stream would be impacted on some level.
DUF will have approximately $1 per share in cash and debt each on the books post-ipo.
Compensation expense ratio - DUF is a people expertise operation, quite similar in this fashion to investment banking/M&A ipos such as (EVR)/(GHL)/(TWPG) etc...As such, compensation expenses are by far the highest expense line item. DUF's historical compensation expenses are a bit more difficult to decipher than most as they've made a few acquisitions over the past few years, most significantly being the private equity backed Corporate Value Consulting acquisition in 2005. These acquisitions have led to significantly deferred equity compensation expenses which have shown up in 2006 and 2007 (and will again for the final time in 2008). Folding out these acquisition related awards, DUF's compensation expense ratio is in line with other 'people expertise' operations at 50%.
*Note* - DUF does not fold out these acquisition related expenses in the prospectus, so the numbers below will look different than those in the prospectus. I feel the numbers below are more representative of the overall operation in 2006 and first half of 2007.
Much of DUF's revenue growth has been fueled by their own acquisitions and related M&A advisory services.
2006 - Revenues were $278 million. Compensation expense ratio was 50%. Operating margins were 11%, net margins 6%. Earnings per share were $0.50.
2007 - Without seeing the impact of 3rd quarter M&A slowdown on results, I'm not going to try and forecast the full year here. This is one of those ipos that is coming right in the middle of a whole lot of confusion in their core growth driver niche and frankly I don't know how significant the M&A slowdown in the third quarter of 2007 will be on DUF. Instead let us take a look at the first half of 2007 and go from there. Revenues for the first half of 2007 were a very strong $171 million. DUF at the halfway point was on pace to blow away 2006 revenue numbers. Compensation expense ratio was 52%. Operating margins were 14%, net margins 8%. Earnings per share for the first half of 2007 were $0.42.
One would have to surmise that DUF's third quarter of 2007 will be stagnant at best, most likely a bit weaker than the first half of 2007. If we are a bit conservative on the back half of 2007, DUF earnings per share range should be $0.70 - $0.75 for the full year. On a pricing of $18.50, DUF would be trading 25 X's 2007 earnings. Again keep in mind due to the acquisition related deferred compensation expenses, GAAP earnings will be much smaller than this number. This number however is a truer indication of their current business.
Conclusion - This is a tough one. DUF had a very solid first half of 2007 fueled by prior acquisitions and a strong M&A environment. DUF is a niche leader in valuation advisory, a nice growing segment whose growth is not entirely fueled by M&A. I really would like to see DUF's third quarter earnings report. I think the abrupt global M&A slowdown in July had to have impacted DUF in some fashion. I like expertise related niche leaders, however I would be very careful adding DUF on an aggressive open pending the third quarter earnings release. M&A activity in the first half of 2007 was about as strong as it has ever been. That pace has slowed considerably thus far in the 2nd half of 2007. DUF's niche leadership is enough to recommend in range, however I'm not interested here on an aggressive opening until I see the third quarter earnings report.