Boutique M&A Advisory Firms Challenge Large Investment Banks

Summary

• Boutiques have cornered about 15% of the $4.4 billion of M&A advisory fees U.S. companies have paid so far this year.
• If the M&A markets soften, big banks may be able to use their scale and financial muscle to put pressure on boutiques.
• The lessons from the financial crisis of 2008 indicate that big banks may also stumble in a weak M&A environment, giving boutiques the advantage.

"In the big business of advising on mergers and acquisitions, smaller is increasingly better. A group of small M&A-advisory shops, known as boutiques, have muscled in on the signature Wall Street offering and now routinely take lucrative deal assignments from the big banks that have for years dominated the business," according to the Wall Street Journal.

The M&A market is heating up overall, but boutiques, in particular, have significantly increased their market share. According to the article, "At a time when other profit engines at the big banks are sputtering, boutiques so far this year have taken about 15% of the $4.4 billion of fees U.S. companies have paid for M&A advice, according to Dealogic. That is nearly twice their share in 2008, before the financial crisis battered big banks' reputations and sagging pay and morale prompted top stars to depart."

Top bankers are, indeed, partly responsible for the trend. After leaving large investment banks like Goldman Sachs (GS), Morgan Stanley (MS) and JPMorgan Chase (JPM), they also sometimes take mega deals with them. Two brothers, Michael and Yoël Zaoui, are advising the French cement maker Lafarge in its $60 billion merger with another giant cement maker, Holcim, of Switzerland, according to New York Times. Robertson Robey Associates, a microfirm, advised Grupo Corporativo Ono of Spain in its $10 billion acquisition by Vodafone. The M&A advisory business very dependent on relationships and trust, it is hardly surprising that rainmakers at large firms would find it lucrative to strike out on their own.

The fact that boutique banks are also subject to fewer conflicts of interest, also helps. They are solely focused on M&A advisory, as opposed to distractions like proprietary trading, lending or cross-selling fancy financial instruments. "With scrutiny of deals increasing from shareholders and their lawyers, boards are often eager to hire an adviser that's seen as conflict-free, even if it's to work alongside a full-service firm."

Moreover, clients get more attention, more partner time and more control over their projects, when they are dealing with boutique M&A advisory firms. Particularly in middle market deals, where the numbers of buyers or targets may be much larger, boutiques are nimbler and able to react faster.

This is somewhat ironic since the big banks always claimed they had a larger reach due to their worldwide presence. That is changing as boutiques have formed working relationships with other boutiques or middle market banks in various countries.

Technology has also helped - the cloud has enabled smaller firms to extend their reach. For instance, Berkshire Capital, a US-based boutique focused on asset management and securities industries, has used Navatar to expand globally.

In fact, technology isn't just a key differentiator, it has also become very cost-effective. "Smaller advisory firms have performed relatively well compared to their bigger peers in the crisis because the business of advising clients on deals doesn't generally require a firm to incur a lot of expenses, compared to trading," says Mark DeCambre.

Most of the expenses go towards attracting top talent. Bankers at Moelis & Co (MC), that recently went public, were paid $1.2 million on average last year, according to regulatory filings. Not every firm offers seven figure pay packages; however, a boutique firm's compensation as a share of its revenue is typically in the 50% range.

From a banker's perspective, in addition to compensation, they enjoy the more partnership-oriented culture at boutiques, which provides greater independence to pursue client relationships, as opposed to having to sell securities and other financial products.

Some boutiques have grown so quickly that it's not clear whether they should still be considered boutiques. Evercore (EVR), also a Navatar user, has a market capitalization of $2.15 billion, according to Dealbook. Quite a few larger boutiques, such as Houlihan Lokey, are in acquisition mode as well as investigating IPOs.

Will boutiques continue to increase their market share? It seems very likely. With the M&A market continuing to improve, they seem poised for brighter days ahead.

The down side to their business is that 80-100% of their revenue comes from M&A advisory. One or two large deals could make or break revenue numbers. Also, if the M&A markets soften, big banks can use their scale and financial muscle to put pressure.

The lessons from the financial crisis of 2008, however, point otherwise. According to Deloitte, while big banks stumbled during the turmoil (an average bulge-bracket advised on only 56 deals in 2009, falling 58 percent from a peak of 132 deals in 2007), boutiques remained strong and benefited directly from the weakening of bulge-brackets in 2009. Since then, their dollar fees earned have increased at a marginally higher CAGR of 22 percent compared to that of bulge-brackets, suggesting that their relative and absolute growth is likely more than an aberration.

In fact, boutiques are still benefiting from the 2008 crisis since the big banks continue to face criticism for their role in the turmoil and the potential conflicts of interest.

It won't be surprising if both bulge-brackets and boutiques start adopting each other's tactics, over time. Big banks need to be more specialized (in addition to overcoming the negative perception issues) and boutiques need more scale and diversification. But it seems likely that boutiques will continue to entice more clients and dealmakers from big banks in the near future.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.