When one of the worlds most successful M&A advisory firms announces an acquisition of its own, people are bound to scrutinize the deal. Thats certainly true with regard to Evercore Partners planned takeover of International Strategy & Investment Group, the New Yorkbased research outfit launched in 1991 by celebrated economists Ed Hyman, a member of Institutional Investors All-America Research Team Hall of Fame, and Nancy Lazar.
At first blush it appears the merger will result in a whole Evercore ISI Institutional Equities thats greater than the sum of its parts. Evercore, the New Yorkbased investment banking firm co-founded in 1996 by Roger Altman, former head of M&A at Blackstone Group and a deputy secretary of the Treasury in the Clinton administration, gains a prestigious research operation, something his firm has been trying to build on its own, with limited success, since 2010.
ISI secures access to a new revenue channel via Evercores investment banking business. This gives us new and significant input to our compensation pool, and it strengthens our ability to retain and attract the very best analysts, says Hyman, currently celebrating his 35th consecutive appearance at No. 1 in Economics on the All-America Research Team.
The firm is unquestionably an equity research powerhouse. It leaps from No. 10 to No. 5 on this years ranking outperforming a number of bulge-bracket operations with significantly larger resources and 23 of its 28 publishing analysts earn a place on the team. ISI researchers secure the top spots in nine sectors, more than any other firm except survey champion J.P. Morgan.
Evercore also has much to celebrate of late. It was among the advisers on one of the years most high-profile deals, North Chicagobased pharmaceuticals manufacturer AbbVies $54 billion acquisition of Irelands Shire.
This is one of the very few, if not the only, mergers I can remember in the last 15 years thats taking place in a position of maximum strength for both players, beams ISI Group president Vinayak Singh. He, Hyman and Charles Myers, head of Evercore Institutional Equities, will direct the new entity after the firms research, sales and trading operations are integrated. (The deal is expected to close before the end of the year.)
Evercore says the new firm will provide fundamental, macroeconomic and policy research and cover some 620 companies across 12 industries for more than 1,750 institutional investors.
Client reaction has been mixed, with many adopting a wait-and-see attitude. ISI has built a team of highly respected fundamental analysts. I have been kept adequately informed as to the merger, and I really dont think it will affect our usage of ISI research, although I recognize it may be too early to make that assumption, observes one money manager who voted for the firms analysts in this years survey. (We keep confidential the names of respondents and the firms they work for to ensure their continuing cooperation.) Polling concluded before the takeover was announced.
The merger is an excellent idea from the business perspective. ISI has a group of very good analysts. Evercore has a group of very good bankers. That could create a great symbiotic relationship, believes another buy-side backer. However, ISI has been an independent research firm and has been unencumbered by the conflicts that can sometimes occur between bankers, analysts and economists. Time will tell whether ISIs research will remain as independent.
Others raise the same concern. ISI has always been independent and innovative, and I hope that they maintain that same spirit under new ownership, says one ally. Honestly, my first reaction was negative, but time will tell.
Longtime clients put the deal in perspective. ISI either needed to refocus on macro, where we felt they had begun to fall short relative to their peers, or get much bigger in terms of breadth of industry group coverage, to effectively compete for commission dollars with bulge-bracket firms, explains one investor. Given [Evercores] relative lack of research capabilities, the deal accomplishes neither of these tasks.
ISI began to move into fundamental analysis in 2008 when it hired Citis David Raso, then in his eighth straight year at No. 1 for coverage of the Machinery sector. In the years since it has enticed more top-flight talent from rival firms, including Credit Suisses Omar Saad (Apparel, Footwear & Textiles; Retailing/Specialty Stores), Deutsche Bank Securities Mark Schoenebaum (Biotechnology, Pharmaceuticals/Major), and Morgan Stanleys Gregory Gordon (Electric Utilities) and Douglas Terreson (Integrated Oil).
At the same time, however, ISI began to lose many of the researchers who had helped solidify its reputation as a premiere macro shop, including technical analyst Jeffrey deGraaf; economist Nancy Lazar (an ISI co-founder); political analysts Thomas Gallagher, Andrew Laperriere and Roberto Perli; and portfolio strategist François Trahan. (DeGraaf opened his own firm, Renaissance Macro Research; Gallagher moved to Scowcroft Group, a Washington think tank; and Laperriere, Lazar, Perli and Trahan joined forces last year to launch Cornerstone Macro.)
The merger was necessary for ISI to survive, contends one client. Over the past few years, there has been a noticeable falloff in the quality of ISIs macro research, as many of the firms top analysts such as Lazar, deGraaf and Trahan departed to start competitors. While some of ISIs top industry analysts remain, we believe this talent will be hard to retain going forward.
Others worry that the new entity will prove too pricey for smaller asset managers, even though they believe the merger makes sense. Hyman, 69, is getting older and was looking for a way to monetize his company outside of an [employee stock ownership plan], explains one client. I think over time it will put pressure on ISI to raise fees to the buy side. We are a fairly small investment shop and find it difficult to pay our research and soft-dollar costs on commissions alone, and must be more selective in whom we use to maximize value received. I would be curious as to the details of the earn-out provisions for ISI over the next several years. Are they based on retention and commission levels? Overall, I see this more as a negative for smaller buy-side investors.
Neither firm will disclose the terms of the transaction. Evercore Partners, in its August statement, announced that it was buying ISI along with the 40 percent interest in its Institutional Equities business that it doesnt already own and will issue up to 8 million share equivalents, worth roughly $406 million at that time, for the two acquisitions. Roughly 70 percent of the maximum share consideration is dependent on Evercore ISIs hitting certain targets over the next five years. Those targets include a compensation ratio of 55 percent and operating margins from research, sales and sales trading increasing from 12 to 17 percent over the performance period.
The deal presents a great opportunity for Evercore to buy a high-quality research organization at an extremely cheap price, in my estimation, says Michael Mayhew, chairman of Integrity Research Associates, a Darien, Connecticutbased consulting firm that reports on trends in the global investment research industry. Evercores attempt to build its own research department took too long to take off, he adds, while ISI management recognizes that building an investment bank from scratch would be too time consuming and distracting. The structure of the deal gives ISI the opportunity to get a reasonable valuation if theyre able to experience the growth thats built into the deal.
That may not be so easy. Commissions for U.S. equity research are down sharply despite the fact that U.S. stocks have been reaching record highs. Ive never seen anything like it, where the market has more than tripled and [equity commission] volumes are basically where they were in 2009, Hyman says.
Singh, a 20-year veteran of ISI, acknowledges that fee volumes have continued to decline much more than any of us had expected.
Still, there are encouraging signs. Demand for research remains high and volumes have risen modestly over the past 18 months or so. I wont say research is healthy, its just off the bottom, Mayhew says.
Nonetheless, its still very tough, and my business plans do not include volume picking up, Hyman explains. But the odds of improvement are greater because volumes are so low now.
All of which may soon be a moot point, if European regulators have their way and are successful in establishing a global precedent. The U.K.s Financial Conduct Authority has come out in support of a European Securities and Markets Authority proposal that would require research expenses to be unbundled from execution costs a change that, if implemented, would have far-reaching effects on asset managers and research providers. (See Unraveling Research.)
This is a scenario where no one seems to be happy except the regulators, says Mayhew. If every piece of research must be purchased separately, then its highly likely that money managers will consume less which will lead to narrower margins, lower profits and potentially lower pay for research providers, he explains. It may also prompt buy-side firms to create or expand inhouse research operations rather than rely on the sell side or third-party providers, Mayhew adds.
One way that independent researchers can ensure their own survival is by following in ISIs footsteps and finding an investment banking partner. An equity research director at a bulge-bracket firm, who asked that his name not be used, believes that the Evercore ISI arrangement may represent the future of investment research. Large firms have become too bureaucratic, whereas small firms struggle to make any money. But a boutique with the financial backing of an investment bank could prove to be a winning combination, this observer says. Ed may really be on to something here.