Research 2.0

Thursday, September 14, 2006

Petrie Parkman IPO - just okay at $200M or below.

Another boutique investment bank has filed for an IPO. Petrie is in the energy sector so given the current market dynamics everyone will agree that "now is the time!"

Having worked at firms like this for years one can't resist having a look to see if they have an innovative business model that would actually suggest that outside equity holders could earn strong returns.

Petrie looks to be actually far worse than average. At first glance one is struck by their stunning growth - revenues were up 79% YoY for 1H06 to $62.3M. However expenses were up 81% to $62.2M wiped out any profit for the period. (We understand that typically this is a high period for compensation so overall profits will be better for the calendar year, as they were for the full year 2005, see below.)

Aside from the fact that the company revenues are all directly linked to the red-hot energy sector they are even more concentrated with a full third coming from just one client in 1H06.

For the full year 2005 the company generated a 5.6% net margin. Looking at 2006 we can use $125M as full year revenue and suggest a 10% margin target to guess at a $12.5M net. Putting a 10x multiple on what could be peak earnings for the company and adding the $60M in cash we get to about $200M.

There are plenty of expansion opportunities for the firm in related areas and geographically but they will all involve investment. Due to the compensation overhead ($1.2M/employee in 2H06) the outcome will depend on a sustained level of high activity in energy.

On the surface Petrie looks to be an excellent company in their niche and provides excellent value for their clients and employees. The risk/reward for outside equity holders doesn't look very good unless the stock is priced at a very reasonable valuation. Investors need to price in the likely case that revenue in a future year will be down and given the business model and compensation structure they are not likely to fare well then.

[UPDATE - Well the company was acquired by Merrill for what was reported to be $500M or so. Even though it's a rich valuation the deal is good for both sides. Merrill has the banking, trading and fixed income operations to make the $500M pay off quickly in what will always be a big sector and the company is spared from the misery of being a low-profit, low-multiple public company.]