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Morningstar | Continued Strong Growth Is Open Question as Evercore Tests Limit of Independent Model

In a healthy merger and acquisition environment birthed by generally positive economic sentiment and U.S. tax reform, Evercore continues to put up strong quarterly results. The company reported net income of $69 million, or $1.52 per diluted share, on $448 million of net revenue in the second quarter. Net revenue increased 21% from the previous year but was down 3% from a particularly strong first quarter. We don't anticipate making a material change to our $85 fair value estimate for narrow-moat Evercore.

Evercore has been a strong growth story with an annual revenue growth rate of approximately 20% since the financial crisis, but legitimate questions regarding its sustainability are arising. The high revenue growth rate is a product of a long economic expansion period and material growth in the firm from about 40 senior managing directors in 2009 to around 95 currently. Many are wondering if it's near time for a pause in this economic expansion, which would take a major toll on senior managing director productivity. Currently, advisory senior managing directors are generating approximately $16 million of net revenue each compared with $6.5-$9 million from 2008 through 2012; however, it's the long-term ability to grow--the driver of the company's intrinsic value--that we're most concerned about.

As recently as 2013, Evercore had a long runway to catch up to its largest publicly traded peer, Lazard. Back then, Evercore had around 65 senior managing directors, another 45 managing directors, and $625 million of financial advisory revenue, while Lazard had peak managing directors of about 150 and $1 billion of financial advisory revenue in 2013. However, Evercore now has a combined head count for senior managing directors and managing directors of nearly 200 with $1.3 billion of advisory revenue booked in 2017. Lazard as an indicator of maximum potential is no longer applicable.

While management concedes that it previously underestimated its maximum revenue productivity per senior managing director, its commentary now indicates that it's difficult for it to imagine productivity growing and that revenue growth will come primarily from adding head count. As we believe that we're near the peak of the capital markets cycle in the United States, we also believe that senior managing director productivity isn't likely to move significantly higher. Evercore will have to add head count in select industries and geographies in order to grow. Instead of looking to Lazard as an upper bound for Evercore's net revenue in financial advisory, Goldman Sachs with $3.2 billion and Morgan Stanley with $2.1 billion of financial advisory revenue in 2017 may now be the benchmark.