Greenhill Exits Private Equity To Focus On Advisory Work

Robert Greenhill says the scale of the advisory opportunity merits his firm's undivided attention.

Image: Chip East/Reuters/Landov

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In the midst of all the hubbub over financial market re-regulation and the return of lavish bonuses at Goldman Sachs, the news that Greenhill & Co. plans to extricate itself from the merchant-banking business over the coming years barely left a ripple on Wall Street. And yet the boutique firm's decision to focus on its core area of expertise advising clients on mergers in boom times and restructuring in bear markets seems to signal that at least one firm has decided that becoming bigger, more diversified, and doing more proprietary deals isn't the only path to success on Wall Street. Fulfilling Wall Street's traditional role as an intermediary is quite lucrative enough. "The scale of the opportunity," declared the firm's founder, legendary dealmaker Robert Greenhill, "merits our undivided attention."

It's not the first time that investment banks have stepped away from the notoriously volatile private equity business. Robert Niehaus, who joined Greenhill in 2000 to create its Greenhill Capital Partners business, had previously worked in Morgan Stanley's in-house private equity fund, Morgan Stanley Capital Partners. In the early years of this decade, Morgan Stanley (along with Deutsche Bank, Citigroup, and JPMorgan Chase) spun off or otherwise separated their private equity businesses from the rest of their operations. But it's the timing of this move that makes it interesting, as some of the biggest and most diversified firms are returning to profitability at a rapid clip. And at some of those firms, such as Goldman Sachs, gains from in-house investments are contributing to those firm-wide profits. Not all, however, are as good at managing those businesses as Goldman Sachs has proven to be. "Larger firms in finance often get into many lines of business where they do not have a sustainable competitive advantage and fail to concentrate on those areas where they can really connect their activities and make the whole greater than the sum of the parts, says Clayton Rose, a senior lecturer at Harvard Business School.

And not all of those who get into a business line that doesn't pan out are willing to admit their mistake or act on it. Indeed, it could be argued that one of the reasons for the near apocalypse was the insistence of many financial institutions on pursuing lucrative business opportunities that they couldn't manage as well as their peers. "But nobody was willing to admit that they couldn't do it as well as Goldman or someone else, so no one ever pulled the plug," says a former Citigroup banker.

Greenhill, however, is willing to admit that it hasn't been allocating its resources as wisely as it could and that it is prepared to make a U-turn. It has sold the rights to raise new proprietary funds to Niehaus' merchant-banking division for $25 million; over time, as the existing funds mature, the two businesses will be completely separate. In the press release announcing the move, the firm's top officers said that they see the biggest opportunity existing in a classic intermediary business. Hanging on to the private equity division would, they argued, simply muddy the waters. We will have the least potential for conflicts compared to our much more diversified competitors, said Scott Bok, co-chief executive officer at Greenhill.

For most of the last 20 years on Wall Street, there has been a tension between intermediary businesses like Greenhill's core advisory services and proprietary businesses such as the merchant-banking operations, in which the financial institution earns a profit by investing its own capital rather than collecting a fee from assisting a client. To many Morgan Stanley alumni, dealmakers like Bob Greenhill are great examples of an era when the bankers' ability to work wonders for his or her clients mattered more than anything. Greenhill can boast one of the biggest Rolodexes on Wall Street, and used his skills to push his former firm, Morgan Stanley, to the top of the league tables in many client-oriented categories. But during the 1990s, the importance of sales and trading operations and proprietary dealmaking grew, making intermediary businesses look less attractive by comparison. When Bob Greenhill lost the struggle for control of Morgan Stanley, that really said to everyone that the power on Wall Street no longer resided in the hands of the gatekeepers, but with a new kind of banker who was more involved in the proprietary stuff, says one Morgan Stanley banker who left the firm a few years after Greenhill was ousted as president in 1993.

When Greenhill, now 70 years old, founded his boutique firm in 1996, it was as a pure advisory business. Niehaus' arrival changed that, with mixed results. In the good years, it was a big contributor to the firm's profits. After the firm went public in 2004, the merchant-banking operations helped Greenhill return an astonishing 123 percent on shareholders equity in each of the next two years. But by the fall of 2008, the merchant-banking division was proving to be a drag on performance as well as presenting potential conflicts of interest. The group reported investment losses of $21.8 million, and had to de-recognize performance fees from the previous quarter, leaving the entire firm with a loss. True, that was in a tough market environment, but as Harvard's Rose points out, smaller players in this environment don't enjoy a competitive advantage in terms of access to credit or deal flow for their private equity or merchant-banking businesses, and so they don't have the ability to outperform their larger investment-banking peers in this area on an ongoing basis.

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