In our original report on Thomas Weisel Partners entitled “Getting Back to the Basics in the Capital Markets” we argued that TWPG shares were poised to witness considerable upside based on growing momentum in traditional capital markets activity such as equity underwriting and increasing evidence that M&A volumes were poised to rise sharply.  Thus far the investment idea has not worked. TWPG shares are now off 25% since the date we introduced the stock, even though our thesis continues to play out as we expected.  As a reminder, here is our investment thesis on TWPG shares:

1. Even if the economy does not improve meaningfully in the next 12-months, capital markets activity will.
2. TWPG has taken advantage of the downturn to right-size headcount and selectively enhance its human capital. The franchise remains remarkably strong and well respected.
3. TWPG shares do not reflect the earnings power of the company in an economic recovery, which we think is $1.00+.
4. TWPG has one of the strongest platforms to target growth companies among its peers, yet the stock trades at the lowest valuation.

Almost one-month into 2010, all signs point to a significant increase in underwriting and M&A activity for the year compared to 2009.  According to PWC, in the fourth quarter of 2009 a total of 32 IPO’s were completed in the US that raised total proceeds of $16.8 billion.  Almost half of the IPO’s completed were sponsor led (venture capital, mezzanine fund, private equity etc.), which is an important development for TWPG.  The company has long-standing relationships with many of the leading venture capital firms in silicon valley.  In addition, there were more than 69 IPO filings in the fourth quarter and another 11 in the first quarter.  In the fourth quarter of 2008, only seven companies filed to go public in the US, while there were no filings in the first quarter of 2009.  No one will confuse the current environment to 1999, but it is clear that the slow and steady normalization of traditional capital markets activity continues.

Source: PwC

According to Thomson Reuters, for all of 2009 M&A transaction volume declined 28% YOY, while the number of deals decreased 7% compared to 2008.  In the US, M&A transaction volume declined 29.6% and the overall level of private equity and venture capital acquisition activity was at the lowest levels since 2002.  Trends in Canada (now a key market for TWPG), were considerably better with total M&A transaction volume increased 29.4% YOY to $154.5 billion.   We expect M&A volume to pickup substantially over the course off the year as credit tightness slowly eases and corporations look to acquire growth and put their  growing cash balances to work.  As a firm, TWPG has established itself as a leading advisor to small/mid cap growth companies in the healthcare, technology, consumer and increasingly energy and metals and mining sectors. Among these sectors, we anticipate technology could be the area with the greatest amount of deal activity over the next 9-12 months.  This should bode well for TWPG and the company’s venture capital clients.

For the fourth quarter of 2009, we estimate that TWPG was named as an underwriter on more than 20 secondaries and convertible bond offerings, completed at least three IPOs, and served as an advisor on at least three M&A transactions (including a $2.6 billion deal).  In the table below, we have outlined the company’s transaction activity in the fourth quarter and what has been announced thus far this year.  TWPG has already been named as a lead on two IPO’s that were filed this year.  Upon reviewing the table, it should become obvious that a large percentage of the company’s underwriting activity was completed by Thomas Weisel Partners Canada (aka Westwind Partners).  As we have stated in the past, the timing of TWPG’s acquisition of Westwind Partners could not have been worse, but that should not diminish its strategic importance to the company.  As the table below demonstrates, TWPG has become a well respected financial advisor to small and mid-cap companies in the energy and metals/mining sectors.  This should lead to a higher peak earnings profile for the company as transaction activity continues to improve. Perhaps most importantly, we think TWPG is poised to meet if not exceed consensus 4Q09 revenue and EPS estimates based on the information in the table below.

Source: PAA Research

TWPG will report 4Q09 results on Tuesday after the close.  During the downturn, the company has shied away from providing explicit financial guidance, which we expect to remain the case in 2010.  For the quarter we forecast $55.8 million in revenues and a loss per share of ($0.11) compared to current consensus of $55.6 million and a loss per share of ($0.20).  We expect management to reiterate its expectations for profitability for 2010.  It appears for now that the street remains skeptical about the company’s profitability prospects in the coming year; current consensus is for a loss per share of ($0.08) compared to our estimate of EPS of $0.09.  Here are some of the key questions we would like answered on the company’s earnings call:

• How would the company characterize the overall pipeline of deal activity compared to three months ago and does management expect traditional VC backed deals to become a bigger portion of the transaction mix in 2010?
• What are the prospects for gains on the company’s internal venture capital portfolios?
• Have trading volumes finally stabilized to the point where commission revenues could increase in 2010 compared to 2009?
• What were the key hires during the fourth quarter and how much will the company invest in human capital in 2010?
• What is the status of the shelf-filing?

TWPG currently trades at 0.8x and 1.0x book and tangible  book value, which is a sharp discount to other publicly traded boutique investment banks.   The company has a net cash position of $2.00/share and has $1.50/share in NOL’s.  At $3.72/share, the market is valuing the company’s business at close to $1.00/share, which seems egregious.  We remain confident that TWPG has earnings power of $1.00/share+ as capital markets activity recovers.  In a scenario in which capital markets continue to stabilize, corporations put cash on hand to work, and liquidity is restored to smaller growth companies, we anticipate TWPG shares could trade as high as 2.0x book value or $8.00/share.

As always, please act accordingly…