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The Value of Experts
Inside GLG, the World's First "Expert Network"
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Back in 2016, British cabinet minister, Michael Gove, famously said, “people in this country have had enough of experts.”
He went on to qualify his statement, specifying “experts from organisations with acronyms.” But the first part stuck; it seemed to reflect the populist zeitgeist of the time in both the UK and the US.
Within professional services, though, Gove’s comment was wide of the mark. Investors and consultants can’t get enough of experts; indeed a whole industry has emerged to service them. Investors in particular have long relied on experts to provide them with insight into the companies and market sectors they evaluate. Traditionally, they cultivated their own networks of contacts but it’s hard work growing and maintaining a Rolodex, particularly if your area of focus shifts every few months. So an industry evolved to address this problem, matching up experts with investors.
Pioneering this industry was Gerson Lehrman Group (GLG). Today, GLG has a million experts in its Rolodex, and 2,700 clients who pay to access them.1 This week, it filed its S-1 prospectus ahead of an IPO…
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GLG was founded in 1998 by two men, Mark Gerson and Thomas Lehrman. Gerson was straight out of Yale Law School but Lehrman had spent two years working as an analyst at hedge fund Tiger Global, so understood the needs of investors. They originally set up the company as a publishing business, commissioning industry guidebooks to help institutional investors navigate sectors of the market. The guidebooks didn’t sell, but investors expressed interest in speaking to the books’ authors to gain more informal insights. So the pair began offering subscriptions to their network of contributing authors and consultants. By mid 1999, they jettisoned the publishing side of the business and focused exclusively on nurturing their network of experts and selling access to it. Mark Gerson explains:
“We thought it was kind of ridiculous that the hedge fund business got so much information by asking for favors – ‘Could I please have 15 minutes of your time?’ – when they would certainly pay for that information. And the people who have it would love to talk. We just thought there should be a way to get the two connected.”
The business model was simple. Clients would ask GLG to set up a call with an expert in whichever field they were researching. Experts could be business professionals, academics, consultants, former executives, anyone with domain knowledge. GLG maintained a database of experts – which it constantly added to – and screened them to make a match. Clients paid a fee for unlimited access to the network. Initially the rate was set at $48,000 for six months per industry vertical, with renewal rates based on use, but these rates soon nudged up. In its third year of operations, GLG earned over $10 million in revenue. Experts were remunerated at an hourly rate of between $100 and $500 an hour.
The business got a boost in 2000 when the Securities and Exchange Commission introduced a new rule called Regulation Fair Disclosure (Reg FD), prohibiting public companies from disclosing important information selectively. The rule required public companies to tell everyone everything at the same time, through public announcements and press releases. This sparked greater demand from investors to uncover information from alternative sources. (As a reflection of the trend, another player in the market was called Off The Record Research.)
Growth continued unabated for several years, alongside the growth of hedge funds in the 2000s. By 2007, GLG had 200,000 experts in its database and reported revenues of $232 million. In December that year, its founders sold a quarter of their business to private equity firm Silver Lake Partners, at a price that valued the company at $875 million (equivalent to 3.8x sales). The following year, GLG announced a strategic alliance with Credit Suisse to allow Credit Suisse research analysts to access its network and help distribute its services to their institutional clients.
But the industry hit a roadblock on the other side of the financial crisis. Incentivised by the fees available and seduced by the relationships they forged in the hedge fund industry, several experts crossed the line and started giving out insider information. Sheelah Kolhatkar lays it all out in her book, Black Edge (subtitled “Inside Information, Dirty Money, and the Quest to Bring Down the Most Wanted Man on Wall Street.”)
To [FBI Special Agent B. J.] Kang, the whole concept of the expert network business model sounded corrupt. He could see that certain expert consultants got hired again and again because word had spread through the hedge fund industry about how “good” they were—meaning that the information they provided was, in Kang’s view, probably illegal.
In 2010, the Securities and Exchange Commission charged a number of expert network consultants with insider trading, including seven from one firm, Primary Global Research. The experts were technology company employees who passed on non-public confidential information about their companies to Primary Global Research clients. One of the experts was a supply chain manager at chipmaker AMD. He did over 400 hours of calls in the two years leading up to his arrest with clients of Primary Global Research, earning $130,000 in fees. A hedge fund he spoke to, Barai Capital, illegally made $2 million of profits trading AMD stock on the information.
GLG itself became implicated in the insider trading scandal when one of its experts passed confidential drug trial information to another hedge fund: SAC Capital. Network companies recruited extensively from within the medical profession – calls with doctors were in high demand from investors in the pharmaceuticals sector. A study published in the Journal of the American Medical Association found that, by 2005, nearly 10% of physicians in the US had established relationships with the investment industry. The article noted that the speed and the extent of this intertwining were “likely unprecedented in the history of professional-industrial relationships.” One of these physicians – an expert in Alzheimer’s – developed a particularly close relationship with Mathew Martoma, a portfolio manager at SAC Capital. The two had over 40 calls and meetings and the information shared enabled Martoma to make $276 million for his fund – “the most lucrative insider-trading scheme in history”. Martoma was sentenced to nine years in prison; he was released this summer.
In the aftermath of these events, many hedge fund clients suspended the use of expert networks. GLG’s revenues, which had grown at a double-digit pace in 2010 after the market-driven slowdown in 2009, began to decelerate.
The expert network companies responded in two ways.
First, they strengthened their compliance procedures. GLG introduced a range of controls, including a cap on the fees experts can receive without written consent from their employer, limits on the number of consultations they can hold with any one client and extensive annual training. Today, the firm employs 50 dedicated compliance professionals.
Second, they diversified into different client segments. As hedge fund demand waned, demand from private equity firms picked up. Today, private equity firms represent the most active users of expert networks. A survey commissioned by Capvision, another player in the space, suggests that the market for expert knowledge is worth $3.4 billion in 2021. Of that, 57% comes from financial institutions with the bulk of the rest (33%) coming from consulting firms. Private equity accounts for over half of the financial institutions segment, and around two thirds of the consulting segment. Although GLG doesn’t provide a split of its client base, it does list private equity funds first among its seven client segments.
Going forward, GLG reckons the demand for its services will rise across the board:
The world’s economy is shifting increasingly towards knowledge work… And while the proliferation of available data on the Internet has raised the expectation that insights are readily available, the sheer volume of detailed information has made it increasingly difficult to find actionable insights. As a consequence, too many decisions are made on partial insight or, worse, hunches. These knowledge professionals are increasingly seeking the right insights—those most applicable, contextually relevant and actionable—at the right time.
The Capvision commissioned survey estimates that industry revenues will grow at 13% per year, reaching $5.5 billion by 2025.
GLG’s fees have gone up a lot since its early days. As at the end of June, the annualised value of contracts it had in place was $521 million, equivalent to around $200,000 per customer. Some customers are larger than that. In the days of Mathew Martoma, SAC Capital paid GLG $1.2 million a year. The S-1 doesn’t provide an analysis of revenue concentration, but it does disclose that last year the company lost an especially large client – “a large consulting firm” – worth $30 million.
The economics of the business are very attractive. GLG’s gross margin is around 74%, which – as Byrne Hobart points out – is one of the highest take rates of any platform company, anywhere. Uber, which matches people with drivers (expertise of a more generic kind), has a take rate of around 18%. Accounting policies among its peers vary, but GLG’s is not an unusual margin. Third Bridge has a gross margin of 77% and VisasQ – the only peer to be publicly listed (in Japan) – has a gross margin of 62%.
Expert networks have been able to retain pricing power among clients for two reasons.
First, they have turned compliance into an advantage. Clients could recruit experts directly via LinkedIn but the networks provide a compliance shield that helps mitigate clients’ exposure to regulatory risk. (It’s not that the networks have a secret source of experts; the GLG S-1 admits that “we use certain commercially available third-party recruiting, communications, and marketing related websites and software systems, such as LinkedIn and, in China, WeChat, to identify and to recruit qualified experts into our network.”)
Second, consulting and private equity clients just aren’t that price sensitive. They conduct multiple calls as part of a due diligence process and the cost of those calls is bundled into the deal transaction costs. As Yishi Zuo, CEO of Deep Bench, a peer company, writes: “If you are making a $50 million investment, what is an extra $500 to you for a call that could make or break the deal? If you are a consulting firm, these costs are generally passed on to your end customer so price becomes further abstracted.”
A client mix weighted towards private equity and consulting firms would therefore seem to be an advantage in this respect. Unfortunately, GLG doesn’t provide a breakdown, but revenue growth lags others in the industry, which could reflect a lower weighting.
Underneath all this, expert network companies spend a lot of money recruiting and validating experts and keeping them on the right side of the law, as well as matching them up with clients. GLG has 2,300 staff on payroll to do this work. After operating expenses, its margin crunches down to 20% at the EBITDA level. The company’s strategy is to use technology to streamline some of this cost. “Over the past two years, we have invested heavily—and expect to continue to invest—in digitizing the GLG experience.”
In its filing, GLG argues that scale “means we can attract more clients to participate in our platform, and so powering our flywheel.” However, experts are not exclusive – they can contract with multiple networks – and so scale is less defensible. Also, there’s a lot of churn in the actual users of the expert network’s services. GLG’s 2,700 enterprise clients are an umbrella for 60,000 underlying users (of which 21,000 used the service in the first of this year). Many of these users are juniors in their firms and turnover quickly.
Where scale is a benefit is in driving operating leverage in the business. Broadly, the larger players generate more revenue per employee than the smaller players. GLG generates around $260,000 of revenue per employee, which compares with $120,000 to $220,000 among smaller players. One competitor that stands out positively is AlphaSights, the number two player in the market, which is a third of the size of GLG by headcount, yet does $300,000 revenue per employee.2
Because experts are not exclusive and the cost to recruit them is quite low (thanks to LinkedIn), competition in the industry is high. One database of expert networks lists 161 players. Some of them target specific geographies (like Capvision in China); others target specific verticals. Tegus is gaining traction among public market investors because it transcribes and publishes all its calls – in some ways taking us full circle to the industry guidebook origins of GLG.
Among these players are some marketplaces that play off the lack of exclusivity – companies like proSapient and Inex One. Expert networks emerged to channel a fragmented supply of experts to a smaller pool of willing buyers. The proliferation of networks has led to the next derivative: marketplaces that sit between fragmented networks and the buyers. GLG highlights this risk in its S-1: “We have a large number of competitors and many of our clients will leverage multiple providers simultaneously, either directly or through proprietary or third-party platforms.”
Silver Lake Partners didn’t do very well out of its investment in GLG. In 2015, eight years after taking a 25% stake, GLG bought it out for $200 million, roughly the same amount it initially paid. A few months later, another private equity firm, SFW Capital Partners, paid $212 million for a 43% stake, reflecting a reduction in the value of the business.
The IPO is a route to exit for SFW and its return should be better. If VisasQ, which listed in Tokyo last year, represents a benchmark, multiples could be quite high. VisasQ came to the market on a multiple of 8x sales. It used its currency to acquire US based Coleman Research – twice its size by revenues – at a multiple of 2.3x sales, and now the group trades at 14x sales guidance for this year (ending February 2022).
The problem is that competition is increasing at a time when revenues have been very strong because of private equity activity. How value is shared between the customer (through lower prices), the network and the expert is a dynamic that is in flux. It’s clear that experts have value; the question facing prospective GLG investors is who captures it.
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There’s likely a long tail to the activity levels of the one million experts. GLG doesn’t disclose it, but Capvision discloses that their top 10 experts took 2.2% of all expert remuneration in 2020, the top 50 took 7.0% and the top 100 took 10.7%. In 2020, Capvision retained the services of 40,764 experts out of a database of 360,000.
It’s a shame GLG doesn’t disclose the number of calls it arranges, as calls per client or calls per employee would seem to be valuable key performance indicators of the business. On page 109 of the S-1, the company discloses that “Network Members have conducted over 4.4 million interactions with Clients since 2003” but on page 100 it states that they “collectively have been deployed across over 3.4 million Client inquiries (from 2003 to June 30, 2021)”.