Evercore Inc. (EVR) Earnings Call Transcript & Summary

Hi. Good afternoon. Thank you for joining us. [Operator Instructions] And also, for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. Okay. We're pleased to have with us Ralph Schlosstein, President and CEO of Evercore. Ralph, thanks so much for joining us.

Thank you. It's my pleasure.

Great. So maybe let's start with a big-picture question before we dig into the M&A environment. Over the last few years, Evercore has shown the most consistent share gain in M&A advisory among the peer group, and you've also invested to expand your product set beyond just pure M&A advisory, whether it's capital markets or private placements, shareholder activism. What do you think you need to do over the next couple of years to leverage your strengths, particularly as we go through a more difficult macro environment?

Well, some of what we need to do is to continue to do what we have been doing, which is to both internally promote and to hire extraordinarily high-quality investment banking talent because our Advisory revenues are always a function of the product of the number of senior managing directors we have and their productivity. We have, by far, the most productive senior talent in the industry, but we have to continue to grow the number of that -- of those senior managing directors if we're going to continue to grow for reasons other than a cyclical recovery in M&A. And the investments that we've made, one of the things that genuinely helps us recruit is that I can sit in front of any high-quality banker who is working at a large firm or at another independent firm and tautologically say to them that if you're interested in working on an independent firm platform, you can do more business with your clients at Evercore than you can at any other independent firm globally. Why do I say that? I say that, first of all, because we have, among the independent firms, the #1 brand in M&A. As you can see, our league table position is quite significantly superior to our competitors. And in this business, there is a certain amount of benefit that comes from being in large transactions in order to get into additional large transactions. But well beyond that, we've diversified our product capabilities to include equity capital markets advisory, debt capital markets advisory. We have the #1 Activist Defense and shareholder advisory practice among all firms, not just the independent firms. We have hedging advisory. We advise our clients on complicated tax structuring. We recently hired the single most experienced person in restructurings, not capital market -- capital structure restructurings but business restructurings, spin-offs, split-offs, Morris Trust, reverse Morris Trust. And Joe Todd, who we hired earlier this year, has been involved in 80-plus percent of the largest ones in his prior career at Goldman. So -- and then we are, of course, the only independent firm that has equity research and equity underwriting capability. So we're the only firm that can work with our clients on the 2 most important things that any Board or CEO is focused on, their M&A strategy and the transactions they may want to undertake to execute that strategy and their equity. Why is it valued? How is it valued? And should we raise additional capital? So we're in a good position vis-à-vis our competitors, given the diversification that we've done, but that doesn't change the fact that it's a pretty slow M&A environment right now.

Great. So maybe let's talk about that. I think you mentioned on the earnings call that while deal announcements are likely to be weak in this environment, clients were still in -- actively engaged in dialogue. Has anything changed over the last 1.5 months? I mean markets have rebounded nicely. The debt capital markets are wide open again. How has that impacted your pipeline?

The -- it probably shortens the pause but doesn't eliminate it because probably the most important element -- obviously, equity and debt markets are critically important to financing transactions, but the willingness to enter into a transaction, ultimately, is tied to the visibility or clarity about the future direction of the economy and earnings. And we happen to be in a particularly uncertain time right now. Not for all industries, software generally is not affected. Health care has been limited in its effect and certainly among the pharma companies. So there are areas where uncertainty has not particularly increased about earnings -- the future of earnings, but there are many businesses, and I think you can judge that from the number of companies that have suspended earnings guidance who normally give it, we happen to be one of those companies who don't do that, but a very large number of those who do provide earnings guidance have suspended them. And I think it's kind of a logical thing that if the companies themselves who are closest to their own business are unable to provide real guidance as to the future direction of their earnings over the short to intermediate term, it certainly makes it even more challenging for buyers who have less perfect information about those businesses than the leaders of them -- themselves. So the biggest thing that we need to come out of this pause, particularly for larger transactions, is more visibility, more certainty about the pace of recovery and its impact on various companies.

And I guess -- so you're saying that once we get that in a level of certainty or we get a little more certainty than we have right now, it -- the pause between when deals start to accelerate is shortened at this stage. Is that fair?

Yes. I would say that's the case. There's definitely more active discussion. I'm not sure I would call it yet dialogue between companies, but there's certainly more active discussion between Evercore and I assume some of our competitors and our clients, and that's logical. 2 months ago, clients were focused on liquidity and the condition of their balance sheet. And the economy was going into free fall, and they had enormous uncertainty both as to whether they would be able to finance themselves since the capital markets were completely closed and what their earnings and cash flow would be. It's now apparent to most companies that we've bottomed, but not at all clear, at this point, what will be the pace of recovery and also will we escape a second wave of virus infection.

Got it. And is there any difference you're seeing between the large and mega deal space and some of the more midsized deals in this environment? Do you think there's going to be a difference in the pace of recovery of either of those 2?

I'm not sure there'll be a difference in the pace of recovery, but I think during this pause, the larger transactions are affected more consequentially. If you look at the year-to-date data, M&A globally, the dollar volume is down around 40% of announced transactions. In the U.S., it's down over 50%, and transactions greater than $5 billion is down roughly 80%. So this has clearly affected, in terms of dollar volume, the larger transactions to a greater extent. And that shows up also in the fact that the number of transactions is down probably mid-teens -- mid- to high teens as compared to roughly a little over 40% in terms of the dollar volume.

Got it. And do you need to do anything differently in this environment? Or is it more about staying in touch with clients and keeping the conversations going?

Well, the -- I think the -- over the next year or 2, it's likely that private equity will be a little bit more important than it has been on the buy side over the last year or 2. Obviously, there's lots of portfolio sales out of the private equity business over the last 2 or 3 years. So that's one thing that we clearly are focused on. The second is the -- our broader capabilities have given us a door opener with clients who, heretofore, in an environment like this, we wouldn't have had as much to talk to them about. So in the second quarter, there were 2 very large debt financings done. We generally don't underwrite debt unless a client just puts us in there to give us a tip or a payment for other things that we've done. But Boeing, the largest investment-grade transaction done, Boeing raised $25 billion in the public markets probably about a month ago. And the largest noninvestment-grade financing was Ford raising over $8 billion. We were the adviser to both of those companies, and those were predominantly new clients for the firm. So the broadening of our capabilities has allowed us to maintain a really strong dialogue both with current clients and new clients about the things that they are most concerned about.

Got it. You mentioned PE. Sponsors are raising funds right now. Do you sense a little bit more willingness among them to put money to work here, especially given the market recovery?

Well, so far, if you look at what they've done, they've tended to do PIPE transactions, which have some combination of equity upside and downside protection. So they're responding to the uncertainty about the future economy in much the same way that large corporations are responding. Only, their response is not to sit on the sidelines but to incorporate downside protection or structure, so more preferred -- convertible preferred or downside or debt with warrants. And so the PE firms have adjusted in their own way to the economic uncertainty. It hasn't involved a complete freeze of investment or pause on investment, but it has certainly affected the structure of the investments that they are making.

Got it. And then you spoke about the 2 debt underwriting deals. Is -- can you talk a little bit more about your underwriting business? How are those businesses trending? What are you doing there?

Yes. And just to be clear on the 2 transactions I described, the debt transactions, in both cases, we were simply the adviser to the client, helping them, okay? So we didn't underwrite those transactions. We just advised the client on the structure of the transaction and when to go to market, et cetera. The equity underwriting business, which is a -- clearly a growth business for us, and this is actually on Page 7 of the presentation that we posted on our website simultaneous with this meeting, but -- and we generally don't give forward-looking statements, but this is something that an enterprising investor or an enterprising research analyst could have put together because it's all public underwritings, and the underwriting spread and the share that we get is all in the public domain. But our equity underwriting activity, which was $20 million in the first half of the year, is going to be sufficiently large in the second quarter of the year that our underwriting activity for the -- revenues for the first 6 months will exceed the record revenues, $90 million, that we had all of last year. So we're making real progress in that business. The quality of our research and our distribution and our banking relationships is really coming to the fore. So I'm very, very excited about the progress that we've made this quarter and the level of dialogue and activity that we have generally in that business.

Got it. And then maybe let's pivot to restructuring. I mean it's on a lot of investors' minds right now. What are your thoughts on the restructuring market and on Evercore's ability to take advantage of the upcoming wave of restructuring?

We have a -- among the independent firms, there are probably 3 or 4 that have comparable-sized restructuring businesses, Lazard, PJT, Moelis, ourselves. We're all benefiting. Our business has changed somewhat from the last cycle where we were -- probably 90-plus percent of our restructuring revenues came in the form of debtor advisory opportunities. And last year, which was a record year for us in restructuring, our mix was more toward 2/3 debtor, 1/3 creditor. And that's important because as you certainly would understand, we're not always going to have the best relationship with every troubled company. There may be other independent firms that have a stronger relationship and will be selected by the debtor to represent them. And even in circumstances where we're competing and we have deep domain knowledge and deep restructuring knowledge, if we haven't succeeded in winning the debtor assignment, we can pivot very quickly and take that knowledge base and industry knowledge and apply it to the creditor group. So our mix of revenues has certainly changed from the last cycle. I think one of the things that people -- investors don't necessarily appreciate, although if you think it -- if you -- if I say this, I think you'll say it's pretty self-evident, is that the preponderance of what I would call forgiving capital structures, basically means that in this, and I believe in future restructuring cycles unless that changes, those cycles will tend to be longer and more drawn out, which is certainly a good thing for our business and the other independent firms because it means that instead of having a sharp surge in activity where all of the proverbial dung hits the fan, you tend to have a stringing out of that based on the time it takes for true liquidity crises on the part of these companies rather than just covenant breaches or other events that could cause the intercession of the lenders. So -- and good examples of that, we were the adviser to TXU -- or to EFH, the old TXU. That company was economically -- the equity was economically worth 0 probably in 2009 or so. That restructuring was finished in 2018. Harris, which I think was finished in 2017, we weren't involved in that one, was also economically close to worthless many, many years before that. So the good news, as I said, last year was a record for us in restructuring activity and revenues. And I don't think anyone would look at last year, other than the energy sector and maybe a little bit of retail, as being a particularly hostile debt environment. Default rates were at or near their absolute low -- their lows. So I think the good news is that the restructuring cycle, we believe, will be more attenuated as it was to a large extent last time as well.

And then can you speak about your restructuring team? How large is it? How do they work with the M&A bankers in an environment like this?

Yes. Well, we have 7 restructuring senior managing directors and another, I think, 8 or 9 managing directors. So we have a large and senior team. And then what happens -- and in total, probably 60 bankers globally -- 70 bankers globally. And what happens in environments like this when M&A slows down, people take off their M&A and strategic advisory hat and put on their restructuring hat. And we have people who were in industries that have had particularly significant restructuring activities. Like shipping, our 2 shipping partners, they're not in restructuring, but they certainly have extensive experience in restructuring, as you can imagine. Our energy partners are all like that as well. And the younger people in various groups, that's also the case. So there tends to be a taking off of the M&A jersey and a putting on of the restructuring jersey to a certain extent during these periods of time as well.

Got it. And then maybe moving over to expenses and hiring. Can you talk about how you see recruiting panning out over the next year or so? And then also just given the sharp decline that we've seen in M&A activity, how should we think about your comp ratio for 2020?

Well, we do our very best each quarter to estimate what we believe the comp ratio will be in -- for the full year. And generally, in less uncertain environments, we've been pretty good at that. And in our first quarter, we basically reported a comp ratio of 62%, but we specifically said this is the comp ratio for this quarter because we really don't know what's going to happen in the second and the third and the fourth quarters. And we're really not far enough along to know what will be the appropriate compensation ratio for the full year because we're just missing way too many important pieces of information. What will our revenues likely be? What's market comp for the nonpartners in our business, which we -- generally, if we want to keep our team together, have to pay that? So even if I were inclined to give you forward guidance on that, I honestly couldn't do it. And we've basically said that to our Board and -- at this point in time. What I will say is that in terms of recruiting, we were able in 2009, '10 and '11 to attract some quite good talent to the firm because the distress in the large firms was quite significant. And we had the advantage of not only the constant attractiveness of our business model, which is always a draw for bankers who are really deeply committed to working with clients rather than managing or leading. And so the attraction of Evercore today is just as strong as it was over each of the last 10 or 11 years. In fact, I would argue it's stronger because what I'd started out talking about, which is the breadth of things that they can do with clients. What is different this time is while there's certainly some -- a pickup in credit losses in the larger banks, they're extraordinarily well capitalized right now. They're very well prepared for even a deep economic decline. So it's not at all clear what effect this deep recession will have on banker comp at the large firms. And that also will be a -- will also have an effect on the push part of do people want to leave.

Got it. And how about on the noncomp side, can you talk about the actions that you're taking there?

Yes. There's some patently obvious ones, like travel and entertainment, which is obviously going down lots and lots and lots. And I do believe that it's -- the low of that will probably be in the second or third quarter. But it's definitely, over the intermediate and probably longer term, going to be lower because clients are either less inclined to meet face to face or less demanding of meeting face to face. So that part of the noncomp expense clearly is going to be beneficial to our margins and to our shareholders. In addition to that, we've -- we started actually last fall, and late in the fall, with a pretty widespread program to look at all of our noncomp expenses, which, in a 10-year period prior to that, we had grown mid- to high teens in advisory revenues in each year, and our -- each year, our margins expanded and our revenues, obviously, grew. The -- we didn't have to focus down to the gnat's ass on the noncomp expense side of the equation. In today's world where this is going to clearly be a challenging year from a top line growth point of view, but even going forward, I've said this internally that we grew mid- to high teens, as I said, in Advisory in the 10-year period up to '18 and '19, and we averaged $1.7 billion of Advisory revenues in those 2 years. If we were to grow mid- to high teens for the next 5 years, we'd be the same size as Goldman Sachs in Advisory. And if we grew at that pace in 10 years, we'd be twice the size of Goldman Sachs. That's probably not going to happen. That's a forward-looking statement I'm prepared to make. But -- and the basic point is, today, we're the fourth -- we're fourth among all firms after Goldman, JPMorgan and Morgan Stanley in total Advisory revenues at that average of $1.7 billion in '18 and '19. So it's pretty clear to me that while we're going to continue to take market share and continue to grow, the growth rates are likely to be more in the mid- to high single digits on average. There'll be years where we don't grow as much, and there'll be years where we'll have much higher growth based on the cyclical recovery of M&A markets. But that argues for being very careful about all of your noncomp expenses, and we've done a very thorough scrub of both our policies and our implementation of those policies and knocked out Bloombergs and knocked out unnecessary data sets, et cetera, et cetera. And then on the cash side, which ultimately filters into the income statement as well, we've pretty much deferred all nonessential investments either in space or in technology. So I would expect a real leveling in our noncomp expenses.

Got it. Then -- I mean I have a final question, and then there's a quick question on the web. My final question was just on capital return. I was wondering, how are you thinking about it? You have a ton of liquidity. You have about $850 million in liquid assets. How should we think about your dividend over the next few quarters?

Well, the -- obviously, the Board makes that decision on a quarter-by-quarter basis. But it's hard for me to -- sitting here today and looking at the improvement in the markets, it's hard for me to see a scenario today that would cause us to not pay the dividend that we've paid over the last couple of quarters -- a few quarters. So I certainly don't see a scenario. I won't -- obviously, if we went into a second and protracted economic downturn, I would -- I might be reconsidering that. But certainly, as things look today and given the amount of monetary and fiscal stimulus that has been applied to our economy and to economies around the world, it's hard for me to see a -- really the kind of scenario that would prevent the dividend to be paid exactly as it has been over the last few quarters at the same level. With respect to share repurchases, the -- we've, every year for many years, made the commitment and fulfilled that commitment to buy back at least enough shares to offset any dilution that would occur by virtue of issuing RSUs to our employees and year-end compensation or issuing RSUs to people we hire in order to either replace their leave-behinds or to encourage them to join the firm. In each of the last 3 or 4 years, we've bought back considerably more shares than that. And basically, between dividends and share repurchases, we've essentially returned a little over 100% of our earnings in each year to our shareholders. This year, we're -- on the buyback side, we're being a little bit more cautious until we see how the remainder of the year evolves. But we've already fulfilled that obligation.

Got it. And then just maybe a couple of final thoughts. Any thoughts on the impact of the upcoming elections on the M&A environment?

I'm reluctant to make a comment on this, but I frequently have observed privately that, to me, one of the hardest jobs today is to be an antitrust lawyer or a CFIUS lawyer because the application of those statutes and regulations has been not necessarily consistently governed by law but more by who is in favor or out of favor. I think that approach is likely to continue if the -- if President Trump is reelected. I suspect that the approach would be more consistent and predictable if Vice President Biden were elected. But it's also possible that it would be a little bit less friendly to consolidation. And -- but how those 2 balance off, maybe slightly less friendly to consolidation but nonpoliticized application of antitrust policy, I don't think it's a massive thing. I do think if President -- if Vice President Biden is elected and the Democrats win the Senate, it's likely that over a couple of year period of time, I don't know whether they would do it immediately because the economy would be weak, that we'd see some upward movement in corporate tax rates. If I were advising him, I'd say do it over 2 or 3 years. And I think he said publicly that he thinks it should be 25% to 28% or 28%. I don't think anyone wants to take the corporate rate above that. And look, for a -- the average company, that will have a modest effect on net income but not a staggering effect, probably maybe on the order of a 1 year's earnings growth. So I don't think that Vice President Biden would have the same sort of central focus on the level of stock values in the market, but he's a middle-of-the-road Democrat on economic issues.

Got it. And now we're out of time. Thank you so much, Ralph, for joining us. And thank you so much for taking the time.

Thank you.

Great. Thank you.

I really enjoyed it. Take care. Bye-bye.

Bye.