Evercore Inc. (EVR) Earnings Call Transcript & Summary

So good afternoon, everybody. I'm delighted to introduce our next speaker, who is Ralph Schlosstein, Co-Chairman and Co-CEO of Evercore. Ralph has been with Evercore now for over a decade, over which time, Evercore has become one of the most well-respected premium comprehensive advisory firms, I think, in the industry, and have also seen a fourfold increase in their share price. So Ralph, thank you very much for joining us. It's really a pleasure.

Look, I thought I'd start off with a broad question, which is it feels as if the world is really changing at a very rapid rate at the moment. Could we just start off with your assessment of where we are in terms of the economy? What your expectations are as we head into 2021? And then within that context, what your priorities are today and perhaps how those have evolved over the last few months just given how rapidly the world seems to be shifting?

Sure. Well, the economy is kind of a split story. There are industries and lots of people who are still negatively affected by the pandemic. But for the world that most of the people on this call are concerned about, which is the investment world, the world is pretty good to very good. The economy is recovering. We clearly have some slowdown in the recovery, which is relatively narrow in its effect as a result of the second wave of the virus, but I think that's a several month phenomenon, not a several quarter phenomenon. So I would say with the exception of maybe a leveling off of growth for the -- in the first quarter, I expect a pretty strong and steady recovery in our economy. Obviously, the markets are discounting that for our business, which is a big part of which is M&A. This is a good environment. The 4 conditions that we always talk about as being necessary for a strong M&A environment, strong equity prices, supportive debt markets, reasonable visibility about the direction of the economy and CEO confidence, which is affected by the first 3. First 3 are already in place. CEO confidence is clearly recovering. And then when you add to that the unprecedented amount of cash on the balance sheets of companies and the unprecedented amount of dry powder in private equity firms, we have a very good environment for our business. In terms of our priorities, if you -- if we did this in April or May, I would have been focused on 4 things: The safety and health of our employees and their families; our liquidity; pivoting our services to meet the needs of our clients, which clearly were on pause in the M&A world; and finally, making sure our infrastructure supported the continued full operation of the firm. We've made it through that period of time. As you saw in the first 9 months, our revenues were flat. And I think we've talked about a pretty constructive environment going forward. So we're focused now on growing our business.

So Ralph, you obviously spend a lot of time with corporates, both with management teams as well as with boards across a broad range of industries and a broad range of geographies. And I appreciate that this is a very broad question, but what would you say is top of mind today in corporate boardrooms? And would you say that the euphoria that we're seeing in market is matched by the tone that you see in boardrooms and amongst management teams around the world?

Well, let's just start with there were a number of uncertainties that existed a month or so ago. One was if we had a second wave, would we have a complete shutdown of the economy? That's clearly off the table. Two is what happens in the election. And if there was a Democratic sweep, would we have the elimination of capital gains differential, higher corporate taxes, higher taxes on the most wealthy individuals and various other changes? While the election was won at the Presidential level by Biden, you have a much narrower majority in the House for the Democrats. And in all likelihood, you're going to have a 50-50 or 51-49 or 52-48 Senate. And so the probability of the things that the market was concerned about happening, I think, has gone down a lot. And I think that is reflected in the view of -- in the boardroom and of executives that the likelihood is that we're going to have a somewhat divided government. A lot of the things that they thought might have affected negatively, the markets are pretty much off the table at this point. And then when you add to that record amounts of corporate cash, and no one could go through this period of time, the last 8 or so months, without at least asking themself the question, how has my business changed? How has this accelerated changes that I thought I might have to make over 5 and 10 years? And change precipitates strategic action. So all of those things, when you put them in a pot and boil them, support a very good environment for our business.

So maybe we can just kind of continue from that because, obviously, we've seen this pickup in M&A activity in the second half of the year. And I think -- in fairness, I think it's been a lot stronger than what a lot of people would have anticipated. So could you help just dissect what's driven this pickup? How much of this is just deals that were put on ice back in March coming back because corporate confidence has increased? How much of this is new deals because the pandemic have really just changed the strategic reality for a lot of firms? And just -- and perhaps as an add-on to that, is this really the start of a new M&A cycle? Or is this just a continuation of the cycle that existed pre-pandemic?

Well, I think the -- first of all, the answer to your first question is it's both. There were transactions that when the pandemic hit were put on pause. Those were picked up. Probably the first of those -- of substance was the sale of Grubhub, which we represented, to Just Eats Takeaway. And we were representing Grubhub prior to the pandemic in exploring strategic alternatives, and we picked that up again in May, June and a transaction was announced in July. So that's an example of things that were picked up. And then there are also plenty of new things that are -- so you have the benefit of both of those. And you also have the benefit of private equity. Sales that were put on hold have picked up and acquisitions that weren't necessarily complicated have begun. So -- and in terms of the -- is this a -- I look back at the cycle, I always say that M&A is a secular growth business because it tends to be correlated to global market cap and global GDP, which has an upper vice over any period of time. But it's a cyclical business and it used -- it typically has 5- to 8-year up cycles and 2 to 3-year down cycles. So if you go back all the way to '80, that's what you'll see. In 2009, which was the beginning of the recovery from the financial crisis, there was a book written about the economy, not about M&A, by Rogoff -- Ken Rogoff and Carmen Reinhart. It was called This Time Is Different. And the basic thesis of the book was that economic recoveries from financially induced recessions are longer and slower. And we had a 11-year recovery basically until the pandemic hit, but at 2 plus percent growth rate on average. In '12 and '13 and in '14, when we started to be 5, 6 -- 4, 5, 6 years into the M&A recovery, people asked me this question a lot. And I said, well, this is a pure hypothesis, but it's quite possible that M&A recoveries from financially induced recessions are longer and slower. And we had a 10-plus year recovery. Pandemic hit, M&A went on pause, then you have massive amounts of stimulus, fiscal and monetary. And we had basically a 6-month pause. I think it's quite possible that we collapsed into 6 months what would normally be a 2-year downturn and that we could be very well at the beginning of the next upswing. That's certainly what it feels like today.

So perhaps you can just dig down a little bit and talk about some of the different geographies and whether you're seeing any divergent trend. So the U.S. does seem to have been very strong, in particular, in large-cap deals. Europe has obviously lagged, although activity very recently seems to have picked up. And I guess Asia is somewhere in between. Is that consistent with the dialogue? And maybe you could spend just a couple of minutes on Europe. I mean, do you think there is a lot of pent-up demand there that could come on stream quickly if the Brexit is kind of fixed, whatever that means, or if there is an effective rollout of a vaccine across Continental Europe and the U.K.?

Yes. I think Europe is going to have a recovery and activity will pick up probably more slowly than in the U.S. because, first, the economic recovery is slower there; second, the degree of stimulus is lower there; and third, you have the disruption of Brexit, which -- while I don't -- it's just -- we don't know for sure what's on the other side of that hill, and it's probably a little bit of disruption. And disruption is not great for M&A. Having said that, the proportion of M&A activity that is accounted for by Europe for the last dozen years -- half dozen years has been below what it's been historically. And at some point, when they sort out the new post-Brexit world, I expect that M&A activity will pick up, particularly on the continent within the EU. And Asia, Asia, as you say, is in between. It's not a huge factor for any of the independent firms. If you look at the market share of fees that the independent firms have in the U.S. and Europe, my guess is it's 35%, 40%, 35% plus or minus. In Asia, it's probably 10% to 15%, and you're dealing with lower fees on top of that. So we have a nice business there, but that's not what drives the growth in our firm today.

So perhaps you can touch on the dialogue with financial sponsors that you're having. Again, financial sponsors have lagged strategic so far this year. But again, the recent data did point to a significant pickup in activity by financial sponsors. How important do you think they will be as a driver to M&A next year? And how are financial sponsors, again, thinking about the opportunity set, again, just given the very rapid rebound in risk assets globally?

Well, financial sponsors have been reasonably aggressive sellers of assets and starting to become more aggressive buyers. I think there was a hope on the part of the sponsors that a second wave would cause some cheapening in stock prices and there might be a cheaper entry point than they're going to get it seems today. But I think for the most part, they've put that behind themselves. And particularly in the -- in tech, things like software, which have turned out to be certainly pandemic-proof, and so there, there's been a constant level of activity all the way through other than for the 4-month or so pause. And then in the industrial, the high cash-flowing businesses, what value investors would typically look at, their stock prices are still pretty reasonable. And I think we're going to see more private equity activity there as well. So I think you've got record amounts of dry powder and you've got record amounts of invested capital, which will be turned over time. So -- and for our firm particularly, we're in a unique position. We're the only independent firm that when we go meet with a sponsor-owned company, we can talk and be relevant to them on the 2 or 3 most likely ways of exiting because we have a strong [ reward ] in all of them. We can talk to them about selling the business. We can talk to them about IPO. We can talk about merging into a SPAC. And there's no other independent firm that has the capability to execute all 3 of those.

So perhaps we can spend a couple of minutes talking about your restructuring business. It's obviously a very important business, especially just given what the world is going through at the moment. How has the pipeline in the restructuring business evolved over the last couple of months? How is the broad availability of financing, even for distressed companies, changed either the timing or the magnitude of the restructuring opportunity? And do you think that we could see, at least in 2021, both strength in restructuring and M&A revenues happening concurrently?

Well, I think we're definitely going to see that in the fourth quarter of this year. We're most likely to be seeing it in the first quarter of next year. And as I've often said, nobody in this business has visibility beyond the next quarter or so. It's clear that restructuring activity will be above that of the really good years of the healthy economic and market years of '17 and '18. My -- I would have to guess that restructuring revenues in '21 would be above those -- the levels of '17, '18 but below the levels of '20. And that would be a guess, but not -- so -- and M&A, obviously, is on a very good trend right now.

So can you spend a couple of minutes just talking about your restructuring business? Do you feel it's appropriately staffed today given the magnitude of the opportunity? How being -- how have the pricing dynamics in that business been? What's competition like for talent in that business? And maybe you can touch on -- I think you did touch on it briefly, just what you think the duration of the cycle could be?

Well, we have a terrific team. If you look at our team, we have 5 or 6 partners in that business around the world, 5 in the U.S., 1 in Europe. Of those 6 partners, only 1 was in that seat 5 or 6 years ago. And they're a remarkably talented group. I feel like we have 5 LeBron James and Kevin Durants, and our productivity shows that. So none of the major firms -- very few of the major firms, independent firms that are public report their advisory or their restructuring fees separately. But I have every reason to believe that last year and this year, our business is roughly the same size of the larger competitors that we face in that business. PJT, Lazard, Houlihan Lokey, they tend to be a little bit more on the creditor side. And Moelis, I think, is a little bit smaller, but that -- I could be wrong about that. So I'm really incredibly thrilled with the team that we have in the field right now. If we could find a 6th LeBron James or Kevin Durant, we definitely add them. So we would not only have the best starting 5, but the 6th man of the year or 6th woman of the year. But this is a -- there may be, I don't know, 25 people in that -- in the entire business that are real difference makers, and we've got 5 of them. I don't know whether that's right. It could be 20. It could be 30. But we have a really terrific team and we're -- they're having a great year.

And could you just touch a little bit on pricing dynamics and competition for talent and what you're seeing just, again, given how unique this cycle is?

This here is -- the competition here is just among independent firms. None of the large firms have restructuring practices because they are too frequently conflicted by being a lender or a shareholder or some other financial entanglement with the company that's being restructured. So the first thing is in restructuring, we compete just with the other independent firms, not with all firms. The second good thing is that they're -- in virtually all of these situations, there are several seats at the table. So if you don't win the debtor assignment -- there are usually 2 or 3 classes of creditors that you can represent. And one of the things that has definitely happened in our business, which has been a big plus is, 5 years ago, our business would have been probably 90% debtor -- 90% of our revenues in restructuring would have been debtor revenues. Today, that's much more evenly balanced. It still has a modest bias toward debtor because of our great corporate relationships, but today, we're probably getting at least 1/3 of our revenues from creditor assignments as well.

So perhaps, we -- let's talk a little bit about your ECM business. It's been, I think, a key positive surprise this year for investors, and I think it's also been something that's really differentiated you relative to some of your peers. I think on our numbers, you're probably going to do over $200 million of revenue in that business this year, which is 10% of your overall revenue, maybe more. I mean, can you just talk about what drove the step-up in the business this year? I know you're involved in one very large transaction, but you have been involved in a broad number of transactions over the course of the year. And longer term, what is the opportunity set? Do you think you could take similar types of market share in the ECM business to what you've taken in the Advisory business over time?

I do. Obviously, there's a part of the Underwriting business that we don't participate on, block trades. That's just not our cup of tea. We like fee businesses. But I think what -- when the full year is seen by our investors, our investors and the analysts who cover us will conclude that Evercore is a lot more of an all-weather firm than you might have concluded at the end of 2019. This has been a pretty remarkable year. And what we've done over the last several years is we've added in a meaningful way to the capabilities of the firm to serve our clients. And so equity underwriting is a critically important part of that, debt advisory, hedging advisory. We have obviously the #1 activist defense practice in the industry. We hired earlier this year the #1 person in corporate restructurings, splits, spins, Morris Trust, reverse Morris Trust. And what that has allowed us to do is to be relevant to our clients on anything that they want to do in the capital markets or with large firms. And so what happened this year, the pandemic hit, our clients were intensely focused on liquidity, capital, their balance sheets, and we were in a unique position among the independent firms to serve them, to advise them and to execute for them in those transactions. So we had these strong underwriting capabilities, but our bankers who are spending most of their time working on what their clients were most interested in, which was M&A, all of a sudden, the client's interest changed. Our partners are highly entrepreneurial. They're very talented. They're very close to their clients. So one of the things that I talked about earlier, pivoting our firm's activities to what our clients cared about, we were in a position with all of these capabilities to serve our clients even through this very difficult period. And while we don't disclose what came from restructuring, what came from debt advisory, what came from revenues from M&A, we do not disclose underwriting, the mix even of our advisory revenues will be somewhat different this year and much more all-weather than I think most of our analysts and our investors would have anticipated coming into something like this.

So Ralph, if you take a step back, what do you think your business looks like in 5 years' time? And I appreciate there's lots of unknowns around what happens with the economy, what happens with financial markets. But you've doubled revenues over a 6-year period. Is that a realistic proposition over the next 6 years? I appreciate that the starting point is very different. But as you've said, it's a much larger firm today. You're in a lot -- you're in a much broader range of products. You've got a much larger footprint. Is that something that you think is achievable? And if that's not something that you feel is the most relevant metric, when you think about the KPIs for the business, again, over a 3- to 5-year period, what are you monitoring? And what do you think defines success in your mind?

I think the 2 big drivers of our growth going forward are going to be the Advisory business and I would say the capital raising business, of which underwriting is the largest part of it today. And I think it's -- honestly, it would be hard to double revenues from here in the next 5 years. That's a 15-plus percent growth rate. And the -- if we did do that, our Advisory business would probably -- if we were $4 billion-plus of revenue, our Advisory business would have to be 3/3, 3/4 somewhere in that -- 3/5, somewhere in that ZIP code. And that would have us the same size as Goldman Sachs in its peak year. I'm not sure that that's doable. I think we can certainly close the gap. I look at it slightly differently. If you look at our annual growth in revenues over that same period, it's $150 million, $175 million a year, something like that. That, I think, is imminently achievable. But off a $2 billion base, that's mid -- somewhere between 5% and 10% growth annualized rather than 15-plus percent. Yes, it's just a larger base. And what ultimately drives our revenue growth in our largest business, Advisory, is how many partners do you have and what's their productivity. We already have by a factor of almost 2 the most productive group of partners in terms of revenue per partner among all the public firms. So I'm not sure how much further that could go.

Can you spend a couple of minutes talking about the operating margin? So I think this year, you're on track for 21%. I think you've got a target of around 25%. But as the business continues to grow scale, do you think that the 25% could go to a higher number, 27% or 30%, over time? Or do you think there's a cap just given the nature of what the business is? And then secondly, obviously, the non-comp margin has improved a lot this year. How much of that do you think sticks as a result of the Zoom economy or just the world never really going back to where it was from a T&E perspective?

Okay. I'm going to give you a really long answer, but I think it needs to be nuanced. First of all, let me start with the target. Unequivocally, I believe that we can earn 25% margins in normal markets. In really good markets, we'll do as we did in 2018 and earn 28%. And in weaker markets, we'll probably be in the low 20s as you just hypothesized will be for the full year. I want to point out as it pertains to this year that on our third quarter call, we said our comp ratio estimate, which was 63/6 in the first quarter, second quarter and third quarter, was our best judgment at that point in time, but that this year, after 9 months, there was much greater uncertainty as to where we would wind up for the full year for 2 reasons. Number one, we really did not have, even when we reported earnings in the third week in October, a real clear view on where full year revenues will wind up. And number two, we didn't have a clear view on what would be competitive compensation for our teams. I now know a little -- I now know a reasonable amount more about the first of those items. You don't. And neither of us know a whole lot more about the second of those items. But I wouldn't presume from the first 3 quarters that we're targeting a 21% margin for this year. Just as has happened in previous years, what happens in the fourth quarter has a significant effect on both margins and the comp ratio for the full year. Is that -- does that answer your question?

No, that's actually very, very helpful. So we've got a couple of minutes left, and there's a couple of questions here on capital returns. So I thought we could perhaps end with that. And look, I think, look, Evercore not only has obviously seen a very impressive absolute performance in terms of share price, but you've also returned significant amounts of capital to shareholders over the course of you being a public company. Can you talk a little bit about how your thought process around buybacks and dividends is evolving? And just given the very constructive outlook I think that you've painted for next year, does it make more sense to be more aggressive on buybacks at this point given that -- I think of all investors based on the questions I'm reading, do you think that Evercore still is a very attractive valuation proposition?

I actually -- the answer to that is yes. And the math of that is -- and this is not a forecast or a prediction, but we've done over $2 billion of revenues in the last 2 years. We've done that at 25% to -- 24.6% to be precise, to 28.2% margins. But let's just pick 20%, 25%. That's $500 million pretax. It's $375 million after-tax. That's roughly $8 a share plus. To me, at $96 a share in a business that has no additional need for capital returns, 100% of its earnings to its shareholders in the form of dividends and share repurchases and has reasonably attractive growth prospects going forward, I think that's very cheap. And I think if you compare it to the profile of the S&P, which is trading at a 10 multiple premium to that or 8 multiple premium to that, I do think our business is undervalued. What I always say is that our job is to grow the fundamental value of the business, revenues and earnings, and to make it go up over time. And the share price is like a squiggly line around that line. Sometimes we're -- sometimes, the market thinks M&A is going to explode and we get capitalized at maybe too high a multiple. I would say for the last couple of years, we've been capitalized at too low a multiple. And we did what I described in '18 and '19 while we had some 20 of our partners who are still in the ramp-up phase, who had been newly hired or had just been promoted. So I happen to believe that Evercore, exactly as it is today in a normal environment, the earning power of our franchise, particularly with a more robust Underwriting business, is above what we did in '18 and '19 in a normal environment.

So Ralph, with that, unfortunately, we're out of time. I would love to have continued the conversation, but hopefully, we can do that next year. And hopefully, we can do it in person. But Ralph, thank you very, very much for joining us. It's been a pleasure.

I look forward next year to my annual track down to the combat in town.

We'll see. We'll be waiting for you. Thanks, Ralph.

All right. Thank you. Bye-bye.

Thank you.