Houlihan Lokey, Inc. (HLI) Earnings Call Transcript & Summary

Okay. So up next, well, I'm delighted to welcome Scott Beiser, who is Houlihan Lokey's Chief Executive Officer and a member of the firm's Board of Directors. He served as CEO for 17 years, and I think he's worked at Houlihan Lokey, on at least my math, for 30 years. And over that time period, Houlihan Lokey has been an extraordinarily successful company. So Scott, thank you very much for joining us. I really do appreciate your time.

Look, I thought I would just start with a discussion around both the M&A and the restructuring environment, just to kind of level set where your expectations have got to. And I appreciate there's a lot of different moving pieces here but let's start with M&A. And I guess a couple of questions. The first is, look, how would you characterize the environment today relative to when you last spoke, which I guess, was a few months ago, what have you seen change? And secondly, look, you spend a lot of time with companies, both public and private, both with managements and with Boards, what do you think is top of mind today? And how has that evolved since we've had the news about a potentially successful vaccine getting rolled out in the first quarter next year?

No, first of all, Richard, thank you for having us. The trends that we talked about in the last earnings call back at the end of October, in many regards, are still in place. They just accelerated. So the M&A environment is on a rather robust perspective right now. In many cases, we're actually seeing activity better than where it was pre-pandemic. This is clearly not something 180 days ago that you would have thought. What we've described, I think what's happened is, initially in the early days of the pandemic, certain number of deals just died, certain and a greater amount probably went on hold and new activity meaningfully dried up. Somewhere probably in the middle of summer, I think it just felt like everyone said, we need to just get on with our lives, notwithstanding the world is not showing a great shape, and we want to continue to start doing transactions. And they figured out that they were willing to do things with a less ability to go travel, less ability to talk with management, and effectively, I think we saw August was better than July, and September became better than August, and October became better than September, et cetera. So it's just continued to improve. I think by the time you see everybody's results in this final calendar quarter, you may have a little bit of noise in it. Some of it is some transactions motivated to close for tax reasons prior to December 31. I don't think there's a whole lot of that, but there is some of it. I think you have some catch up going on, where some of the deals that were put on hold back in March, April and May came off a hold in summertime and now finding their way to closings. On the flip side, since we weren't bringing in as much new business in that spring time period, that would have been the normal business that might have started to close this time. So you still have some activity that just wasn't you might fill in the pipeline. But today, that pipeline is rapidly filling and whether you see it on larger deal announcements or the mid-cap deals that we tend to participate in the M&A side is there's just a lot of new transactions being formulated. The CEO confidence has improved. Private equity firms are back at it almost in full throttle. And like I said, it's a very, very bullish time, I think, on the M&A side. How long would it last? Don't know. But right now, it's as good as it's been. And clearly, since the start of the pandemic, and like I said, in many cases, even better than it was pre-pandemic.

So you operate in a number of regions where COVID infection rates have picked up, and you've actually got this, as you know, this series of rolling shutdowns across a number of geographies, both in Europe, but also now within the U.S. How has that impacted your ability to close deals? Because I know that you've said previously that in-person due diligence is actually very important, especially in private markets. So do you think that will have a knock-on impact as we head into next year? Or do you think people are just learning to deal with this new operating reality?

Probably more of the latter. I think they're learning to deal with the new operating reality. Having said that, if you have a key individual in a transaction, could be the business owner, a key lender, and if they have personal health problems or they maybe have family members with personal health problems because of the pandemic that -- you got to take care of your health issues first. So I would say it's a lockdown that's caused a ripple effect in the business. But if you have a specific health issue that's going on with a key executive, or a key lender or a key buyer or a counterparty, we found some deals are getting dragged out a little bit longer just because you're waiting for the outcome of that person's individual health.

And you obviously deal both with public companies, but also with private companies. Are you seeing a significant difference in confidence levels or willingness to transact between the 2 of them? And I guess you're really in a good position to kind of make an assessment of this, but do you think that some of the public market exuberance that we're seeing in terms of valuations are reflective of the corporate confidence levels that you see in those 2 markets?

So I think you have somewhat of a bifurcated market that's occurred because of the pandemic. Just made it -- this whole income in a quality issue that people talk about mostly on the individual level. You now have it at the corporate level. So I think the bigger your company is, maybe the more public that you are, depending upon which industries you're in, you're feeling pretty good about business and prospects. And the smaller the company, in certain circumstances, if they don't believe they have access to either debt or equity capital, and in certain industries, they're not obviously feeling very good about their prospects. In terms of overall CEO confidence, I do think it is influenced by the public stock markets, even if you were not in public participant. And typically, M&A does improve when asset values go up. People just feel a little better about it. And right now, I think you still have reasonable concurrence between buyers and sellers and what things are worth. When it goes the other way, when you get a dramatic drop in valuations, buyers, I think, tend to reflect that reality quicker than sellers. And that either causes deals to slow down or could be put completely on hold. But right now, I think you've got reasonable symmetry between buyers and sellers and lenders and borrowers that's enabling the transactions to go through and, in fact, accelerate.

So are you seeing much of a difference geographically in terms of activity levels and in terms of pipelines, specifically between Europe and the U.S.?

Europe's gone through, in many regards, I think it kind of led both negatively and then positively and then back and forth in terms of their experience with COVID. They lock down quicker, faster initially than they seem to improve and then they got a little worse and then they seem to improve. So we do see that has a little bit of ebbing and flowing in the business. But right now, no, I wouldn't say we see a significant difference between our U.S. clients and our European clients or the cross-border activity between those 2 particular geographies. They're both net on the financial side, seeing improvements. From an actual economic and business front, I think many of the same situations, these smaller businesses, and we all know it on the retail side, the restaurant side, gyms and other travel and leisure, these businesses are still hurting. And every time you think now maybe you're finally it's clear sailing, we find new lockdown measures have occurred and has kind of impacted their businesses.

So I think since you last spoke, we've obviously had the election. I think most of us think the election is hopefully over. But obviously, you've got the Senate runoff race in Georgia, but it does seem as if we're going to have a divided government. I know one of the questions that you were getting back in October was around potential rewrites of the tax code and the ramifications that, that had for business activity. Now we have the election result. It seems as if the probability of a change to the tax code is a lot lower. So how do you think about that all in? Do you think it has a meaningful impact in terms of either the willingness or ability for people to transact, especially within private markets?

Yes. I think there was more concern about this and potential increase of people wanting to do something back in the summertime regarding apprehension of what would happen post elections. And I think now it's more of a rounding issue at this point. There's some transactions that are clearly motivated by a potential change in the tax code. But like you said, I think right now, people's belief is that there either won't be a change or it won't be as meaningful of a change as they thought. And it's just not the #1 or maybe #2 or 3 item that's addressing executives or private equity firms in doing transactions. And I think probably the amount of year-end rush to get deals done or certain kinds of valuation dons has actually been less than we would have forecasted several months ago. Whether that will change, depending on the outcome of the Georgia races or once the new administration gets going on whatever activities might be, but right now, I don't think that's the -- this is not the driving issue impacting transactions.

So can you touch a little bit on financial sponsors? And just how active they've been, how important they've been to the business and how their thought process has evolved? Because, obviously, again, had significant decline in valuations that bounce back very, very quickly. Financing conditions, though, against that, are very benign, and they can obviously sell things as well as buy things. So where would you say they are in the evolution of their thought process? And how important do you think financial sponsors will be in 2021 in terms of a driver of activity?

So to what's there -- as a group, maybe as important as any other subsector, I mean close to maybe up to 1/2 of our business is somehow, some way touched by financial sponsors, private equity hedge funds, family offices, et cetera, and in all 3 of our product lines. In the early days of the pandemic, I think they were more focused on their troubled companies in their various portfolios. And what do they need to do to make sure that those companies survived and continue to succeed. After that, took maybe a couple of months for them to go through, then they started to focus on new activities, either adding to existing companies that they had and platforms that they had or brand-new transactions. It has come full circle from if you would have called a typical private equity firm in April about some new idea you had. They'd probably say, "Go away. I am busy with the troubles that I have." And now you've got a situation, in certain circumstances, if you go to a private equity firm and say, "Hey, I want to show you an opportunity of a new acquisition. They are so busy on other kinds of transactions. It's just -- it's -- the catch-up, I think, that has occurred is the financial sponsor community is very busy right now. They're being, I think, selective in what they can and want to buy. And it's less necessarily about the -- which industries they like or don't like. At a certain point, I just think they have gotten to a much stronger level of business. And so instead of where they went from not wanting to look at anything because they were worried about the distress, to maybe they didn't want to look at much in the middle part of the summer because it wasn't sure where the economy was going. I think they're back in business and reasonably full steam ahead. We probably had as much number of new pitch activity with the sponsor community as we've had pre-pandemic. So it's literally in 180 days kind of come full circle.

So let's segue and talk a little bit about restructuring. And I think your prior comments were that you expect a strong restructuring environment heading into next year. But I think you did say that activity levels, at least in the near term, could slow a little bit from what you saw perhaps in the third quarter. Has that changed over the last couple of months? And how would you evaluate the restructuring opportunity today compared to, say, where it was 3 months ago?

So the vast amount of new activity that we got in the March, April, May, June time period is we've said on the previous earnings call, has clearly slowed down, mostly due to, I think, the central banks across the globe have infused capital and made things easier for certain companies to take on some more debt to at least survive for a longer period of time. So new activity is less today than it was call it, 2 quarters ago, maybe even 1 quarter ago. Business is still -- having said that, business is still strong. We do think restructuring revenues will probably peak pretty soon. But we don't think they are going to shrink as rapidly as you typically find in a cycle. So they did not rise as fast as maybe some people predicted. And then they may not shrink as rapidly. And then it will just be -- we think a still an elevated level, somewhat higher than the pre-pandemic amount of business that we did for the foreseeable future for a couple of reasons. One, there are still a lot of companies whose, what I'll describe, their business plan does not fit with the current marketplace or what the marketplace will look like a year from now. There's just been some impairment in their business and what they're going to be able to achieve. They're just not going to get back to the old revenue and profit levels. And two, the amount of indebtedness that these companies have is greater than where it was at the start of the pandemic. So you've got a larger subset of companies that still have some level of trouble ahead of them with either the equal amount or more debt. And well, yes, they've been able to get debt and yes, interest rates are lower, which helps on the short term. Unless something more dramatically changes or rebounds in the economy for these particular industries, we do think 1, 2, 3 years from now, they're still going to run into some level of difficulty, and that's why we think this is a multiyear cycle of elevated restructuring. Like I said, it just will not be as high as we once thought it was at a peak period, but it will probably last longer than we would have thought 9 months ago.

And are you seeing any particular jurisdictions or sectors change in terms of what you think the restructuring opportunity is relative to where we were again a few months ago? Or is it still broad-based across quite a broad range of industries?

Well, so I don't see, from a geographical standpoint, we don't see huge differences on how North America versus Europe versus Southeast Asia, et cetera, are going to operate. It clearly is an industry sector area. There are a handful of industries that are still distressed, and we still think will be distressed, even post vaccine, post coming back to some level of normal, and then those are going to be the industries that we would expect there's going to be a decent amount of work on a go-forward basis.

Okay. So perhaps we can talk a little bit about your strategic priorities from here. And I think Houlihan has grown very impressively over the last few years. When you think about the next 3 to 5 years, to what extent do you think you can continue to compound growth at a similar rate to what you've seen, just given how you've broadened the product set, but also the jurisdictions that you operate in as well as the acquisitions that you've done? And are there either particular products or industry verticals that you're particularly excited about when you think about the next 3 to 5 years?

So I'll break it in a couple of pieces. From a geographical standpoint, we are still primarily a U.S.-centric firm, a large presence and a growing presence in Europe. And we're still much smaller in the Middle East, Latin America, Asia, et cetera. So there's large parts of the globe that we think we can continue to grow into. But these are decade-long tasks. This is not something that you can get to an acceptable level in our minds in a year or 2. It's going to take a decade or 2. So that's the geographical standpoint. On the industry standpoint, in the middle market, we view, the key isn't that you're in the major industries, it's that you're in the right subindustries. So we really have -- when we think of the top dozen core industries we're in, it's really about subindustries, maybe we're 2/3 of the way of building out all of the subindustries that we'd like. So this, in our opinion, still a lot of white space in terms of subindustries that we could get into. And then there are some ancillary product areas, the capital markets, which we define to us as mostly providing, not as a provider of capital, as an agent, a debt capital service. That's becoming a bigger and bigger part of our business. And we're seeing in the marketplace, and we've spoken about this in the past. We think, on a secular basis, more and more companies and private equity firms are going to turn to banking firms to assist them to go raise that debt capital and do it themselves. We're seeing the globalization of finance continue to get more and more complicated, which makes it more reasons that you're going to hire experts like ourselves and our peers. And we've not really seen a technology disruptor change even modestly, let alone radically, our business profile. So people are still hiring human beings to complete the test that we have. And therefore, we think there's still quite a bit of growth for us in the foreseeable future. Oh, final comment I'd say. Look, we've always said we are not smart enough to know where the world's economies are going, where interest rates are going, the stock market is going, political ways are going. And so we're not focused in 1 particular industry or 1 geography or 1 assumption on where economy is going. We're just always constantly trying to build the business so we can do well in multiple environments because we do know we don't control our destiny in that regard, we just need to want to be able to have the tactical capabilities to improve the business when new trends come about. And I think that's been part of the success that we've accomplished over the last couple of decades and hope to continue to do that for the decades to come.

So I think you mentioned the debt advisory business. Has the pandemic changed in any way, either the timing of that opportunity or even the magnitude of the opportunity? And then as a follow on, we've seen some of your peers grow their equity capital market and advisory businesses quite rapidly over the last 12 months. Do you think that some of the developments this year in terms of capital raising on the equity side being done much more virtually creates an opportunity for you that didn't exist perhaps pre-pandemic?

We're still much more focused on the debt side. In some regards, have the pandemic or the depths of the pandemic lasted longer, net that would have helped us better. So making it harder for companies to get debt short term is bad for you, but long term helps convince more and more clients that they should go out and hire somebody. So in some regard, we went from rescue financing to more traditional financing. The pain that occurred in the early days was helpful to us. In some regards, it could have been more helpful if it would have lasted a little longer in terms of further building the franchise. But that part of our business is doing very well. In terms of your question on the equity side, we're still a very minor player on anything that's kind of equity capital raise. Not -- we're not really focused on the traditional sales, trading and research side of equity. We think for a variety of reasons, that doesn't make a lot of sense in our business, whether it's the size of companies that we deal with, we just don't have the infrastructure to be competitive against some others. I think it will be interesting in the whole SPAC world, which is a brand-new robust area of -- it participates in the equity capital markets, but it doesn't take the same kind of assistance and research, in our opinion, at least to do some of these facts than what you've seen in the typical IPO. So I think it's early days on what we can do in the SPAC business. And we do some of the valuation work. We've been involved in some of the underwriting concepts there. We clearly can do M&A activity. So I mean it's another new area, but I won't put that as a traditional, what we define as kind of sales, trading and research on the equity side, which we haven't gotten into and no expectation that we will get into it.

So perhaps we can talk a little bit about your acquisition strategy because you have used acquisitions, I think, very, very successfully to augment the growth of the firm over quite a long period of time. And you did issue equity earlier this year to partly fund further acquisitions. So can you talk a little bit about the acquisition strategy, how that's evolved, how 2020, you think, has impacted the pipeline of transactions? And perhaps talk a little bit about what you've learned from the acquisitions that you've done so far, both positively and negatively.

So I'll take the first part of your question, which is kind of where is the activity level and what's changed, and we'll talk a little bit about what we've learned. So we've been, for the last decade, a major player in doing acquisitions. And acquisitions, to us, have been to either add bench strength, get us into a new subindustry, potentially a new geography. And we think it's core to our business. We'd like to deploy individual skill sets internally. We'd like to hire individuals when we need it and we'll acquire. So we believe all 3 are important to the growth of their business. As we head in the pandemic, as we head into the equity offering that we did back in May, we were seeing an acceleration of conversations that we're having, either because companies were getting concerned about trying to go on it alone and thought it would be better off in a larger platform like ourselves. These weren't necessarily distressed situation and conversations we're having. It was just a view that probably there'd be some increased dialogue. There still is some increased dialogue today from where we were pre-pandemic, but it's clearly less than it was back in that May time period. 2 factors that we alluded to in the last earnings call or so. Certain companies, as the M&A marketplace has improved, has said, "We want to -- in fact, we've decided we want to stay independent, and we're not interested in aligning with Houlihan Lokey or anyone else." That's just, once again, they've come back in their thought process just because of what the market is. And the second thing is we think some companies' valuation expectations have gotten a little too high. They look at our stock price, they look at our peer stock price. They're all up reasonably over the last 3, 6 months. And so that's kind of influenced their view of what they're worth. In some of the larger deals that we've looked at, once again, they may be more interested in willing to stay independent. Having said that, we're still talking to numerous companies. We would still expect to close several transactions in the next year or 2, which has been our typical pattern. And would expect to use, if not all of it, a good portion of that equity capital raise. In hindsight, we're very happy with how and why we raised it. Ultimately, the marketplace did improve. And you didn't know in May whether you'd be able to raise equity down the road. Today, obviously, it's a different environment. But we continue to talk with many companies, and our expectations are to continue to do deals. They'll probably be a little slower pace, maybe a little less from a size standpoint than we would have thought back in May, would be that answer to your first question. And the second, we've done enough acquisitions. I think we continue to learn what makes the most sense for us. And it's usually far less about price and structure of the deal. It really comes down to ultimately the people in this industry and the company that we buy needs to believe that they will do better on our platform, i.e., they will have higher bonuses going forward. Otherwise, kind of why do the deal even in knowing the purchase price. We need to believe that it will be beneficial to our business as well. That's always the first part. A little harder, obviously, to do due diligence in a virtual world for a service company. So you may see some acceleration of conversations when we can get back to getting on planes and traveling, but there is still some of that going on. We've tended to learn which companies fit in best. And sometimes you want a brand new subsector that there is no other -- there's not other synergies with parts of the firm. And sometimes you definitely want it to fold into an existing industry group or a geographical group that we have. We tend to like businesses that have some level of spread out ownership and spread out to client base. We think that's a little more stable. And we tend to talk to these companies for a decent period of time, as I've described it. We like dating for a while before we get married because ultimately, you need this thing to work for many years, and it can't just be a transaction that works for a year and then regret it. So those are, I think some of the lessons, having nothing to do probably with the pandemic. It's just you do enough acquisitions, you tend to reflect back on what's worked and what hasn't worked.

So could you talk a little bit about just the hiring environment broadly and how that's evolved? I assume that in the early part of the pandemic, people were very focused on their own health and safety, and probably looking to change jobs at that point in time was something most people were not looking to do. How has that evolved? And then secondly, I know we've talked about this before. But a number of money center banks have talked about growing their corporate franchise into the middle market advisory space over the last few years. Have you seen any noticeable changes in terms of the competitive environment of who you typically come up against when you go into pitch for new business?

So our hiring desire is really through all of this calendar 2020, which they haven't dramatically changed. We did not accelerate our desires on hiring due to the pandemic, thinking, well, we were much stronger, and we should be able to hire more people. And conversely, we didn't throttle back saying, look, we're more worried about the prospects of our business so we want to hold off on hiring. So I think we'll have a very normal looking number of new MDs that we hire in fiscal '21, that looks a lot like fiscal '20 and fiscal '19, et cetera. And there's still a large enough marketplace for where we hire people, not overly worried about, are there enough people. They were in some parts in the early days. Nobody wanted to move maybe from their current employer, either like you said, they were more worried about their personal health. Or you don't want to leave an employer in rocky times because you don't know how things work out. I think people are kind of pass that in a normal hiring mode from that standpoint. And in terms of the, I'll call it, bullish bracket firms who describe really pre-pandemic that they, too, wanted to get into the middle market, a couple of things. Most of the bullish bracket firm's definition of the middle market is different than our definition of the middle market, which, to us, is typically in the $1 billion in value or less. And so some of the bullish bracket firms might view that the middle market is really $1 billion, $2 billion, $3 billion. So we don't necessarily cross in many paths. And then a lot of times, the skills are different. And I won't necessarily say one is better or worse than the other. But if you tend to work on larger deals that tend to be public, that maybe across the border and have certain tax issues, you develop a certain skill set to deal with those kinds of companies. In the middle market, you're tending to do with probably more private than public companies and maybe individual owners, different level of sophistication of the financial staff. You're talking to multiple buyers instead of a small handful of buyers. So a lot of times, the skills that we might have at Houlihan Lokey don't play well in a larger cap world, and likewise, the skills of larger cap institutions when it play well in the middle size market. So I wouldn't say we've seen a major change in the competitive landscape either for pitching and getting business or even the hiring of individuals. We tend to have very few probably close to 0 of, I'll call it, traditional bullish bracket bankers on our staff. And likewise, there've been very few, if any, that I can think of that have left Houlihan Lokey to go to firms like yours, as an example, which is we're existing in a different pond, if you might, in terms of where we hire and train and grow people.

So we have a few minutes left. So let me ask a couple of questions, one about the margin, and then secondly, maybe we can talk a little bit about capital returns. But let's start off with the margin. So the pretax margin has been pretty healthy, around 24% on average over the last few years. When you think about the longer term, do you see prospects for that to increase either because some of the improvements on the noncomp side as a result of this work-from-home environment stick? Or because as the business gains scale, you think the comp margin could improve as a result of the greater scale of the business?

I think we've always said, don't expect our margins to meaningfully move upward or downward in a variety of different cycles. And really, if you look at the 5 years we've been public, I think, I don't know, 23% to 25%, give or take, is what our pretax margin is. So surprisingly, in this particular year, our pretax margins are likely to actually be a little higher than what I might call normal, which is not what you would expect, but it is because the noncomp costs have come down so dramatically due to the whole limitation on travel, conferences, et cetera. In exchange for that, and you've lost some of the out-of-pocket revenues, our compensation ratio went up to compensate, if you might, for the fact that our revenues -- our bonuses are really paid on fee revenues. But you, as investors and analysts, really see what our payout ratio is against gross revenues, which includes our out of pocket. So what we found was our compensation payout ratio went up a bit, and our noncomp went down a little bit more. And our margins are slightly up. I suspect when we get back to a more normal environment, we're going to see some, maybe not all of the noncomp start to go up again as people start traveling and doing conferences. And then you would see same thing happening that the comp may not come all the way back. But I think you should always assume we tend to be a relatively stable pretax margin player and debts for the foreseeable future is the way I think people should be thinking about it. Don't expect any large down cycles from that or any large increases from where we're at or have been.

So lastly, let's talk a little bit about capital returns. Have your capital return priorities changed in any way? Have they evolved? And just given the opportunity set that you see over the next few years, which sounds very optimistic, do you think it makes sense to accelerate share buybacks at this point in time?

So I think we always start with what capital we have, whether it's from daily operational profitability from the equity raise that we did. Our goal is, can we deploy it in a fashion that's beneficial to all shareholders. And if so, we're always going to use that. If we do not see enough opportunities or we don't need that amount of capital, then we're going to return it to shareholders. We typically always start with our annual dividend. Our goal and our objective is to -- as long as we can continue to increase that annual dividend, which we've done since we've been public. We've not done a special dividend since being public. We tend to be like our peers. You want to repurchase your shares at kind of the same amount that you're issuing to your employees as part of your year-end compensation. And what we've said about the equity raise that we did for acquisitions. If we ultimately don't spend at all, we'll return it to shareholders. More likely than that, I think we'd probably do it in a share buyback than a special dividend. But that's in the conversations we've had with our Board in terms of capital. The key thing is we do not want to keep any meaningful amount of capital for any lengthy period of time just to sit there on the balance sheet. We'd rather return it to shareholders. But if we can use it in a fashion that we think is accretive, then we want to use it in acquisitions or other types of opportunities that we might see.

Okay. So I think with that, we're pretty much out of time. So Scott, thank you very, very much for joining us. Hopefully, we get to see you again next year, but in person. Hopefully, you get a trip in New York. So thank you very much.

Thank you, Richard, for having me. And we look forward to getting into New York City, once again, one of these days. Stay healthy, and have a good holiday season.

Yes, you too. Thank you.

Great. Bye-bye.