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

Hello, good afternoon, everyone. 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. I think I'm right in saying that Scott has been CEO for 18 years now?

That's right.

All right, 18 years. And you've been at Houlihan Lokey for 31 years in total on...

37.

37.

A little rounded up.

And the company went public in 2015 and has obviously done incredibly well since then. So Scott, thank you much very for joining us. Look, I thought I'd just start off with a broad question, which is 1 that we've really started all these presentations with, which is really just your assessment of the macro environment. And it's just incredible to think about how much has changed since this point last year, especially in terms of just the market focus now on interest rates and inflation and whether we're going to have overheating as an issue. Yes, so maybe you can talk a little bit around how you think changes in inflation, changes in interest rates, supply chain disruptions could impact activity levels overall across all the different businesses that you're in?

So first of all, Richard, thank you for having us. We see still probably more positive signs than negative signs. There always is issues on what the market might be worried about, what investors are worried about. But at the end of the day, I still think the economy in the market is in generally happy moat. They've discounted for the most part, prospects of higher interest rates, supply chain issues, geopolitical issues, COVID issues, and I think that's been driving investor confidence and been driving higher stock prices. Capital markets are still open. And everything we still see is net more positive than a negative. Having said that, I'd give 2 cautionary notes. One if you would have asked any of us that question 18 months ago, we would have never thought we would be as a society or economy where we are today. And two, we do know it's been a dozen years since we've had the last true economic downturn. So it's been a long time, but the outlook for the foreseeable future, I think, still looks pretty good.

When you talk to your corporate clients, how concerned are they about some of these things, whether it's inflation, whether it's supply chain disruptions? Do you think the market is right to discount these factors when you talk to your companies and you talk around how pressing these are as issues for them?

It really varies by industry. First of all, I think just generally on interest rates, while most people still think interest rates will go up, they believe it will go up a modest amount and otherwise won't really drive negatively their business plan. Supply chain on certain industries, we're seeing on the consumer side, we're not as much seeing on the business services or technology side. So it varies by industry and a little bit by geography. Yes, and so I don't think there's a one-size-fits-all and they talk about these issues. But I think one of the litmus test is whether the CFOs and CEOs or the private equity firms when they're modeling over the next couple of years, are they forecasting a recession? Are they forecasting declines? And they're not at this point. They're still looking out the next 1, 2, 3 years I think with some positive growth, maybe not as much growth as we saw over the last 12 months coming from the downturn that we had in early 2020, but they're still expecting notwithstanding some of the macro issues growth.

Okay. So before we talk about some of the businesses, maybe you can take a few minutes just to talk about your strategic priorities? And maybe talk about how they've changed over the course of the year, just given everything that's evolved since we were here at this time last year?

So first and foremost, for Houlihan Lokey would probably be the successful integration of GCA, which we wouldn't have been talking about it last year because the deal hadn't been completed. It's a big transaction for us, a big opportunity for us. So that is going to be something we'll be focused on for the foreseeable future. We are still looking at a number of subindustry sectors to get into. In the middle market, there are not only dozens but probably hundreds and hundreds different of industry sectors. So while we think we cover the major ones, there's many subsectors are still a strategic priority for us. I'd also add, and we've talked about this for a year, the agenting in the capital markets. So what we're basically talking about is hiring an investment banking firm to help either companies or private equity firms find unique debt capital generally in the private marketplace. We think it's still early innings on where that whole industry is going to go. And I think we're continually using all data analytics and certain amount of technology to improve our business to be a little more efficient, hopefully, be able to find some incremental clients be able to do things from a more efficient standpoint. So that's what I'd say our core strategic plan is at this point. And then finally, I'd also add our valuation area has been all this and rapidly growing as well, and we see some new avenues and channels that they will continue to be able to grow for the next couple of years.

Okay, great. So before the GCA deal, you talked about a high single-digit annual revenue growth number as a longer-term target. And I think you've actually done a lot better than that since you've been a public company. How do you think about how the GCA deal changes that in any way? And do you still think that's the right type of growth number that you can achieve when you think about the longer term for Houlihan Lokey?

So we've never posed per se, guidance numbers, but kind of our long-term targets is somewhere have been in that 7% to 10% growth rate. Part of that would be through organic and part of it would be through acquisitions. You're right. Since we've been public, or even beyond that, we probably have grown in the low mid-teens year after year. So I think if you look at GCA, a couple of things are going to happen. Remind everybody we're a March 31 company instead of December 31. So in this fiscal year, we're only going to have 2 quarters with the results for GCA. So as we head into fiscal '23, we'll obviously have a full-year instead of just 2 quarters. The next thing that happens is, realistically, when you buy a firm, it doesn't matter really any firm, but especially a firm of that size, it does take some time for your colleagues to get to know each other, to figure out how to jointly pursue business, pitch business. And then you got to get hired. Most contingency transactional work we do are going to take 6, 9, 12 months to complete anyways. So I think that sets you up for fiscal '24 to have in some of that built-in growth expectations. We're effectively the 1 plus 1, which we clearly think will be worth more than 2, it does take a little bit to get there. So I would describe short term, subject to whatever the marketplace might do, we probably actually have a little better growth profile expectations. And then I guess we'd say the same thing. After that, you'd still expect kind of the growth expectations that we've had and talk to people about after that. So short term, I think, looks very promising. Long term, we'll be probably similar to whatever we've thought in the past, albeit we see we've done better than that for the last decade or 2.

Yes. So the one thing that's changed in the M&A market this year has just been the tremendous contribution we've seen from financial sponsors and the uplift in activity. I think if we look at Dealogic, I think it accounts for almost close to 50% of the revenues this year, which is obviously a much, much higher in the past. You have, I think, one of the strongest financial sponsor franchises of anyone really on The Street. So maybe we can just unpack a little bit what's happening and talk a little bit about the sustainability. So if you look at activity levels this year and think about 2022 and put it in the context of the dialogue that you have and think about the pipelines that you have, is there any reason to believe that this level of activity is not going to continue into next year?

Short answer is no. We think it's clearly set up for calendar 2022 to be another good financial sponsor year. So we've been focused on financial sponsors for a little better than 2 decades. So I think, longer than many of our other peers. And we think of financial sponsors is both private equity, hedge funds, family offices, some wealth funds, et cetera. Throughout that time, we've -- probably about 50% of our business is associated with sponsors under that definition. A couple of things have happened. Almost year-by-year, the number of new financial sponsors has continued to grow. And actually, new entrants are helpful. Those people are looking to deploy money and therefore, looking to do transactions. The dollar amounts of dry powder continues to grow. We've even looked at it and sliced it off even if you took the top 10 or 20 mega, mega size funds and institutions, you'd still find that the amount of capital that's been raised and still hasn't been deployed has grown. And then you have to remember, strategic acquisitions are generally driven by somebody looking to do something for their business to hopefully enhance it. But they're not necessarily a typical strategic company is not in the business of doing deals. Obviously, private equity firms, as an example, that's their lifeblood. They're in the business of doing deals. So they are set up much more ideally to do work with firms that are in the investment banking field and other consulting, et cetera. So we think they're going to continue to grow. They're an important part of the industry and all of the body language, dialogue and conversations we've had with them suggests that they're still planning to be very active. And I'd say one last thing. If we were talking last year, we said a certain amount of transactions heading into the calendar fourth quarter of 2020 might have been tax motivated, focused on what could happen in the change of demonstration, et cetera. Doesn't feel like there's much of any tax motivated transactions going on, which also gives us a sense that there's not a temporary blip here who seems to be more of a subsequent increase in activity.

So maybe you can talk a little bit about how you approach that client base, so financial sponsors relative to corporate. So do you think of it as a continuum? Do you think of it as a separate client base? And maybe you can talk a little bit about what you think differentiates your franchise relative to your peers just in terms of the success that you've had in that part of the market?

So we'll attack it from a multiple standpoint. So I think early on, industry investment bankers, M&A bankers, et cetera, they view that they are the ones who want to always have the dialogue with the financial sponsors. We still allow that and encourage that but we also have a dedicated workforce of about 2 dozen, who do nothing but call on several hundred different financial institutions. So one, they're in constant contact and they view that as their clients. We need to understand what's in the portfolio, what the financial sponsors are looking to do. So our purpose in life is a couplefold. One is to provide them with information and ideas and perspectives, if they want to get into a new industry or maybe exit an industry. They have some issue with one of their portfolio companies that could be on the restructuring side. They may need a business valuation, we could be on the sell side or buy side. So it's learning as much as you can about what their goals and objectives are. And then they're looking for deal flow. They want to use us as an agent as an adviser to continue to provide them not only with ideas, but hopefully opportunities both to buy, to sell, to trade in, et cetera. And considering that Houlihan Lokey, I think not only is it in the U.S., it's now in Europe and Asia, it's got a global footprint. It effectively is in every major industries, for the middle market, we probably supply more pieces of the ideas, more potential transaction opportunities on the buy side or sell side as almost anyone. And that, I think, is one of the key attributes that's relevant to the financial sponsor community to want to continue to work with you.

So how has the competitive dynamic changed? I mean -- and the reason I asked that is everyone seems to be focused on growing this. And look, I think even before this year, I think this was an area that was prioritized from a growth perspective, but it really feels like it stepped up this year, it feels like most people agree with you that this is sustainable, if anything, it could actually accelerate given the amount of dry powder, just given the capital raising environment, people don't seem to believe that higher interest rates are going to derail this. So what are you seeing on the ground in terms of the competitive dynamic? Has it actually changed much? And the reason I ask you that question is I know you do play in a slightly -- in a very different market to some of your peers in terms of the size of the companies that you typically serve.

So one is, I think they are -- the longer you know them, when you've only first gotten to know a firm for a year, you obviously don't know as much if you've known them for 5, 10, 20 years. So that's helpful. We will look at the firms, and I think the financial sponsors have evolved not only by size. They've also evolved in certain geographies that they want to play in or not. And many of these firms have become industry focused as well, but they'll only do deals in a couple of industries. So you need to go in to start the relationship, but then ultimately, you need to make sure that you're bringing in the right kind of banker relationships that they want to hear about, which could be the industry bankers we have. It could be a particular subproduct area that we have. So if you're bringing the right talented people to continue to talk to them. That's what's going to continue to, for them to be receptive to continue to have the meetings, the calls invite you to opportunities, pitches, et cetera. So the maturity of the financial sponsor industry is huge. I mean when I started the business in the '80s, there were a couple of dozen of them. Now there's a couple of thousand of them, and they've got more sophisticated and more specific and so much like banking, which has gotten more specialized, we've tended to follow what the sponsor community has done as well.

Great. So let's talk a little bit about the different geographies that you operate and the U.S. has dominated the recovery dominated in terms of the recovery, at least in terms of announced volumes. Europe has picked up more recently. How do you see this evolving into 2022 and maybe even beyond? I mean do you think this recent strength in Europe is likely to continue? And then maybe you can talk a little bit about the dynamic in Asia and maybe talk about it in the context of maybe the deteriorating relationship between the U.S. and China in particular and whether or not that impacts the M&A dynamic in any way?

So we started as a U.S.-centric firm. We have been slowly but surely growing to other geographies. Our kind of senior management thought has always been ultimately land somewhere where you're maybe 50% U.S.-centric and 50% outside never because we want the U.S. to shrink, but we want everything else to grow. And we come to that conclusion by looking at the market cap trading volumes, M&A, IPO and et cetera activity, the U.S. and the globe. Having said all that, while we've continued, I say, have put in more effort, more money, more acquisitions, more hiring outside of the United States and probably inside the United States on a statistical basis. The U.S. just for the last 15 years has been the best performing place. And once again, it's doing very, very well. We think Europe is improving. Now we were very much a much smaller, smaller player 10, 15 years ago in Europe, and now we're quite sizable player in Europe. So I think we've got a better feel for what's happening there. Europe as a whole has not by any means caught up with the United States. But there is clearly a lot of growth and we think it's going to occur for quite a while. And obviously, have many similarities in the United States put aside, you've got different countries and different languages, but in terms of size of business and what they want to do their desire. You look at the financial sponsors, which many of them started in the United States now have significant operations in Europe. Asia is a little more difficult, I think, to talk about it's even a larger geographical area. And when you say Asia, you really need to be talking about truly are we talking Japan, are we talking China, are we talking India, et cetera. Your comment on China at any given time, I think the U.S. has certain good relationships with countries and strained relationships with others. We don't do enough work in Asia in total to think to look at us to be, I think, the core expert on what's going on there. We've done a decent amount of work in China on the valuation side. We recently announced, obviously, a sizable financial restructuring project out there. There's a lot of work out there, but it's probably going to take a couple of decades to continue to weave your way through both the political climate, what kind of talent that you need on the ground. I'm not sure it's any different than when you develop Hong Kong or you develop Dubai. Same thing will happen. There's usually a foreigners who start and then eventually you're going to need to hire more and more people in country.

Okay, great. That's very helpful. So maybe we can talk briefly about GCA. That transaction is obviously completed. I know you're in the early stages of the integration, but maybe you can just give us an update on how that's going. What you've got to? How your thought process has perhaps evolved as you spent more time with GCA around the long-term opportunity? And maybe what stood out to you both positively and negatively as you've gone through the integration process?

So multiple steps. The first 1 was announcing the tender offer in August focused on getting the transaction actually closed, which the tender closed in October, the merger closed in November. Throughout that process and going on today and for many more months has been what I'll call a series of integration events, cocktail parties getting together, how do you introduce not only just the MDs at the partner level, but literally all the way down to the admin assistants, office services, all 500-plus people so that they can know as many of the 1,500 or so Houlihan Lokey people and vice versa. That has been going very well in the United States, very well in Europe. it's been much more difficult to do that in Asia, just COVID and travel restrictions. I think the body language between the bankers have been great. They've, I think, immediately tried to figure out who they should get to know? What are best practices we could each use? And part of that reason is and one of the things that attracted us to that, there is very, very little overlap between what GCA was good at and what Houlihan Lokey was good at. So we don't cross over each other's kind of core competency, whether that's by geography, industry line services, et cetera. So that's, I think, very helpful. The next stage, and we actually announced this, this past Monday, their San Francisco, New York, London offices have now already moved into our offices. We've got another 5 more offices to go. That will get accomplished in the next month to year. So there's a little bit of real estate noise to have that happen. What will take a little longer is, I'll call it, the back office integration, the ERP systems, the CRM systems, the HR systems, all of those things there's only a certain pace that you can do it at no different than any other transaction, but this one is much bigger. But from a client-facing standpoint, I think we've been very pleased from a back office standpoint, I think we're very realistic that it's going to take us a couple of quarters to get it all right.

And as you spend more time with their clients in particular as well as the bankers. Is there any reason to believe that the productivity over a multiyear period isn't going to converge with Houlihan Lokey's?

So historically, and almost every single transaction we've done and done over a dozen in the last 10 or so years, productivity, whether you define that as revenues by MD, revenues by headcount, average fee size, et cetera, has always gone up. Doesn't happen usually in year 1. But by the time you look at in year 2 or 3, that does happen. We have no reason to believe that won't occur as well here. Part of it is taking the best of talents that you have in each organization. We bring certain channels they didn't have. So they were very strong in technology. They might run into a project in the industrial consumer health care side, that wasn't a focus. They now have bankers that they can do that. They weren't really in the restructuring or valuation side of the business. Conversely, we were not in all of the different places that they were in Europe and in Asia. They have certain subsector skills and technology that we didn't. They didn't have the financial sponsor platform that we talked about a little earlier. So hopefully, all of the connections that people have, when you only are in a certain number of channels, a lot of opportunities you just -- in your dialogue with different private equity firms with different strategic companies, lawyers, accounts you might know, just kind of gets thrown away because you're not capable of handling them. So I would say the amount of deals, opportunities that each side may be passed on will continue to shrink. And I think the collective improvement of the talent of both organizations is improved from there. So bottom line, yes, we fully expect increased productivity. Don't expect it in quarter 1 or quarter 2, do expect it year probably 2 or 3, you'll start seeing it.

Good. So restructuring is another important business for you. Obviously, activity over the course of this year has been much lower than last year. Can you talk a little bit about your longer-term view of the restructuring business and where you see that headed. So if we do see interest rates pick up a lot faster, does that really have an impact or have companies now termed out that their debt to such an extent that they're not really as exposed to interest rate fluctuations as perhaps people thought? And I'm also curious, are you seeing what you thought was a restructuring mandate show up as an M&A mandate given the fact that the financial sponsor community is so strong? Or are they really just very different types of mandates and opportunity sets for you?

So several questions there. First of all, I'd start with since we've been in the restructuring business for 3-plus decades, it is a growth industry and a lot of people don't, I think, understand that. And so that -- by that, I mean each peak has been higher than the previous peak. Each trough has been higher than the previous trough. If you fix it on every once in a while, there's a blip in revenues because there's some calamity that's occurred out in the marketplace, that's an unfair comparison on a pure year-by-year basis. When you look at the total amount leverage of indebtedness, it is much, much greater today than it was in 2007 or pick almost any other time period you want. When you look at the default rates today, they're depending whose numbers you want to quote, but something under 1% is kind of what they say. And throughout time, we've seen peaks at 5%, 7%, 10%, you don't even need to get anywhere near those peaks to see that growth occur. The folks that deploy capital, the private equity firms, the alternative investment funds, et cetera, have gone from the United States to Western Europe to Southeast Asia, to Latin America, et cetera. So it's globally a lot more companies. As those companies and countries get more into a creditor's right restructuring mindset, there will be more work for everybody. And that business of ours is very, very global. So I'd set that as the stage. When you talk about kind of how you get into the mandates, it's kind of where you are within that are you teetering a little, maybe you need some balance sheet help. And so we might come in more in the capital markets concept. It might be just a liquidity enhancement depending on how the business goes, it might creep more into a full-on distressed restructuring. So sometimes we're leading with our capital markets banker. Sometimes you could lead with an industry banker. But having said that, I think the actual task of a restructuring is different than a task of an M&A. And a little on in interest rates. While we described earlier that I think the markets are still poised to do very well going forward, I'd actually -- if we could pick the perfect Goldilocks back pattern. Having a little more turmoil, a little more volatility, a little higher interest rates would be net good for our business, and I say that for a couple of reasons. If you assume interest rates went, call it, 100 basis points. I don't think it would meaningfully deteriorate what happens on the M&A environment, though it would take those companies with more questionable business plans already with too much leverage may tip them over quicker. The capital markets effort we have, our main issues is how do you convince people to hire you to want to do it. Now obviously, if interest rates were going to go up 500 basis points, we'd come to a different conclusion. But I actually think some level of reasonable, however, you want to define that increase in interest rates, a little tightening of the access to capital could be net-net good for our industry, for our business for Houlihan Lokey is next.

So maybe you can also give us an update on your Capital Markets Advisory business? I think you've been pretty consistent over time in terms of seats could get to the same size as the M&A advisory business, which is a very substantial business. And I guess the specific question is just given sponsor deployment, given the fact that leverage is very important to that client base, does that accelerate the time frame you think you can get there in that business? Does that actually have an impact given you have relationships with those firms and they're very big users of obviously financing products?

So we're very, very still bullish on what we in the industry can do on the financing side. However, since everybody has done so well in M&A. However, long we thought it might have taken for our capital markets to rival the size of our M&A. It's probably got elongated not because of any disappointment in the financing side. I mean, remember, the amount of debt that's placed in companies is, and the number of companies that need to get for whatever reason, take out a shareholder, grow a business, recapitalize for owners and other is a magnitudes more than the number of companies that want to do an M&A transaction. It's in some regards, it's easier to start a dialogue with the company about financing needs. It's not a hostile conversation and a restructuring standpoint, it's not a conversation that maybe they don't really want to sell, maybe they don't need a business valuation. So we think the market receptivity to wanting to hear about what we can do and what they -- the company might be able to do in financing is significant. The real issue is trying to convince the CFOs, trying to convince more and more of the private equity houses that is there are now thousands of capital providers, you should hire an agent instead of trying to do it yourself. That's our real competition. It's not the other name folks that you talked to over the last day or 2.

So we have a few minutes left. So let me ask you about the competitive environment from a hiring perspective. And I think as you know, this is a financial conference, a lot of banks present here, fascinating to see how the tone has changed over the last year from being concerned about credit, speed of economic recovery to focusing on growth again and obviously, middle-market, middle market expansion is something that comes up again as a growth avenue for a lot of banks. Are you seeing anything change? And I appreciate, again, I think when they define middle market, it's probably very different to how you define it. But have you seen anything change in terms of the competitiveness of the hiring environment from your perspective?

You know on the senior side, we all hire a couple dozen whatever might be of MDs in any given year. They're up there. They're available. There's lots of them. the cost of hiring them has gotten a little higher in good times and they come down in man times. I think clearly, on the junior side, our competition is not only our normal peers, not only one of the bigger firms like Goldman Sachs, but into the Google's world, start-ups. So there's a lot going on, I think, at the analyst and associate level that makes it more difficult in terms of who you're competing against to bring in talent. How do you attract and keep people from more than 2 years? All of that is just in today's society a little more complicated. There's plenty, plenty of people, I think, to be able to do the kind of work that we Do. but there are more opportunities. And since we haven't seen a downturn, this whole generation doesn't know from maybe they can't get a job tomorrow. Maybe they'll get laid off, maybe wages do go down. that's not how the 25, 30, 35-year-old things because they don't have any other framework reference.

Okay. So we're making this gradual migration back to in person, which I think is very positive. Can you talk a little bit about the receptiveness of client going back to in person relative to virtual? And maybe talk a little bit about what it means in the context of noncomp margins that have -- which have improved a lot over the course of the pandemic and maybe reflect a bit on what does that mean in terms of productivity, given that in a virtual world, you could touch a lot more clients in an individual day than versus in-person?

So just the best guess right now, which will definitely be wrong in a year or 2. But I would say the clients wanting to see us or when I have in-person meetings or they want to go to in-person management presentations at best is only a 1/3 of pre-pandemic level. We kind of think maybe it will level out at about 2/3, meaning we are going to see an increase in travel. We are going to see an increase of in-person conferences, much like this is -- you didn't do it in-person last year, you did it this year. I don't think it comes back to where it was before because we've all learned that there are certain things that you can accomplish virtually and people are more picking and choosing. And this does feel like it's at a little more sense of permanency to it. You still need to in certain circumstances do better and meeting directly with people. So all of that, we think, has a little bit of pressure on increasing the non-comp costs. On the other hand, I think we've all learned how to become more efficient. The middle June middle and senior people have probably benefited from a not traveling road. I think the junior people have suffered. They haven't been is trained as well. They've lost a little bit of the culture, they've lost a little bit of the socialization. So we're a mode of a hybrid concept is at least our thought process. It's not to go back 100% like we were before. And it's not completely you can do whatever you want to come in whenever you want. But I think the classical, look, the investment bankers have always worked hard. So rule number 1, you've got to satisfy the needs of the client. And there will be some amount in-person interaction with colleagues and with clients, and there's going to be some remote working and especially at the junior level back to that competition, I think you need to offer that. So each organization, each subgroup is going to need to find that right mix.

So my last question is just on capital returns buybacks. So you obviously did the largest acquisition, I think, in the fund's history. I think you are on -- you are on track to buy back a record amount of stock, I think, this as year well. So how should we think about the capital return philosophy from here in terms of buybacks versus dividends versus special dividends? This is the appetite and ability for you to do further inorganic acquisitions?

So I think our comments have been consistent and it hasn't changed post GCA. It's always going to start with -- we don't want to hold on to the investors' money if we can't deploy it successfully. It's not our job. It's not -- we're not a balance sheet organization. I'd say we start with always wanting to be able to raise the core dividend. We typically do that once a year right after our fiscal year. We've never really per se held on to money for a prospective acquisition, most that we've done have been small enough that we don't need to do that. But if we can deploy any excess cash we think successfully be an acquisition, we'll use it for that. If there aren't acquisitions that we're going to make, then we have gone down the share repurchase path. We about talk it at the Board meeting special dividends, but our tactics has been much more if you do have excess go do share repurchases. We have debates you try to spread it out over the year, you do it as close as possible to when you do the equity grants to employees, et cetera. But really since public being public, we've not done a special dividend, and I would still anticipate increasing the core dividend and doing share repurchases throughout the year.

So with that, I think we're out of time. But Scott, thank you very much for making the trip. It's great to see you in-person, and hopefully, good to see you next year.

Great. Thank you, Richard.

Thank you. Thank you very much, Scott.