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

Okay. Let's get started then. So next up, we're pleased to welcome Scott Beiser, Houlihan Lokey's CEO and a member of the firm's Board of Directors. Scott has been with Houlihan Lokey for 34 years now, I think, if I have that correct, and previously led Houlihan's infrastructure services and materials practice. With him is Gregg Newman, Global Co-Head of Houlihan's Capital Markets Group, where he works on debt and equity capital financing, has been with the firm for 10 years. Thank you both for joining us, and really, really appreciate your time.

Thank you for having us.

Okay. So let's jump right in here with you, Scott. It's really great to have you back on stage. I think maybe we could just start with sort of the bigger picture macro discussion and just your perspective on the macro at this point, how it's over -- and how it's frankly affecting the overall business. But then maybe if you could just also, within that, talk a little bit about some of the geographic differences. You've broadened your footprint so much. I think you now have a little bit more of that perspective on Europe and maybe even Asia as well.

So we -- I said in the -- maybe it's an earnings call or 2 ago, that we kind of think the trough in the marketplace for what we do is probably in April. So we do continue to see improvements, I think, not necessarily exactly day by day and month by month, but things have been improving. There's, I think, a variety of reasons. Stock prices have held up pretty good. Interest rates, the vast majority of people now believe that they've peaked. And so there's some stability in that. I think most are feeling that there isn't necessarily a recession or a significant one ahead of us. And so all of this is providing some incremental impetus for certain companies to start doing transactions again. And each and every day that the private equity firms aren't doing a deal, eventually, there is that pent-up demand. And we now have grown from where we were a couple of decades ago. While we still have more business in the United States than here else, we're a meaningful player in Europe, a growing player in Asia, Latin America. The U.S. is still the biggest marketplace for doing financial type of transactions, but we think that the U.S. financiers continue to effectively take their skills and go across the globe. And so we're finding at different times, different parts of the economy and different industries are performing at different levels. And I think one of the key words that we always talk about is diversification. So we try to have diversification in our skills of bankers, diversification in different industries, diversification in geographies, different product lines. And that's enabled us to, I think, continue to be able to grow better than hopefully normal and has allowed us to maintain a more, probably stable type of margin than some of our other competitors. And it is that going to different geographies. And there's still lots of places that we can continue to grow to, but it's going to be decades, I think, before we fully fill out the globe. It's not something we'll accomplish in the next couple of years.

Okay. That makes sense. So maybe just one of the very big picture one, which is we're now sort of -- looking like it's going to be a third year of weaker investment banking activity. I think you sit in boardrooms of a wide variety of customer -- of clients. And maybe just your perspective on what's sort of top of mind in boardrooms today? And I guess just what are the key concerns or key things that people focus on differentiating between sponsors and strategics.

So the first part of your question, I think the general view of either investors, private equity firms CEOs, they're getting more confidence. Predictability is getting better for them, predictability on what they think next year's EBITDA might be, predictability on where interest rates might be, predictability on where the economy is going. They cannot predict geopolitical issues. They can't predict election cycles and things of that nature, but the more predictability that they have, the more confidence that they have to go do a transaction. So I think that has meaningfully improved today from where it was, call it, a year ago. And in terms of the strategic versus the financials, and our business is generally split 50-50, not a perfect split like that. The financial folks have obviously been impacted by interest rates. Most important, and Gregg will talk about it a little later, is availability of capital is most important to us. Having lower interest rates would be better. But I think companies are starting to get a little more comfort in being able to deal in today's interest rate world. We do think that at a certain point, the private equity firms, they're in the business of doing transactions, and they cannot go year by year by year and not do transactions. So they're, if I might, they're jumping off the diving board into the pool at a little faster pace, not a heavy pace but more than they were a couple of quarters ago. The strategics are -- it's a mixed bag. I think some of the strategic firms, I'm sure they're public, might be sitting with a higher stock price than they would have thought of a year or 2 ago. So they're feeling a little more buoyant to be able to buy business, and they have the access to a currency to go do it. And some of the other strategics are trying to effectively continue to position themselves and at times compete against the financial firms. I don't think we see a huge difference where we'd say one of that subgroup is doing much more activity than the other. They're both calling to increase activity versus shrinking new activity.

Okay. I guess just one last big picture one. I feel like it's important given 2024 is an election year. Is that something that comes up with clients? Is it something that you think could impact activity? You've obviously seen many election cycles, not only in the U.S. as well as abroad.

So I don't think the election cycle, at least in the U.S., is top of mind for most of our clients right now. I think it's a little too early. I think as we head into late spring, early summer, it will be something that's talked about on a couple of factors. There's always the antitrust issue. Is the Congress, administration more controlled by Democrats and Republicans? That's less of an issue for what we do, I think, in the middle market-sized deals. Antitrust is not a major influencing factor. I think tax code is probably more of the issue. So depending upon what people think we know there's the -- a lot of what was done under the Trump era is due to expire in 2025. There is speculation when Biden got in there would be certain changes in the tax code. There haven't really been. But whatever people see or expect will happen, that will start impacting them on the tax code. But having said that, the U.S. elections are in early November. So once you know what's going to happen, it's probably too late to complete something if you're motivated by trying to do it by December 31, 2024. But most tax changes don't necessarily occur on December 31. They occur whenever Congress, administration will start talking about it. So people do believe there's a potential for some tax changes. They will be kind of racing against the clock to potentially do something in advance of those tax code changes if they do, in fact, occur.

So that's really interesting. So I guess maybe you could just talk about the tax code changes. You've obviously seen this has happened before. So how do buyers think about that, right? Does that just mean that the target's worth less if they think there's going to be a higher tax rate as some of those provisions sunset? Is that how that works? And in the past, how has that sort of worked itself out?

Yes. I think it influences sellers and borrowers more than probably buyers and lenders. So if there are changes in the estate tax laws, if there's changes in the capital gains scenarios, if there are changes in private equity land, those will impact certain things. If there's a fundamental change and an increase in corporate tax rates, once again, people will assess how much of that changes the valuation of that asset. But all of those things -- changes in the tax code in many regards are good for advisers. And whether you're a lawyer or you're a banker or you're accountant, having something change causes people to think about doing something, albeit it's easier to plan when things are constant. And sometimes people have been wrong, but I've seen this over the decades. Usually, when there's expected changes in XYZ year, you will start to see an increase in transaction activity as people on both sides of that equation want to try to accomplish something in advance of the code change.

That's a positive. Okay. Great. So maybe we can turn to some of your strategy. You obviously do operate in a different part of the market than I think a lot of your public peers in the mid-cap space. So maybe you could just talk about the competitive environment today and then I guess whether you do see enhanced hiring opportunities or what the outlook, I guess, is for hiring into 2024 and 2025.

So I think we've been relatively steady in our hiring. We've almost never really had a target that says we need to hire X number of people. But if you look during good times and bad times, as a percentage of our existing MD count, we've been at a pace for probably about 2 years at, I'd say, 1.5 MDs per month. That comes in exactly like that. We've not been in an environment where we're purposely trying to accelerate or overhire or purposely because we think the economy or business is poor to underhire. I think it's different in the folks that are not in the middle market and have a different mindset and strategy in terms of hiring and have reported that they have hired a larger statistical amount than they've seen in the previous years or 2.

Okay. So maybe just digging into some of the strategy for different businesses. Maybe we can start with Corporate Finance. That's obviously your biggest segment. Where do you see the best opportunities to expand in that segment in particular?

A number of places in no particular order. One is in the capital markets side. It's probably the biggest growing on a percentage basis within what we define as Corporate Finance. There are just more and more opportunities to be an agent or an adviser on the debt placement side for private companies. There are another couple hundred sub-industry sectors. So we see the world and we're divided up in our M&A folks, not just on an industry level but really a subindustry level. So the trick is how many more incremental sub-industries can we and should we get into without overextending ourselves. There's a geographical component. I think we're very satisfied in our presence in the U.S. and Europe. Still have a long, long way to go. We just opened up our first office in Latin America. We only have 1 or 2 offices in the Middle East, and we're nowhere where we can and eventually need to be in Asia. So there's growth there. Our best total clients, if you think about it, is the private equity or a financial sponsor community. Since they're in the business of doing deals, we want to continue to find how we can do more things for them and how we can do more work with additional private equity firms or hedge funds or sovereign wealth funds or family offices that we haven't done before. And part of it's a branding exercise. You got to get your name out there, and you got to get the right people and the right talent in place and so. We think within Corporate Finance, there's still quite a bit of a growth. And one way to look at it is our market share. We think within the middle market is bigger than anybody else's, but it's still in the smaller single digit. There's still plenty of room to grow.

And then maybe on FVA, which I think has been a business where it's changed a lot over the past few years. How are you thinking about the opportunity set in that part of the business? Where are sort of the best opportunities to grow, I guess?

So what we call FVA is really where the firm started back 50 years ago, and it's still a very vibrant, important part of the business. It does very well. It makes money. It's not meant to be a market-leading machine than the rest of the business. Overly simplified, I'd say half of the business is not tied to the capital markets or M&A marketplace. And therefore, it deems the more regulation, the more taxing changes, the more accounting needs, the more litigation that's out there, all of those things are good things to help our FVA business. The other half of the business is tied to the M&A marketplace. And right now, I believe it's probably a lagging indicator versus a leading and mostly because FVA is not on a contingency basis. It's on a fixed fee basis. So clients are not interested in really hiring that part until they're more confident a transaction will go through. And so I would expect that will increase as the M&A activity increases. There are still a lot of, I'll call it, sub-service line areas that we can continue to grow into. Nobody quite knows how big that total industry is, but we think it's huge. But there's lots of -- hundreds of much smaller players and types of businesses we don't really want to go after. But as long as there is a need by investors and regulators and accountants and buyers and sellers to want to know what some things are worth, the way we describe it if you can't find the answer on a Bloomberg machine, you should contact Houlihan Lokey or some other firm like ours to help in that valuation exercise.

Got it. Okay. So maybe just one thing about your skew. The business mix has changed over time. You have moved more to the M&A side of the business with the GCA acquisition a few years back. So maybe you could just talk about the philosophy for remixing the business mix overall and then just what that means for your cyclicality.

I mean it's fair to say we are now more tilted towards a healthy business environment than a negative business environment, just where the business has grown. And part of it, it's not just GCA. There is more opportunities to do things in what we define as Corporate Finance and FVA. There is a limited size in the total restructuring marketplace. But I think we are always focused on diversification, and -- which to us is not only those business cycles that we talk about but get into enough subindustries, get into enough geographies, get into hiring enough relevant and important bankers. So we're never heavily dependent on a particular sub-area, which may work against us at some time. And it's that mindset that really started with the founders of the firm. And I think it's been carried on through the management teams over the decades, is kind of how we've continued to balance the business and why I think if you look at our financial results compared to some of our peers, we just tend to have less volatility, not only in revenues but also in profit margins.

Okay. That's great. So maybe just a little bit on M&A. Specifically, I know you've given some stats around this historically, but I think it's just helpful because I think it's a lot less of a consolidated industry. In mid-cap M&A, I think they're just frankly -- it feels like there are so many different competitors out there. So maybe just talk about what your market share is today and I guess what your aspirations are 3 to 5 years from now.

So one of the statistics we put out, which is a totally easy way to figure out market share. We know how many total deals get done because it gets advertised by the various houses that put that information out. When you look at the total number of deals we closed, you get to a very small percentage that we do. Now a lot of the deals that get announced by Refinitiv, et cetera, aren't necessarily deals that are of the right size that we or our competitors would do. But I think when we do talk and understand and look at the numbers provided by some of our other competitors, we've got a bigger market share than most. But it's still, like I said, relatively small in the grand scheme of where we could go. One component is to continue to work with companies that had never thought about hiring an adviser. Some of it is, like I said, by getting into these different sub-industry groups. One of the things that people always ask is -- it's the productivity level or how -- what's the seasoned component of your MDs. So one of the things we looked at in Corporate Finance, about 25% of our managing directors in Corporate Finance have been in that position or at our firm for under 2 years. So that's a combination of promotions, a combination of hirings and a combination of acquisitions. So I did that statistic after we did the GCA acquisition because it therefore wouldn't skew it as much. And so I think almost everybody in the industry does describe, and we'd say the same thing, somewhere between probably 2 to 3 years is the time frame for that group to continue to mature to what we'll call as a normalized productivity level. So you will get some growth in that just due to the maturation of that group. And I think those are some of the reasons that we think we can continue to grow the business. I don't think we necessarily have an exact percentage where we can get to. But I think there's no reason we cannot double our market share and double our revenues over some period of time. How long that takes, I think it's a much tougher question. But we do not have a feeling at all that we're close to peak. And the same would hold true for FVA. It would be a different answer in restructuring. There are fewer competitors, and we have a bigger market share there. So we need some market help to double the revenues in restructuring. I think we have the inside skills and talents to double our Corporate Finance revenues. It'd be nice to have help by the marketplace, but we don't exclusively need help from the market.

Okay. So you talked about being past the trough in M&A, but it still seems like deals are being elongated. So maybe you could talk about what breaks the logjam, or however you want to put it, and really get things rolling. And then I think the other side of that is just in the mid-cap space, normalization probably happens faster than large-cap M&A. But how are you thinking about normalization time line, and frankly, just what that actually looks like?

So the 2 positives, I'd say, the number of new things hitting our new business committees, which is the initial funnel, is as good as it's ever been. The conversion of that new business potential into engagement letters or actually clients getting hired is as good as it's been. The percentage of deals that ultimately never get to a closing state die or go on permanent hold is still higher than normal, and the time line to close deals is still higher than normal. What breaks that? Ultimately, competition. I don't mean our competitors. But if you have 10 great buyers all at the same price, that forces buyers to do something quicker than if you only have 2 okay buyers as an example. If you have more lenders who are trying to compete against each other, that helps break the logjam. And part of it is we still think there's a bit more sway that buyers have sway over sellers and lenders have sway over borrowers. When that -- and it's much closer to equilibrium than it was a year ago, but there are times when it swaps the other way. Now it's kind of 2021. And then you find time frames get constrained because buyers are more concerned if they don't close, they're going to miss the deal, and lenders close more quickly. But we're still in an environment that everybody is saying how about another month or another quarter worth of information and let's investigate that. They're not actually walking away from deals, but they have the ability to keep asking a few more questions.

Okay. All right. Gregg, well, let's bring you in here. You co-head the capital markets business that's within Corporate Finance. Maybe you could just speak to what your business does, how it's performing in a challenging financing backdrop. And then the other side of that, as things start to normalize, what does that mean for your business?

Sure. Happy to do it, James. We're about 95 professionals globally. The team has a little over half here in the U.S. with the residual across Europe and the Middle East, largely Germany and the U.K. And the way to think about what we do is we raise capital in the private markets, both debt and equity. And those situations that we're getting involved in typically have some level of complexity. Otherwise, our clients know how to call their local banks or access the syndicated markets or call their top 2 or 3 relationship lenders. So what is complexity, right? Complexity comes in lots of different shapes and sizes. In this environment, a lot of what is complex has stress in it, right? These are balance sheets that are over-levered, need capital for liquidity or to refinance looming maturities or to address covenant breaches. So that's an area of complexity. In good times, complexity can come with aggressive acquisitions, significant and unique financing structures to grow businesses, to pay dividends to shareholders, to buy businesses that might be turnarounds and are difficult to finance in a traditional manner. So our business in many respects is a microcosm of the overall Houlihan platform. We have good tailwinds in strong markets and good tailwinds in difficult economic cycles. And that's why you'll see in -- for us, we'll partner both with our M&A colleagues around acquisitions and financings in -- for their clients. We'll work with our restructuring bankers where clients are trying to understand is it best solution, restructuring with existing creditors, or is it to bring in new capital. And then we've got direct calling and relationships through our financial sponsors' coverage universe where we're getting called on specifically for our relationships with investors and know-how. And it is a unique platform. We obviously have competitors like every business has in the world, but just the scale and size of our platform and our unique approach to how we're trying to work with sponsors is quite different from our competitors.

Okay. That's really helpful. So you obviously have the expertise on financing. So maybe you could just talk a little bit about the different financing providers out there. Maybe you can just talk about the health of the syndicated markets. And then I guess thinking about private debt, what is the appetite for companies to continue to take on debt that's with yields over 10%?

Yes. All good questions. I'd say I think we're of the view that syndicated markets are here to stay. They're not going anywhere. But there's no question that private debt has grown immensely over the past decade-plus, and we've certainly been the beneficiaries of that. And so really, companies have the alternatives to bake those different markets off, trying to understand in what environment the right capital makes sense for them, which avenues to go down. Today, there is more capital available than there was 6, 9 months ago. So that is a good thing. You are seeing the private credit markets active and competing on transactions. Even the syndicated markets, while slow, it's -- a little bit of it is choice, right? Do companies want to go out and raise capital at the cost of capital that we've got today? And it is a challenge. There's no question about it. Where base rates are, we've seen spreads come in, and we're starting to see base rates normalize, and the outlook for them are to stay steady or potentially decline. But to your point, the impact of the cost of capital is probably the single most impediment -- biggest impediment to a true resumption in my mind of the M&A business, right? And I think the M&A business will start to grow, and the impediments that exist will ultimately be overlooked because the nature of that business in PEs -- PE firms, their business is buying and selling businesses. Their LPs expect liquidity. If they want to raise the next fund, they're going to have to provide liquidity to those LPs. And ultimately, they'll get back to business, and they'll accept the new normal valuation that higher interest rates imply. But certainly, if interest rates were to decline significantly, that would accelerate the resumption.

Okay. And then maybe this one is for both of you. Just thinking about the fundraising side of your business, what do you think the structural pressure is on private equity in terms of going from 0 to higher rates mean? Does that have to -- does that mean you have to shift the business model in the fundraising advisory vertical? And then I think on the secondary side, that's obviously been a growth avenue, but it's not necessarily taken off as fast as perhaps I would have thought. So just thinking about the secondary side as well.

Yes. Really good question, lots of parts. I would say the fundraising environment today is depressed, right? It's depressed for the reason I just articulated, which is until PE firms start delivering liquidity to LPs, LPs can't recycle that capital. So there's that element to it. Having said that, there are always new entrants, new professionals that are starting up new funds, want to launch new vehicles. So there'll always be a consistent flow. Depressed doesn't mean grind to a halt. But even the biggest of players out there, you're seeing their new funds being smaller in size than the last fund and taking longer to execute on. But I do think that starts to unlock over time, certainly, as the M&A market picks up again. I would say the secondary business, it is another tool that many PE firms are using today, right? They're using that tool in the form of GP-led secondaries. It's an alternative to a sale. It's often used for businesses that GPs feel like they'd like to continue to own. There's more work to do in terms of growing it. So it's an important product in the marketplace. There's other business lines in and around the fundraising business and secondary businesses that are interesting to our client base. A lot of times, they don't want to sell businesses or there aren't alternative ways to get liquidity out of their portfolio companies so they can raise capital at the portfolio level through NAV loans, which were -- which we assist them with. Often they'll raise capital at the GP level and take that money and use that money to seed new funds. So there are lots of new and interesting ways to work with the asset managers that are out there. And I'd say the only other trend that I think is very visible today in the market is the diversification of many asset managers, right, getting -- adding on to not just equity but having large credit strategies and infrastructure strategies. And some of the fundraising in those strategies is different, right? It's not all institutional money. Some of it's insurance backed. Some of it is retail is driven. So there's a lot of interesting, new and dynamic things that are going on broadly for GPs and how they operate and manage their businesses that Houlihan and our competitors can assist them with.

Okay. Great. So maybe turning back to you, Scott, on restructuring. I think you've talked about how that business should be in that $120 million to $125 million quarterly run rate. I guess 2 questions. First of all, are you really starting to see any of the traditional Chapter 7, Chapter 11 activity really pick up yet? And then I guess what would it take for this restructuring cycle to get materially above that $120 million to $125 million sort of run rate?

So first of all, I think we describe it much like interest rate, higher for longer. We're at an elevated level. We think it's going to last for longer than what we typically see. So we do not expect, and we've stated this for a while. There's not -- another 50% growth rate from where we're at, and then you'd see an X percent drop from there. And it's a whole spectrum from kind of distressed try to find a solution on the balance sheet to a true Chapter 11 to a Chapter 7. Now a lot of the true liquidation Chapter 7 does not work for bankers because it's just a liquidation. And while you clearly see statistics on the number of bankruptcies, unfortunately, you don't necessarily see statistics published on really restructuring activity in a classical sense because it's not described in that fashion. We're not in a crisis type mode that we were in '08 and '09 or the early days of COVID or in the '01, '02 type of time period. And so I think in my response would be -- we say this all the time to investors if they said, Houlihan Lokey, we want you to increase your restructuring revenues by, fill in the blank, 50% or 100%. We couldn't do that without some market help, and the market help would have to be a recession. And I personally don't think we're in a recession. I don't think we will go in one, or if it is, there'll be a rather mild one. But if we were to enter a recession, not like '08 or '09, you would see restructuring revenues meaningfully increase, but it will also then put a damper on the Corporate Finance business we have.

Right. Okay. That makes a lot of sense. So maybe just turning to the other side of the P&L, thinking about your expenses and margins. It's obviously still a somewhat challenging operating environment. Maybe you could just talk about some of the dynamics affecting your operating margins into next year. And then I guess you had a pretty steady comp ratio. So I think I know the answer there. But maybe just talk about some of the non-comp ratio dynamics.

Yes. On comp, look, we've shown since we've been public and even before, when we published stuff, we've been by far the most steady comp payout ratio for them. There's a whole bunch of reasons why, and we don't see anything that's going to change that going forward. It doesn't mean we will always be exactly at the same number, but just don't expect much volatility from there. On the non-comp side, you get economies of scale as you get bigger. That's the good news. The bad news is we have been impacted by inflationary costs in the lease rates, in IT expenditures and travel costs. We think some of those inflationary components are starting to come back down to a more normal, much like general inflation. So we think for the foreseeable future, you might find the economies of scale will slightly outweigh the increase in inflationary costs. I think the better way to really analyze non-comp, it's not as a percentage of revenues but as a dollar amount per employee. And we are kind of back slightly below but pretty close to pre-COVID levels. And I just don't see -- there aren't market fact patterns that are going to get us to the aberrational benefit that the whole industry got during COVID when there was lots of business and we weren't traveling and you just spent less.

Okay. All right. So just 2 last ones here. The first one is just on capital returns, your priorities there. You've obviously slowed capital returns, which makes sense, challenging operating backdrop. But just how are you thinking about buybacks and dividends at this point?

So I think we always start with we want to always have a dividend, a core dividend, always would like to see it raised year-by-year at some level. That's probably priority #1. We are always focused on trying to repurchase the same number of shares that we issued in any comp cycle. We won't necessarily do it that exact month or maybe even within the year. We don't store money per se for acquisitions, but we are cognizant of what's in our pipeline and probability and whether we're buying that business for stock or cash. And then after all of that, we are looking to generally do any incremental share repurchases. We've never done a special dividend. We'll always talk about it, but that's not something that I would say is high on our chart to consider.

Okay. And then lastly, just on the acquisition side, how does the pipeline for those deals look? And then I guess are there any sort of business types that you're looking at and you think would be additive to Houlihan today?

Yes. I think we're always actively talking to probably a handful of companies at different time periods. They do take a while, meaning it could be years, probably at least quarters. We announced a couple of months ago a deal that's already signed, finally got regulatory approvals, something called 7 Mile. That will officially close, hopefully, in the next week or so. There are a couple of companies we're talking to now. Maybe all of them will close. Maybe none of them will close. That's the nature of the business. I think there's always areas. We are looking for industry, sub-industry tuck-ins. We're looking in -- for some geographical areas. We're looking for stuff within the capital markets. We're looking for things within the placement area. We're looking for some incremental sub-service lines in the FVA business. The one thing I'd say is the GCA acquisition was more an aberration. We're not afraid to do those. There aren't as many of those around. And most of our bread-and-butter acquisitions have been 20-person to 70-person type groups. And that's kind of how we think about it. And we're pretty agnostic between -- we like to obviously internally develop and promote people. We'll also opportunistically hire, and we'll also do acquisitions. And we're open-minded about all 3 and different reasons why you need to do them over time.

Okay. That's really clear. Thank you so much.

Thank you.

Thank you.