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

So well, a couple of answers there. From a sector standpoint, the sectors that have been beat up the most have come back to strongest. So tech for us. I would say, on the other hand, industrials has probably been most impacted by tariffs and so forth. I do think that Japan, for example, is just a fundamental shift, while it's relatively small business for us. It is growing really nicely. And the whole transition in -- from a focus on return on lack to shareholder value in Japan is having profound effects. And feel very good about our business there and in Europe for that matter.

Anthony, let's turn to you. As Scott said, the fastest-growing part of the business, maybe you could just walk us through the current scope of Houlihan's Capital Solutions business which I guess sits within Corporate Finance?

So roughly 175 professionals split out over a number of different product sets. The elephant in the space or the elephant in the group, if you will, is what all deemed to be our sponsor finance practice, which is really raising everything from first lien debt to passive equity primarily for sponsor-backed portfolio companies with the caveat that everything we do has some material amount of complexity. So we're not doing a whole lot of cookie-cutter LBO finance. The goal here is to deliver an outlier outcome when sponsors don't have either the right relationships or the information to optimize whatever it is they're looking to do. So it could be a complicated underlying credit. It could be the market itself is overly volatile or it's in an out-of-favor sector. It could be that the sponsor wants to do something very opportunistic, like an acquisition, a very sizable acquisition, [ tack-on ] acquisition without writing an incremental equity check, getting credit for add-backs and adjustments and synergies could be doing a very large dividend and returning all their capital times, whatever within a very short period of time in their ownership and hold really wherever we can bring to bear our relationships and our knowledge base to drive an outlier outcome for them. We're the biggest player in the world in that space, we do between 125 and 150 deals globally, but the business is largely split between the U.S. and Europe. That's about 100 of the 175. We also oversee our primary fundraising business, our secondary and CV business, our GP stakes business, and then we have a business called Durex, which is really raising passive equity -- LP style equity capital that will pay fee and carry primarily for funded sponsors, but also for independent sponsors to help them consummate acquisitions. So in terms of the size of the business, the scale of the business, the biggest part and the growth driver historically has been, what, again, I'll call the sponsor finance business. But at this stage, we expect the secondary and CV business along with the Durex business to be the fastest-growing part of capital solutions, albeit off a much smaller base.

So the -- I think what you're sort of describing there is complexity, at least for the first part of that, which is actually the term that co-head referred to your business as being driven by 2 years ago. Is this the sort of backdrop that's conducive to that first part of the business?

Look, there's complexity in every market. The complexity changes. The fact is though there's always complexity. The bottom line is that I have been doing private capital raises for 25 years. The market has evolved more quickly over the last 5 years than probably over the previous 15. There's just so much capital that's been infused into the system, both, one from the financial crisis and then from COVID, you've seen a lot of that capital just reformulate into the private markets. And so the shift away from the bond market and the syndicated loan market being the primary large cap market, the direct market has become -- the direct lending market has become extraordinarily large and capable of financing almost anything at this stage. But then you've also seen over the last 5 years, the advent of family offices have grown exponentially that are deemed institutional. They can write checks between $10 million and several hundred million dollars per transaction. They're looking to go direct, not just invest into blind pools. And then you've seen the advent of the more traditional LPs that are also looking to go direct, whether that be in the secondary market or in the direct market. But you've just seen all of these things are happening all at the same time, and it's just added a lot of complexity to the market. So where financial sponsors used to buy a business, maybe they recap it, and do an add-on acquisition or several add-on acquisitions and then they sell it. Now they have to look at it and look across their entire portfolio, how do they maximize the value of each individual assets? How do they maximize the value of the portfolio, how do they maximize the value of the GP. And the ability to talk across all those product sets is extremely important, not only to talk across them, but not to have biases. So we have everything under one umbrella so that we can go in and pitch the array of alternatives without saying, but I do X. It's -- we do all of them. We will put the positives and negatives out there and explain what we believe to be what is executable and understanding their priorities, and then it's the sponsor's decision as to what to do. We're not just pitching one product over another.

The previous CEO, who's also named Scott said -- we try to keep it simple. Yes, exactly. Said many years ago that he believes the capital markets advisory business, which I think is the term he used then, could be larger than your M&A advisory business at some point down -- many years down the road, is that still the case over what time period and why?

100% agree with that. I've said that to Anthony many times...

Over many years.

Over many years, as Anthony reminds me, however, it's much smaller from a headcount standpoint. So it needs to continue to grow. And yes, it will take time to get there. But I have every confidence it will be as big or bigger than our M&A business.

I mean it's an AUM game. I mean, you just -- you follow the money and the fee pools around those product sets. And we have -- the challenging part is we have an M&A business that continues to grow at a pretty significant rate. And so we've got to grow at a higher rate and eventually overtake that. But we've always had the mantra follow the money and the changes in the overall market environment, be there to mediate without bias, and you will see growth. And that growth has occurred very significantly over the last decade.

Absolutely.

We just look at private credit. It's obviously become, as you said, a much bigger component of financing markets versus a few years ago. What does that done to cost of credit, covenant structures or otherwise?

Yes. Look, I mean, like you would imagine, the supply or oversupply potentially of credit dollars has just caused increasingly for the documents to be looser to the benefit of the sponsor. Rates have continued to tighten. People just continue to compete to put money to work. And that's certainly to the benefit of the issuers. And I don't expect that to change. A lot of these asset aggregators have gotten -- an asset manager have gotten so big and they're raising so much capital across all asset classes, but really on the private debt side, it's no longer first lien debt versus a bond or first lien debt versus second lien. I mean it's gotten so stratified in each one of these asset classes has raised so much capital that competitive tension just continues to tighten in the favor of the issuer.

What about more near term around private credit? Are there any signs of stress that you're seeing? Are you seeing anyone pull back at all?

No, it's the opposite. I mean I've been doing this for 25 years. I don't know that I've seen people stretching as much as they're stretching right now. Again, people they -- you constantly hear of funds that go out to raise $2 billion and end up raising $5 billion. And that money needs to be put to work. And so people do not want to lose deals over what they view as small marginal movements either in rate or terms. And that just keeps incrementalizing and making the documents more favorable and the cost of capital more favorable.

Turning to the other side of the business. Secondary has really been, I would say, the biggest structural growth driver, I think, of advisory revenue over the past few years. Maybe you could just comment a little bit on the scope and strength of your primary and, I guess, secondary fundraising businesses?

So on the primary side first, we've done some acquisitions. We brought over full teams, and we've really bolstered the effort on the primary fundraising side. But look, again, we're not trying to be all things to all people. We're largely sticking to our knitting and focusing on our core client base, which is middle market private equity. And so that's really where the growth has come on the primary fundraising side. On the secondary and CV side, look, we were a little late to the game. We probably underinvested relative to some of our peers. But the market if you had to find a perfect home for secondaries and CVs, I would argue Houlihan is it. I mean we sell more companies for private equity sponsors. We sell more company to private equity sponsors. And so the relationship is incredibly tight between ourselves in the middle market. And so we will have a requisite shot on that for all of the CVs that are coming. But we -- what we don't want to do is we don't want to overpromise and underdeliver. We need more people. We need to continue to focus on hiring talent, and we're spending an inordinate amount of time doing that. That being said, we're getting secondaries and CVs done and done well. There's a big one that's going to be announced within the next 2 weeks coming out of Europe, we did a lot of impressive things. But we're certainly not taking the 20% of the M&A market in the way that it stacked up this year. So we view it as a tremendous growth engine going forward. We're going to double and triple down on bringing in the right talent, and that's -- we're spending a lot of time doing that.

Great. This one is for both of you on restructuring. How do you differentiate between the transaction being in capital solutions versus in restructuring? Maybe the answer is both -- but it's kind of a spectrum, right, where you said.

No doubt, it's a spectrum. I mean very few situations, somebody calls up and says, "Hey, we're in a pre-fall and we need a restructuring adviser today". It is -- typically starts as a dialogue, hey, our covenants are getting a little tight. We need some new capital. Let's talk about that. That is usually a capital solutions dialogue that begins. You start to look at the situation. In some cases, it looks like, well, we may be able to get that capital we may not. It may be too far gone, we may need to do restructuring. We have that full spectrum of alternatives to somebody. There certainly are situations where it is just clear something, there has been some shock to the system and it needs to be restructured and capital -- there is no capital solution available and everybody understands that. So it is a spectrum, but they were very much hand in hand, and I think that is one of the beauties of our organization culturally is that collaborative nature and that lack of friction that exists between the various parts of the business, I mean.

Yes. Look, I mean, you said it, it is a continuum of a spectrum. And I think the easiest way to delineate is if new capital is being raised from nonconstituents then that is a capital solutions transaction. If it's a restructuring of the chairs and amongst the existing constituents of the business, that's either liability management or restructuring. Oftentimes, it's both. Oftentimes, we will have some restructuring component of a junior capital tranche, but we'll bring in new first lien capital to pay them down. And so we do work hand in hand, and we have the luxury of a fantastic restructuring platform that we know can get these deals done side-by-side with us. So we're working with them all the time.

Scott, maybe just on the cyclical versus structural dynamics in restructuring, right? Quantum that's growing, you talked about rates coming down. How do you weigh those 2 things up? And how do we balance -- or maybe you can just comment on the near term versus long term?

Yes. I mean long term, I've said this many times, but one of the great exports to the United States that nobody talks about is complicated balance sheets. They are growing around the world and literally on the tail end of a trip around the world, visiting our various clients and offices, and it is very clear that complicated balance sheets are growing around the world. When you have complicated balance sheets, you are going to have some level of normal distress, whatever that is, and it is highly unlikely that those people are all going to agree who gets what. So there will be a need for restructuring long term. Then you have the growth of private credit and just the increase which has a positive impact because you don't have the regulatory overlay that you have in depository institutions that have a funny way of messing up what becomes economically rational in restructurings. Then you also have the fact that increasingly, we have private equity ownership around the world. And while it's something that we take for granted in the United States, it is still in relatively early stages in Europe and very early stages in Asia, and that ownership change changes the way people think about sick balance sheet. And so when you are a professional owner of things and you recognize you have a balance sheet that's not allowing you to optimize the business, you act to fix that. If you're a family that's owned something for 300 years, you don't really want something bad happening on your watch. You do noneconomic things to make sure that it's not on your watch. And so those long-term changes as well as just the depth and breadth of the debt capital markets around the world continues to grow. The specialization of that capital, all of that for balance sheet optimization increases the opportunity for restructuring. I do think that we will probably see over time more LMEs, less full-blown restructurings. We really consider that just in quarters or out of quarters how we think about it. And I think that the TAM will continue to grow and feel very comfortable, and I know I think it was last year, Eric Siegert, who runs our restructuring business sat here with us and talked about it doubling over the next -- from our perspective, our revenue doubling over the next 7 to 10 years. And I agree with that completely.

So last, but certainly not least, in terms of businesses, FVA, we have a little visibility into that, I would say, than some of the others. But what are the best growth areas in this business looking ahead? And maybe you could also talk specifically about the portfolio valuation business.

Yes. Happy to do that. So really, there's 3 businesses inside of our FVA business. There is the transaction advisory business, which is think about it as due diligence largely tied to M&A transactions, very cyclical business, and obviously benefiting from the uptick in M&A activity. There's the opinion business, of which it's a mix between transaction opinions, fairness opinions, solvency opinions, things like that, that are also tied to the M&A environment, but there's also fund transfer opinions and other opinions that are not cyclical at all. And then our portfolio valuation business, which is the fastest-growing part of our FVA business, and that is doing marks for all types of illiquid assets all over the world and we are doing that. That is, I think, an incredibly compelling business. It's very technologically driven. As you know, something that I'm super focused on and we tie into the systems of some very large organizations, the BlackRocks of the world and I'd say, BlackRock doesn't just let everybody plug into Aladdin. So there's a very nice barrier to entry there, and we really appreciate that opportunity to partner with some of the largest institutions in the world, helping them get those marks. And so we -- that's something that we think is a business that we really like. We do think that there will continue to be fee pressure in that business over time, but technology is enabling us to stay ahead of that. And at the same time, the TAM is growing much more rapidly.

Okay. With that, we're out of time. So thank you so much both of you.

Always a pleasure. Thanks for having us.

Thank you.

Thank you all.