Moelis & Company (MC) Earnings Call Transcript & Summary

Good morning, everyone. I'm Manan Gosalia, the mid-cap advisers analyst at Morgan Stanley. I'm just going to get a quick disclosure out of the way, which is for important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. Great. With that out of the way, we're delighted to have with us today Navid Mahmoodzadegan, Co-President and Founding Partner of Moelis & Co. Navid also serves from Board of Directors. Navid, thanks so much for joining us.

Nice to be here, Manan. Thanks for having me.

Great. Navid, maybe let's dive straight in. Can you give us an overview on how you see the M&A environment today? You were one of the earliest to flag that the time taken for deals has been extending. In fact, I think you were seeing that before the war broke out earlier this year. Can you just talk about how that's evolved since the start of the year?

Sure. Well, look, I think, first, last year, as I think everybody is aware who follows our company and follows the industry was a record-breaking, record-setting M&A year. Pretty much every deal you worked on got done. Deals were happening at a pretty rapid pace. And the environment was as good as I've ever seen it in 30 years, where strategics, private equity firms, low financing rates, a general feeling that the economy was coming back very strong out of COVID. And as I think as we entered into this year, the overall activity levels of the firm felt really good as well. And so we thought we were shaping up for potentially another spectacular year. I think as the year has progressed, a few things have happened, all of which are things you're all aware of. But the combination of inflation, mostly triggered by the supply side of the economy, bringing on the specter of higher interest rates, and now we actually have higher interest rates with the Fed action, combined with a macroeconomic outlook that's much murkier with a potential recession on the horizon has made the M&A market definitely more challenging. And so while we still see a lot of activity, also see a lot of client dialogue, a lot of mandates in-house, I do think what's changed since the beginning of the year is the visibility into deal completions. Whereas last year, very, very high visibility in the deal completion, this year, less visibility in the deal completions. And I think a lot of that stems from the fact that there's going to be a period of time where we find equilibrium on pricing of assets. And so in many spaces, we've seen, and certainly in the public markets, asset values come down in the private markets where a lot of our activity is. I believe it will take a little bit of time to find that equilibrium.

And in terms of the extensions that you're seeing on deal times, are those typically the sort of extensions you see coming out of a bull market? Or are you seeing something more than that?

Well, I think there's nothing really typical about the environment we're in right now. This combination of interest rates rising and uncertainty over how high they'll go and teetering on a recession and all of the uncertainty around that, I think, has made this a different kind of environment than we've seen in a long time. Having said all that, the one thing I do want to mention is that all the macro forces that we've been talking about, structural forces for a long time that should help propel the M&A market for many years are still very much intact. Technological disruption that's ripping through every industry, all of which was accelerated by COVID, is still very much intact. That's a theme that's not going away and will impact corporates and financial sponsors. And on financial sponsors, the aggregate amount of dry powder that persist and will continue to persist is also going to continue to drive transactions across the board. And so in the intermediate term, long term, feel extremely bullish about the health of the M&A market and our position within the M&A market. I think the question is, in the short term, how much of the macro instability around inflation rates, the economy will make it harder to get some of these deals done on a timely basis. That's the question.

Got it. I think that feels pretty consistent with what you said on the call in April. Have there been any changes since then? Anything to flag?

No. Although I think, I don't -- I think the environment is getting a little more challenging than even in April. You see, obviously, the movement in the public markets. I haven't checked quite yet, but it didn't look like today was going to be a good day. Late last week, certainly wasn't great. And so I do think probably even since April concerns around where rates are headed and concerns around where the economy may be headed are even more acute.

Great. So maybe let's dig in a little bit more on your earlier comments. So let's move on the strategic front, right? Valuations have come off, but at the same time there's several large corporates that have balance sheets that are flushed with cash. What are you hearing from them? Are they still in sort of wait and watch mode? Or are they starting to get more interested?

Well, one of the countervailing -- I just went through a litany of things that are making M&A tougher. I think one of the countervailing factors which I think will help the M&A market is what you're talking about. So as I mentioned earlier, corporates in every industry are very cognizant that they got to make sure they're well positioned for growth in light of all the technological disruption. And now we have a whole host of companies, growth companies, that we're raising -- easily raising rounds of venture capital, rounds of growth capital on the way to being public and now the IPO market's completely shut down. IPO market's shutdown, SPAC market's shut down and the private fundraising market is close to shutdown. And so lots of good companies that have good technologies or good market positioning are finding themselves in a position where a strategic exit to a cash flushed strategic who needs technological advancement is probably their only exit. And so I do think that will help the M&A market. And I do think you have corporates who are on the lookout for plays now that could have been outside of their comfort zone in terms of valuation. But as those private market values start to reflect what's happening in the public markets, I do think there'll be a lot of that kind of M&A.

And maybe it's also the sell side and the buy side, the bid-ask spread coming closer together for those deals to have...

Sometimes it takes a while for that to settle in on the sell side. And I also think you have a whole host of companies that haven't gone public, either through traditional IPOs and SPACs. A lot of those stocks are off 50%, 60%, 70%. The whole thesis for being public, hey, it will make our employees happy, we'll be able to get some liquidity as founders and we'll have a currency to go do M&A. When your stock's off 60%, 70%, none of those theses hold true anymore. And so I do think going privates of those companies -- we're working on some of those already or corporates looking at some of those companies and potentially taking them out of their situation, I think will help the M&A market once we find this equilibrium you're talking about.

Got it. And then what about on the sponsor side, right, that's about 50% of your overall activity. I think it was even higher last year. They have a lot of capital to put to work, as you've mentioned. But at the same time, they're also pretty sensitive to how high rates can go, where there are talks about a 75 basis point rate hike coming up, and we're going to get more through the year. So talk a little bit about what you're hearing from them, how much of hurdle rates moved higher and how easy or difficult is it to get financing in these markets.

Sure. Well, look, financing is definitely more challenging than it was before. The cost of financing has gone up versus a year ago, given where rates are, the amount of leverage that's available, the quantum of leverage that shifted over a year ago. The good news is there's lots of different types of lenders that are available to finance buyouts. Historically, it was just the banks. And if the banks pull back and got cautious, you're out of luck as a private equity firm. Now you have a whole host of nontraditional lenders, including many of the financial sponsors themselves with their credit arms that are providing ample liquidity to do buyouts, again, maybe at a higher cost, likely at a higher cost, likely with more conservative capital structures. But there's still money out there to do buyouts. So that's the good news. But you're right, at the end of the day, for a financial sponsor, it's all about underwriting to a return. And if the cost of financing has gone up, that puts some pressure on what you could pay. In addition, if there's macroeconomic uncertainty in certain sectors, those maybe sectors where financial sponsors, depending upon who they are and what their macro outlook is, will pull back or be more cautious about consumer-facing names right now if we're heading into a recession. Something that has a lot of European exposure given the war dynamics around Ukraine. I do a lot of media. If you're an all-advertising business, it's a little more challenging these days to underwrite a model like that. And so I think what sponsors will end up doing, they're sitting on lots of money. They'll deploy capital through this cycle. It may be that they take a more cautious view on certain segments of the market and refocus on other parts of the market where the outlook for growth is still pretty good.

So I guess the flip side of that is, again, valuations have come down quite a bit, right? So at what stage, based on your conversations, do valuations come down enough where sponsors really go in and look for opportunities out there in the market?

Well, look, this is the question right now. This is about defining the equilibrium that you've been talking about. Look, we're out there selling lots of great companies right now. Despite some of the volatility, we really do feel strongly that many of the companies we're working with, we will find that equilibrium. And the question a lot of sponsors -- a lot of feedback we're getting from a lot of sponsors is, hey, I love the company, I love that management team. I want to own the asset, I'm a great buyer for the asset. I'm just trying to figure out what to pay for it in light of the current environment. And I think that process of figuring out what they're prepared to underwrite and to what model and figuring out whether our sellers are prepared to sell into that kind of number, which is a number that's probably different than it was a year ago versus the alternative of holding an asset, potentially riding through an economic downturn and coming out and selling it a couple of years from now into an uncertain environment, those are the conversations we're in the middle of right now.

Got it. And what about -- just given public market valuations, there could be more interest to take private deals. Are you seeing some of that right now?

Yes. Look, we're working on some now. I think there'll be more of that activity. As I mentioned earlier, not really fun for a company who thought they were a growth company and public markets would be a good experience for them. And through no fault of theirs, they may be executing perfectly the market views their company very differently than they thought the market would view their company. And so when you're sitting there with a stock that's way underwater and your employees aren't happy and you can't use it as a currency, and by the way, you've incurred $3 million, $4 million of public company costs a year, I think a lot of those companies will question whether it makes sense to stay public or not. And so I do think there will be a lot more of those kinds of conversations, whether it be with financial sponsors and take privates or whether it's sales to strategics.

Got it. And then maybe just looking at the environment, there's higher geopolitical risks. There's also the recent supply chain disruptions. I think all of that is driving more conversations about near-shoring and more investments here in the U.S. Is that already factoring into your discussion with clients? And do you think that this is going to be like the next theme for M&A activity maybe 3, 5 years down?

I think it's definitely going to be part of the conversation. So to the extent to which securing your supply chains and especially securing your supply chains in friendly jurisdictions or inside the United States, I think that could be an M&A theme for certain types of companies, industrial companies, some companies in technology spaces, so on and so forth. So I think it could tilt the aperture for the kinds of deals that companies are looking at. I think historically, a lot of it's been around globalization, international exposure, going to the cheapest source of manufacturing. And I think that drove a lot of the global M&A market, cross-border M&A market. I think this will drive a different set of considerations. Hard to know, sitting here today, is that net good for our business if companies decide they're going to do less cross-border stuff and more stuff in the United States. Is that net good or bad for us? It's hard to know.

Got it. I mean I would say that in a business which sent us an advice for your clients, any kind of movement is actually good for your client relationship?

Yes. I think that's right. I think -- again, our jobs are to sit there and sit with our COO and CFO clients and strategists and really kind of think through where do they want to go as a company, how do we help them achieve their strategic ambitions? And sometimes that leads to an M&A solution, and sometimes it doesn't lead to an M&A solution. Sometimes there are other ways to kind of create that source of supply chain health. And those kinds of conversations are the ones we're having all the time.

Great. And I want to move a little bit more into the strategy, but maybe just one last question on the environment. And that sort of centers around SPACs, and there's still about 500 or so, I think over 500 SPACs out there looking for a deal. There are going to be major liquidation events as we get to the end of this year or early next year. So what's your view? What happens here right now in the environment? And also what's your view on the SPAC market for the longer run?

So I think let me just take a big step back. Before the last couple of years, SPACs existed. SPACs has existed for a long time, and they were generally a pretty niche product, right? It was a way for certain types of companies to go public in a more efficient manner with sponsors who are in the SPAC business, who had a set of investors that follow them. And so for certain kinds of companies, that made a lot of sense. What happened over the last few years is an explosion of transactions where a combination of all the money that was sloshing around in the system, a retail investor that was looking at investing in new IPOs, sponsors who felt that they had an opportunity to make some money and a regulatory framework where if you're wanting to get public fast, there was an advantage to going down the SPAC route versus the traditional IPO route and people in that kind of frenzied environment want to take advantage of that. I think what's happened now is there is no IPO market. There really -- it's very challenging to get even a SPAC deal done right now. A lot of that hot money has evaporated from the system. A lot of that retail money has evaporated from the system. And the SEC has now put in place proposed rules, we'll see if they get adopted, that changed the whole legal framework around SPACs versus IPOs, have made the SPAC path, which is essentially an IPO in sheep's clothing of an M&A deal and really call it for what it is, an IPO process with all the residual IPO frameworks and liabilities aimed at underwriters, right? And that process is underway. And so I think SPACs will go back to being a niche-ier product. Longer term, it will apply. It'd be helpful to certain kinds of companies who are looking to get sponsorship from a set of sponsors who have been in the business, have a track record, have a following. What happens -- your question was what happens in the interim to these 400 or 500 names? I think there's a combination of some of them won't get deals done, they'll liquidate as you mentioned. Some will scratch together and claw together transactions. It will be interesting to see what those transaction looks like. They'll obviously have to be done at valuations that are super attractive to investors because, as I mentioned, the IPO market's essentially shut and people aren't putting money into these kinds of companies unless they're super attractive valuations. And I suspect some of the sponsors are going to have to recut some of their economics to get those deals done. So -- and we'll see as the SEC rules come into place, how folks like us participate in a thoughtful way in those sets of transactions that are likely to happen over the next 12 to 24 months.

That's great color. And then maybe just flipping quickly to restructuring. I think you've said that conversations have started to pick up, but sort of stopped short of calling for another wave just as yet. I think defaults are still low, but then at the same time, higher rates and the way the economy is going, could provide some acceleration to restructuring. I guess what do you think we need to see before restructuring picks up? And what are you doing to prepare in the interim?

Yes. So look, I think right now, the restructuring market as you look out over the next few years, I do think the ingredients for a restructuring wave are certainly there. So what are those ingredients: one, an economy that potentially may be headed into recession or slowdown; two, you have massive maturity walls of leveraged loans and high-yield debt really starting in '24, '25, about $1 trillion of maturities in those 2 years. And if you look out a few more years, another kind of $2 trillion of maturities. And so I think the LBO boom of the last few years, the leverage boom of the last few years as people want to capitalize on low rates, I think those maturities are going to have to be dealt with. And if you sort of roll through a weakening economy and maturity walls that's sort of a recipe for defaults and restructurings and balance sheet work. And I think when that comes, we're perfectly positioned to take advantage of it like we were during COVID when many industries were disrupted and like when we were after the global financial crisis when many, many companies were disrupted. Sitting here today, the activity level in terms of new mandates, new originations is pretty muted because that -- we haven't yet seen, corporate profits are still strong, default rates are still low. Yes, you're getting a tick up in rates, which puts some stress on some capital structures, but it really takes either disruptions in certain sectors and industries pronounced like sometimes you see in oil and gas and you saw during parts of the economy during COVID or default rates ticking up meaningfully. And we haven't seen that yet.

Got it. Okay. Let's move to the longer-term priorities for the firm. I think you can argue that last year where you had record M&A revenues and activity where I think activity was way higher than even anyone's bull case estimate going into the year. I would say that maybe management's focus at that time was on capitalizing on the environment. And now with a little bit of a slowdown or a relative slowdown, you can focus a little bit more on where you see the firm 3 years, 5 years down the line. So I guess, talk about where is the most opportunity that you see and what you're doing to capitalize on that?

Well, it's fortuitous we're having this conversation. We're preparing for our partners offsite, which we're actually holding tomorrow on Wednesday, where our partners globally are all coming in, and we're getting together really for the first time since 2019. So some of these things have been very much on my mind as we're preparing for that. But I think big picture, one, we're going to stay very committed to the basic philosophy of the firm that have enabled us to achieve the success we've achieved. Those philosophies are: collaboration is central; maintaining a great culture is essential; continuing to build out mostly organically, mostly through talent development, our sectors and our products and our geographies. Last year, for instance, we promoted 16 Managing Directors. And so you hear a lot about talent wars and people throwing big contracts in front of people. And we did hire a few lateral -- very good lateral people last year, and we obviously had to pay what we had to pay to be competitive in that market. But 16 MDs, we promoted internally. And so our talent expansion really came, we think, in a much more cost-effective, much better ROI basis than some of our competitors. So I think we're doing some potentially difficult things as the market starts to slow down. And so we're very committed to those core principles. They work. I think making sure we maintain laser focus on executing on those strategies and executing for our clients. In a tougher deal environment, bankers who are focused on the clients, on getting deals done, help find these equilibriums, giving good advice and because we do it in a collaborative way and have always done it very collaboratively, continuing to bring the best of the firm to our clients is the #1 way we're going to continue to take share through this period of time. In terms of strategies, look, I don't -- there's nothing extraordinarily new. We continue to build out some of our product areas. So equity capital markets is an area we invested quite heavily. And in the last couple of years, we have an A+ team in equity and debt capital markets. They're doing phenomenally well. They certainly took advantage of a lot of the SPAC opportunity last year and we'll continue to kind of help mine that opportunity this year, but we're building out our private capital markets effort, private fundraising efforts. So for instance, a year ago, 2 years ago, every private growth company could raise money on their own. They didn't need a banker, right? In fact, it was almost a negative to hire a banker. Why aren't you -- you're not a great company if you have to hire a banker because term sheets were just coming in through the transom. I can't tell you how many of those companies are now calling us saying, "Hey, we need your help. It's getting tougher out there." And so selectively taking on the right companies is something I think we're going to be doing a lot more of. And I think there's a really big opportunity for us to work with growth companies -- very good growth companies to help raise private rounds. We're working on some public market capabilities as well, converts and things like that. So I think capital markets is a big opportunity. And I think private equity fundraising is a big opportunity. So we hired a gentleman by the name of Rodney Reid a couple of years ago from Evercore. He's helping to reshape and rebuild our private fundraising business and getting into continuation funds, which are all the rage in the private equity world these days. And so we're extremely excited about what Rodney and the team are doing and where they're taking the business. We're extremely excited about our capital markets business.

I guess on the capital markets business, it almost sounds countercyclical, right, given that you're getting more companies come to you for advice in an environment where it's more difficult to raise capital.

In that part of the business, sure, yes.

Correct. And I think the capital markets business overall is something that it's more difficult for us to see from the outside. And it might not be as appreciated by investors. So what are some of the things you've done to build that out? And how large is the business today versus 3 years ago? And what -- how large can that business get?

Look, I think that business can get a lot larger. Look, we have -- as I said, we have a great team. They're super entrepreneurial. They love being on a platform where they can really work on high-margin opportunities and high-margin products as opposed to slow business and stuff that relies on a big infrastructure. They're very bright and very hard working, and I think the sky is the limit on what they can create here. It's still early days. Again, that team has been on the ground for a couple of years on the equity side. On the debt capital markets side, we've got a team that's long been in place doing a great job as well. But I think there's a real opportunity there. How it all plays out on what time frames, given the market environment? Hard to predict, but we're very excited about it.

Great. And then you've also spoken a lot about how the increase in dry powder with sponsors has increased activity among VCs. It's changed how the M&A market works. And you've been investing in your sponsor coverage and talking about that for several years. I feel like since inception, you've been investing in that coverage. But as more and more of your competitors do the same, how do you differentiate yourself in that environment?

Well, look, I think there's a difference between companies and advisers where private equity coverage and knowledge and relationship is sort of in our DNA versus people who are just showing up because they need to. And so I do think it's very hard if it's not in your DNA and you don't have the right bankers who have the right coverage mentality and understand how sponsors work to just sort of show up and say, all right, we're in the game now, right? Having said that, we don't take the competition lightly. It's -- obviously, we're in a very competitive business. And what I've always found that the way to continue to gain share and outperform in the sponsor world is you have to continue to stay in front of those relationships and build those relationships with the people. These are people -- big institutions, but within these institutions, there's lots of different people who are making hiring and hiring decisions. And so making sure the right bankers are aligned with the right folks at the sponsor groups to have very good dialogues in the trenches in different spaces and then making sure at a senior level that we're aligned with the senior folks, who oftentimes it's the senior folks at these private equity firms who take the big picture view and say, has Moelis & Company gotten enough of our wallet share relative to what they've given us as a firm in terms of ideas and execution, right? And so you got to have coverage in both different levels and intelligent coverage in both levels. And then you got to have great bankers. If we're not relevant in these spaces, if we're not the acts in these spaces, we're less relevant to the sponsors. And so having a mentality where we are the best bankers in the spaces and not only just great bankers in the spaces, they're also focused on the private equity universe as part of that ecosystem, that's the winning model.

And Ken has spoken a lot about how you can deliver the firm, not just at the senior MD level, but also the VP and the director level as well. Could you build those relationships across levels [ and to have the sponsors ]?

They all matter. All the touch points matter. We preach that to our juniors constantly, which is there's information to be gained. A lot of times, the associate at the private equity firm or even the company will sometimes give you an insight that shed some insight into how they're thinking about a situation, which helps inform what I do. And we try to train our bankers to keep their eyes and ears open, to build those relationships so that we're taking in as much information as possible so we can position ourselves best in the competitive dynamics, but also when we're actually working with our clients and trying to help to get deals done.

And I do want to check in with the group in the room to see if there's any questions. Maybe just a quick one before that is on your international business, you have been expanding that for some time, but the U.S. is still a majority of where your business is. What are you doing on the international side to grow?

Yes. We feel really good about as we -- as again, span the globe, feel really good about our offices all over the world. In Europe, our team there is doing a great job and working on lots of good transactions and we feel great about them. In the Middle East, excellent, excellent franchise there that I think is a market leader. And as you think about India and you think about Israel and you think about Latin America and our offices in Asia and Australia, all really, really good people, lots of continuity and lots of good traction with clients. You're right. It's still -- the U.S. is still the lion's share of our revenue and productivity just because this is where most of the deal activity is and because our businesses there are newer and our people there are less well known in the marketplace, and we have less critical mass in some of those markets. But as I think we continue to build and we're always on the lookout. We're in places like Europe and Germany and France. And then in sectors in Europe, we hired an MD in business services in Europe this year, 1 of our 2 MD hires. So especially when -- business service is a good example, we have a great business services team in the United States. And so if we can find a great business services banker in Europe, it's a double benefit. Now we're covering a space in Europe that we weren't covering a good space. Business services is typically a good space. But then when we compare that person with a great American counterpart, U.S. counterpart, there's a lot of synergy in that network collaboration. And so that's sort of the model. We've done the same in health care and in media. It works best. If we hire a banker in Europe in a space, and we don't have a strong business in that space in the United States it could still work, but the abject success are a little lower.

Perfect. I can go on. Are there any questions in the room? Great. Let's talk a little bit about talent, right? You mentioned there's a lot of internal promotes. You're growing organically. But last year, as you mentioned, the war for talent was not -- has been -- was elevated. And at the same time, it wasn't just at the MD level, but also the sub MD level. So has that changed in the current environment with activity coming down a little bit? And do you expect to hire senior talent at the same level as you did last year?

Look, we'll see this year. Obviously, we're incorporating the current environment and our thinking around how aggressive we want to be. But at the end of the day, when you see and find unique talent that fits well in your system and they're potentially interested in coming. Look, we owe it to ourselves to try to make that happen if we can do it in a way that makes sense economically. And so we'll continue to do that. We continue to build relationships and we continue to do that through all sorts of different markets because you never know when the time is right. So we hired a retail banker last year, a guy named Eric Biddle, who's doing a phenomenal job for us. We -- I think that conversation started 3 or 4 years before. We almost got close a couple of times and the time wasn't right for him, and it wasn't right for us. And then it was right. And now he's on our platform. And so there's a lot of -- sometimes these things are years in the making. And so we always want to make sure we're building relationships and are doing that at the same pace. We've always done that. And how many we actually get to the finish line this year in this kind of environment? We'll see. What definitely won't change is internal talent development. There's a great crop of people coming up over the next few years, who I think will be really great Managing Directors of the firm. Keeping those people focused and in their seat and motivated and wanting to be partners at our firm is our primary goal right now. And I think we've done a great job of that. If you take a step back, 45% or so of our MDs are internally generated MDs. I think 30%, 35% of our MDs have only been MDs for less than 3 years. And so when you look at the next few years, I love where we are because we have hungry, aggressive bankers who are going to fight tooth and nail for their clients through a more difficult environment. And I contrast that with a different model without calling out any of our competitors. I think if your model was built on the 65-year-old banker, last few years were great because they probably did a lot of deals. Are the next few years as a 65-year old banker who's made a lot of money, really going to grind it out over the next few years when it's going to be like -- get a lot more difficult? We'll see. I like our crop people in that market better than anyone else.

Great. And then I guess that brings us to the comp ratio. And I think you're pretty confident on the 59% comp ratio for this year. It's a good number in normal markets, but any puts and takes there?

No, I feel really good about that. I think absent tail cases on revenues, 59% is a very good number.

Great. And then the last question is on capital return. You did 3 special dividends last year. In 1Q, you accelerated your buybacks a little bit. How are you thinking about buybacks and capital returns?

Well, look, yes, with the overall market down and our stock under pressure like all the companies in our space, I think as we sit there, what are the principles. Principle number 1 is we're going to return all capital back to shareholders in the form of either regular dividends, special dividends or buybacks. In moments where we feel like our stock is really undervalued, we'll lean a little bit more into the buybacks as opposed to the special dividends. And so we'll see how the rest of the year plays out. But if stocks are under pressure, our stock is under pressure based on the near-term outlook. I know we feel like our long-term outlook is spectacular.

All right. Perfect. With that, we're out of time. Navid, thanks so much.

Thank you, Manan. Appreciate it.