Moelis & Company (MC) Earnings Call Transcript & Summary

Okay. So we are delighted to welcome our next speaker who is Ken Moelis, Founder, Chairman and CEO of Moelis. The firm was founded in 2007. And I think it's fair to say that Moelis has become one of the broadest independent advisors in the industry with a growing and a global footprint.

And I think I'm right in saying you've got -- is it 4 decades of experience in this business now?

Yes.

So you've seen on a lot of cycles.

That's right.

No, it's great because you've seen a lot of cycles, and that's what this conference is all about, which is where are we in the cycle and what does it mean. So maybe we can just start off with a discussion about the macro backdrop and what it means. And I appreciate -- but this is one of the more complex backdrops, just given the uncertainty around where rates are going to end up, given the uncertainty around whether or not higher rates are actually going to bring down inflation. When you're in the boardroom, what would you say is top of mind today? How have you seen that evolve? How is it different compared to other cycles? And how does it differ between sponsors and corporates? So there's kind of a lot there.

It's a lot there.

But let's talk both about the macro and then just talk about how that is performing, the dialogue and what that means?

So interestingly, you said this is more -- one of the more difficult cycles. The funny part is, it's probably one of the easier cycles, in that, I think it's very predictable. It's just going to be different than over the last 20 years. The Fed has come to the rescue. The last 2 cycles that most of us have been in '08, and '08 was terrifying when it was happening. But the Fed ultimately came to everybody's rescue and the world rebounded fairly quickly after 12 to 18 months. And COVID was -- if people forget in the 6 weeks of the beginning to COVID, if you talk about uncertainty and fear, nobody -- there was no amount of decades of experience that could tell you what was going to happen. The interesting part about this cycle is, I think it's fairly apparent what's going to happen. The trouble is, it's not going to be a self-satisfying short-term thing. And we -- life cycles have accelerated, and none of us really want to wait for the 18 months of grinding, no Fed bailout, no Fed to the rescue. I think it's just going to be a long grinding process of where interest rates have to get to their destination. I do believe -- and I've said it a year ago, that we tend to evaluate these things like the Fed as institutions, why would they do this? Are they afraid of this? If you're advising decision-makers for 40 years -- I've always remembered when you go into room that there are human beings involved. There are individuals. And there is an individual at the top of the Fed. And I always said, look, if we might think about it once a day or once a week, the Chairman of the Fed thinks about it every day. And I would think that he'd think about his place in history. And if I were he, I just wouldn't want to be that guy that unleashed inflation. I've always felt that he's going to make that decision and say, I'm not going to be that person, and I'm not -- and I'd rather err on the side of a recession. I came up in the '81 recession of Volcker, who's become world famous. It was not fun. '81-'82. I look around the room, many of you were not around. I came out of school, there were no jobs. Half my class got laid off at Drexel Burnham in '81. Nobody remembers that. They remember Paul Volcker was crushing up inflation. It was 2 years of horrific negative recession. So I do think he's going to -- I think the Fed is going to make sure that inflation is ended, and that means that we've been preparing, and we think rates -- we've always thought they probably would go to 5 or better, or higher, if not better or worse, and that it will be a very tough cycle. But it's not going to be quick. And that doesn't make it difficult to predict cycle. It makes it difficult to survive cycle.

So when you -- I can't bring that down to what it means in terms of the dialogue. I think one of the things that surprised a lot of investors is that, I think you, but also your peers, have talked about the intensity of the dialogue with strategics being pretty high over the course of this year. I mean, is that still the case today? Has that changed? Does people kind of accept that we could be in for the long haul here, in terms of actually seeing normalization of either rates or economic growth?

Yes. And the strategics, I think, are as active as they've ever been. So you don't get to stop your strategic plan and -- look at the world from health care to -- name any industry. There's -- the Board gets together and then the CEO, and they're usually in the business they have, and almost everybody now has the business they want to be in 5 years. And they're very dissimilar, whether it's industrials company trying to become a technology industrials company. Health care is as dynamic as they can be. Media, pretty dynamic as to what everybody thinks they have to accomplish. Technology has always been that way. So look, you can go sector by sector. There's almost nobody saying, hey, really love the business we're in, let's stop. Now the question is, when do we do it? How do we do it? Should we do it? What time frame? And that's -- those conversations are more active than they've ever been. And one of the reasons it's actually exciting for us is, they were actually looking for more holistic advice. They know the market. The dynamic is really is volatile, and they're used to getting their advice from very large financial advisory firms, banks and some -- and most… And they're very bifurcated. We sell equities, we sell converts, we sell loans, we do your derivative structure. And actually, when things get like this -- this is what happened for us in '09 -- is, there's a search for holistic kind of advice. Don't sell me a product, I've been told to do this by what they're perceiving to be sales organizations. I hate to say it, but that's what happens when you automate large processes. And so, it's a real opportunity. I would say, I'm spending more time in corporate boards and at very high levels around the world because people are interested in sort of, okay, bring this all together for me. I just met with somebody who's the Head of Equity Capital Markets and they want to sell a product. And that's -- I just think it's an unbelievable opportunity for independent advice right now, to not be attached to the product and to be in the room talking about very holistic... And by the way, Richard, what it goes to the point is -- and I've said to our bankers -- this is not the time to try to get a deal done on December 6, 2022. Nothing could be further from probably the right action. I mean, yes, 1 out of 20 companies might be something they have to execute on. And for strategics, capital markets are working. Rates have moved, but they're working. In leveraged finance and private equity and levered loan market, they're just not working. So it's an unbelievable time to build backlog and loyalty, transparency, wisdom. But if you're selling a product right now, you're going to hurt your organization, and I think that's almost our benefit.

So let me ask you kind of a 2-part question, which is, what do you think it takes to catalyze the M&A market higher? Is it just certainty over where rates are going to go? Is it a reduction in volatility? And what -- and I guess conversely against that, what is the probability from your perspective that M&A could reset lower next year relative to the current run rate, which I guess is down, let's call it, 35% to 40%?

Lower than this year?

Well, lower than the -- let's call it, the Q4 run rate.

It's going to be hard to be lower than the Q4 run rate in terms of completion, I think.

That's good news.

Yes, it's good news and bad. But look, I do think a lot of this is getting to the destination. People can make decisions off of a level that they understand. So if the Fed gets to 5% or if they get to 6%, the ultimate result of that is probably that transaction that was done at 20x EBITDA with 5x leverage at a 5% cost of capital is going to have to get done at 10x EBITDA at a 10% interest rate and 3x the leverage, and that's what will happen. The world -- nobody is going to sit in a corner hoping for yesterday. That's not a strategy to be, continue the leadership of your company to grow -- to get to the business you want to be. As I said, everybody has the business they're in, the business they want to be. And by the way, PE has the money they have and the returns they want to generate, and they have to do that. So I think, yes, it's get to the destination, get some predictability. If I was a young Managing Director at a PE shop, I'm not sure I'd walk in the room of my boss and say on December 6th, I got a great idea, let's buy something at the old valuation where we can to get the money. It's just not a great time. But once you know what it is and you can pro forma out, a lot of these deals just -- can you pro forma the return based on the cost, based on the price, based on the exit multiple, based on what you can do. And lastly -- so the strategics will be doing that. I think it's just a matter of getting to a period where, when you present to the Board, when you present your idea, you have some semblance of understanding where the confidence that, okay, this is -- the Fed is not going at 8%, they stop at 6%, maybe not the optimal number, maybe they stop at 5%, but knowing where you are, what the alternatives are, what the right pricing is and what the financing market is. And I think things will go back to transacting. I don't know why they wouldn't go back. The world is pretty large. The flow of capital changes. Like right now, the amount of capital coming out of the Middle East and the Energy, positive, it's changed the balance of where money is coming from. It's changing dramatically, which is an opportunity for all of us to redirect relationships and help people find the new capital. That's part of our job. So -- and lastly, PE is going to continue to expand. I think, again, just going through cycles -- when I was in the '90s, PE rose to prominence. It was all about financial engineering, buy something at 7x EBITDA and leverage at 6x. In the 2000s, everybody started to portray their operational expertise, all these experts and operational partners. I think you could find a time where the relative PE deal is a lower levered deal. It's 2x to 3x pools of capital outsourced. I think outsourcing volatility is a big part of that. People do not want -- I'm on one big university board. And when the endowment comes in, the last thing you want to see is up -- it's just discomforting to see up and down. I see everybody -- kind of wins when products are up and down. And if private equity, you can use your own non-euphemism, but I'll say smooth it out, whatever you want to say. I call it volatility outsourcing. I think people like that, and they're going to pay for it and they'll give it to them. And by the way, also the governance aspects of public companies right now are very distracting between, say, on pay, ESG and all that stuff. I think it's very distracting. And I think the PE firms are going to be dominant on capital allocation and governance in that respect for the freedom they have to make the decisions they make. And therefore, I could see the whole thing shifting to 2 to 3x leverage and just putting up more equity capital, lowering the volatility, changing the rate of return, nobody likes financial engineering anyway and a lot of money going into PE on that basis.

So maybe in terms of some of the geographies you operate in, you performed really well in the first half of the year and since slowed. Maybe just talk about your expectations for Europe and the U.S. next year?

Europe?

Europe and the U.S. next year, and the differences between them?

Interesting for us, and it might be where we are in the life cycle of developing a company. We've had a tremendous year in Europe. Now it is very tough for a new firm. We're 15 years old. Every firm that's ever gone outside their home country claims the other country is inhospitable. Americans do it about every other country, and then we don't realize that no British company has ever made it here. They all had great franchises there for years, and we didn't accept it. It's very tough to get it right. So maybe it's taken us this long, and just -- we have a good franchise there now and good people on the ground. But -- so it could be just that it happened at the right time. I suspect that Europe and the United States will be in a very similar tough cycle. We just might be small enough in Europe that we're outperforming our footprint. But Europe is going to have a tough time in 2023. And never bet against the United States. It's just an amazing economy for creativity, finding its way out. I think -- I'd say, I used to look at the financial markets and say, the first companies in every cycle I've ever been -- and we're homebuilders. That's how you knew the cycle was starting. It was the most significant financed large purchase. So it always got hit first. And then I realized, well, in the last few years, we've created a larger, more sophisticated public company called M&A Boutiques, and that's actually a bigger purchase. And so, we started feeling this. The financial markets are good at discounting and looking out to the future. So we've been in this for, I think, 3 quarters now, where our customers said, hey, I'm going to be careful. I think the homebuyers were like 3 months lagging on us because we're supposed to have the smarter finance people. So I wonder -- we might have a very tough 2023, and I think we will for the consumer, for the general economy, for interest rates. But the interesting part will be, when the financial markets discount the 9 months out, when -- like in COVID -- I think we got on a call in our June conference call of 2020 and said, we saw M&A springing back. We got yelled at by all these, we don't see it.. We said we saw it in the -- We saw it because we're starting that deal flow way before. And private equity did move early in the COVID cycle. And they saw the Fed move and they moved and they got going, and all of a sudden, we had 18 months. We're not there yet. I'm not saying -- that's not what I'm saying right now. But how far in advance of the end -- once the Fed hits its destination, how far advanced will financial markets try to look over the hill is interesting. And there's a lot of money out there. There's a lot of strategics that want to get things done. And so, I don't know that we'll be in the same cycle as what I think the general economy will be in.

And just as a follow-on to Europe versus the U.S. There's been this very significant appreciation of the U.S. dollar relative to pretty much every other currency in the world, but specifically, against the euro and against the pound. Is that starting to become a source of strategic dialogue for corporates? Or do they look at that and say, look, this is just a point in time, this isn't something that's going to catalyze the transaction?

A little of both. Remember, there's been some big -- I mean, the pound almost hit 1 on 1 at one point, and now I think it's 1:2 again. It's come back a long way. The U.K. market has -- we've been screening it as the cheapest market in the world on every metric. And yes, there were -- by the way, there were some cross-border stuff that happened. There were significant deals in defense. I remember there were a couple of large transactions. Right now, there's just such a bias to non-movement that I'd say that -- there's a conversation about lots of things. Most of it is not driven by currency, by the way, because, if you're going to buy over there, you're going to get your revenues over in that currency, and now the translation is going to be a headwind for a lot of people. The U.S. dollar though -- when you talk about some of the economies, I've talked to some -- like the India CEOs, U.S. dollar is a big problem for a lot of these countries. I mean, they are not -- they are getting hurt significantly by the strength of the dollar. I think it's something we don't realize, but it's going to hurt their economies pretty badly.

When you -- there's obviously a lot of news about hung deals in the market, the very biggest transactions. Maybe you can just talk about how functional the mid-cap part of the market is relative to large caps, and how available financing is in that part of the market?

Pretty much non-functional. It's -- well, when I say non-functional. If you're willing to go into the low double digits -- it's not to say that there might not be a 2x bank credit for a middle market, strong healthcare. There are some industries that are still getting 2 to 3x regular-way bank debt. But you don't want to be out there right now. And that's our basic advice to people, is, you might want to prepare, you might want to think about it. The first of the year is usually a moment where a lot of people rethink their capital allocation. People go from, I don't want to lose any more money to, I'd like to figure out how to make some money. So there is a change in mindset. A lot of people in this room probably go through that. But for right now, I'd almost call that broad middle market. It's just dysfunctional. That doesn't mean you can't figure out how to pay a significant amount of money to get something done, but it's pretty frozen.

What do you think it takes for those financing markets to reopen? And let me ask a linked question which is, when you look at what's happened with some of these hung deals and where they've got priced, what does that tell you about what these financing markets will look like when they reopen?

They're going to -- I think we're in a permanent -- So we did a pretty -- I call it back of the envelope, but it was more than that. It was $5 trillion or $6 trillion in the leveraged loan market. We think if the Fed gets to 5% and you assume a 15% squeeze on margin, that half of that levered loan market goes to under 1x coverage. That doesn't mean they default. That's not saying half default. So what's going to happen is -- there's just a lot of deals out there that are levered 5x. And by the way, the companies might be doing fine. But when they get to their refinance wall, which really -- a lot of maturities don't hit to 2024 -- you're going to have to figure out how you fit 5x into 3x. And that's going to be gigantic. That's going to involve a lot of people, money and time to figure that out because, these are good companies. The companies are actually -- a lot of those companies are going to be hitting their standard projection, and people want to defend the valuation, but they're going to have to figure out a way to get 5x down to 3x.

So I think that's a good segue to talk about the restructuring business. So maybe you can talk about what you've seen in that business over the last 3 months. Is it still predominantly liability mandates? Or are you starting to see more traditional restructuring mandates? And as you think about '23, I mean, how much of an uplift in that business do you think you could see relative to this year?

It's going to happen. It's not going to be -- again, it's interesting, '08, I described it as like, you call it the fire department. You were in trouble, same [ until ] - My phone was ringing literally at 2:00 in the morning. People who thought they were solvent in the morning were insolvent like in a day. That's not this market. This is a long grinding -- look, the good and bad of it is, we won't -- by the way, we've gotten pretty active in the crypto space. So that was one fire alarm market that I think that was very, very unique. We've gotten a bunch of crypto assignments. But I think this will be a -- just a long -- good news, probably long investable 24 to 36 months advisory, get people out of -- I don't see it being a red alarm. No, the first quarter of 2023, I don't see this -- like COVID-like spike to replace M&A. But I think it will be like this. And I think M&A will be like -- I think they'll both recover, but it will be a long investable market, I think.

And just kind of another follow-on, which is, obviously, a lot of the lending that was done in -- I know loan market was covenant-lite. How does that impact the timing of this restructuring cycle?

It means that the maturity wall is more significant. I think you're not going to find people - now -- and the maturity wall starts to hit in '24, '25. But just remember, auditors, it often starts a year ahead because you have to -- some auditor might say, well, in this market, you can't refinance that, so we can't give you an opinion -- a going concern opinion. So you'll probably see these -- the pressure will build a year in advance of the maturity wall as people have to have going concern and prove their ability to refinance. So I think it will start earlier than people think. And if you're doing good advice, you'd be telling people, get ahead of this. Just -- it would probably be just more -- just tell them 6 months ago to get ahead of it, but people tend to kick the can down the road and this might not be a kick the can market.

And does the covenant-lite structure mean that debtor side mandates pick up faster than the creditor side? Because I know you do did both.

You probably get hired first by companies because you have more time to control the situation. In like the COVID market, both sides engaged immediately because it was default, and you had to sit down. Right now, the creditor is in charge of their capitalization, and the sooner that they take control of the information and the more active they get, the better they're going to do. It's never good when the other side has a gun. Covenants give you a gun -- a loaded gun. And so, you can force the conversation. It's a good time for us to be -- And by the way, the whole model for pitching and getting assigned, restructuring is going to change because, again, in '08 and in COVID, your phone rang. And it almost became a capacity issue. And today, I think the right thing is to be out there talking to companies who don't realize that 18 months from now, they have a problem, and they're not thinking about it as actively as they could be. So it's a good time to be out in the market talking to people.

Maybe another one on restructuring, which is just -- I think it's a bit of a black box to investors. There's not much public data. Maybe you can just talk about what differentiates your restructuring practice from the landscape?

I'd say there are 2 things. First of all, we like to think -- a lot of restructuring practice, it actually used to be called bankruptcy practice. Then we were all smart. That's not that we really want to hire the bankruptcy. So we became liability management. We almost started -- my background with Drexel Burnham in the 80s and DLJ in the 90s, and exchange offers were the way to kind of roll debt and doing public -- we kind of almost invented that in the late 80s to just exchange one piece for the -- using market forces arbitrage and markets. And I still think that there's a lot of firms that are existentially bankruptcy firms. It's just more comfortable. When you're in bankruptcy, it becomes more legal and more time and responsibility. Liability management is definitely more, think on your feet. It's an integration of arbitrage, capital markets. A lot of -- it's a lot different. And most -- and I know the PE firms definitely. You don't want to go bankrupt. Bankruptcy doesn't be good for the equity ever, no matter what the pitch is. It's very rare that you come out of bankruptcy with great equity value. We think we're better at that. We have like -- we keep track of it. Like 70% of our advisory does not result in a bankruptcy. We think that's a good thing. And then last I'll just say, we don't have a commission structure at the firm. And what you don't realize is that there's a bankruptcy group, and if they're on commission and there's an M&A group and they're under a commission -- The M&A group has been feasting for 5 years, big bone, everything's going their way. Then all of a sudden, you have like -- let's say, crypto happens. And the bankruptcy guys have a shot at it. They really don't want to bring the M&A guy in. I mean the minute you say, hey, Richard, let's go pitch together, I cut my fee 50-50 with you, you actually make a deal before you go in the room. And so you'll find some of the bankruptcy firm -- those practices that are standalone -- attempt to do these things on their own. And look, we kill people if they do that. We truly don't like that. And even on the crypto, we combined our FIG group and our crypto people with the restructuring, and I think that's why we were effective. We went in the room -- I think if our restructuring people had gone in, they wouldn't have understood the technology and what's going on and then it's... So look, this idea of being able -- we might have 80 people -- 75, 80 people dedicated, call it restructuring around the world, but I know we can move 300 or 400 people. My founding partner, Navid, runs technology. He was [indiscernible]. He is back to deals. He's done more restructuring -- the number of structuring with bankers. And so it's easy as some of these media companies are restructuring -- some of them are public, I won't mention -- but it's easy for us to put 300 or 400 people on the ground doing it and merge them, and they'll be effective teams right away, and they won't be fighting with each other. That's going to be very effective as it gets to be a significant line item.

So we just think about your private funds businesses. Could you just talk about the challenges that those businesses are facing in this environment, and whether this backdrop changes the growth outlook for those over the longer term?

The PE firms?

Your private funds business, your secondary business, primary?

Again, if I were -- it's funny, we were talking about how we describe the market, and I'd say it's between bad and very bad right now, if you're trying to produce a revenue tomorrow. In some sense, for us, I think, very bad would be a better long-term generator. It won't be fun, but it would be a better generator of disarray in some of the larger companies that I know are not natural holders of investment bankers. There's some significant companies out there that make a lot more money on checking accounts and credit cards and branch offices. And I think, to get through this cycle and hold on to your talent, is going to be the key to the whole event. And I don't -- again, I don't know if it's -- again, because financial markets, I think, will precede the economy and coming back, trying to guess where the future is. But the goal right now is to just make it through this part of the economy, retain as -- retain all the talent you can that you think is valuable. And I think it will be a very big growth time, and I can't predict if that's 1 year from now, 2 years from now or 3 years. I don't think it will even be 3. But it's a very active world. And people have gotten used to M&A to execute. M&A is a big -- it's not a, maybe we'll do M&A. I think in every boardroom they're talking about M&A or divestitures or spin-offs. And private funds group will be a big part of that, and we're investing in that because I do think PE wants to retain their AUM, and the private funds advisory group right now is not about primary fundraising. It's really about continuation funds and technology to retain capital. So all that's going to be -- we're investing heavily in tech, health care, PFA, and we anticipate if we had the opportunity, we'll continue to hire.

We have a few minutes left. So maybe we can talk a little bit about comp ratios and efficiency ratios and how you're thinking about those. And obviously, look, I appreciate, it's an uncertain revenue backdrop. But have your expectations for the comp ratio changed at all as you think about this year? And how do you balance, frankly, the need to continue investing in the firm versus the need to deliver acceptable efficiency ratios for shareholders?

It was a lot of discussion. So we lifted to 62% for the year. We anticipated a bad fourth quarter when we did that, or a continuation of the -- let's say, the continuation of at least the dynamics of the third, and the fourth is not -- let's say, they've not surprised us to the upside. And so, I think we feel like we're in the -- I think we feel good about where we are. There's going to be a tremendous amount of decisions made in the next 2 or 3 months about inflation because it's 80% -- look, our managing directors -- I'd rather know that it's going to be a very difficult year. It's interesting that the rest of the firm, the 85% that's below that, that underwent significant inflation or compensation increases. We'll see what happens with them because right now -- and I don't blame everybody. We love that. We work so hard to keep this talent. We like the talent we have. We like 75%, 80%, whatever. We like the majority of the talent we have. And it's impossible to get it back. So I think everybody is going to the end of the year trying to figure out how much protection can you give, and that goes through the cycle. So somebody even asked me, if '23 is as bad as '22, then what happens to the comp ratio? And I said, well, I just can't believe everybody is going to be able to withstand that inflation for another year. Right now, we're all -- hey, we just fought like crazy to keep our talent through 2022. The first half of 2022, we are actually excited about it. I will tell you the way we think about it also. We're in front of a lot of great clients that are long lead time, especially the strategics. You don't get to say, hey, I know you want me to do your -- this analysis for you, but we just had to fire half your team. We'll be back to you in 2024. That's not going to work. So the real question we ask ourselves is, okay, how much do we have to invest through this cycle to maintain that asset. And if we were an oil and gas company, it would be how much capital do you put up to get a well out in 5 to 7 years, ours goes right through the comp line. So that's the question. And the moving parts are going to be how disciplined is everybody on that part of their workforce that got extraordinary pay in the last 2 years. And so, those are going to be the moving pieces. I think people will be a little more disciplined than they're saying right now because people are waiting to the bonus pool. But it will all be determined then, and we've got -- and we're going to have to make that decision. Look, I still own a large part of the company, our employees own a large part of the company, and the key will be to balance that so that it's the right decision for the stockholder of the company, and that's hard to explain to everybody, but -- and it's very, very difficult decisions.

Do you think that the recruitment environment next year is going to be better for you? I mean, because everybody is obviously going through the same issue. In terms of compensation levels, there's obviously going to be a level setting this year. I'm sure there'll be a lot of very disappointed people. Do you think that will translate into a better recruitment market for you next year? And do you intend to capitalize on that?

Yes, I think we will. And the answer is because, no matter how strong you are, if you're a large financial institution, I'd say you're still levered 8, 9 or 10 to 1. We're not -- I mean, the biggest banks have 12%, 13% capital or something. So basically, you're 8 to 1 levered in a market where I can't think of any asset I'd have owned a year ago, 8 to 1 lever. That may be energy, and I know most of the banks pulled out of energy with all their wisdom of what's going to happen. They pulled out. So I think we have no debt. You wait a long time and sit there with a completely debt-free capitalization. We have excess capital. We're mostly variable costs, no matter how much you yell at us about what -- ratios will do mid-low-20s pre-tax margin. It's not a bad business for a downturn. And if we can, we'll invest. And if we see the right talent, I think we're going to -- we will pull the trigger and we'll invest, and we think we've been preparing for this.

Okay. I think with that, we're actually out of time. So, Ken, thank you very much for joining us. Hopefully, you can join us again next year, and it'd be more of an upbeat kind of environment. Thank you.

Thank you.

Thank you very much.