Moelis & Company (MC) Earnings Call Transcript & Summary

Before we begin, for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. The use of photography or recording devices is not permitted. If you have any questions, please reach out to your Morgan Stanley sales representative. We are pleased to have with us Navid Mahmoodzadegan, Co-President and Founding Partner of Moelis & Co. Navid, thanks for joining us.

Great to be here, [ Devin. ] Thanks for having me.

So let's start off with the M&A environment. It's clearly been challenging over the last 1.5 years. Can you update us on what you're seeing in the second quarter?

Sure. Well, you're right. It's been really since early last year, the start of the war really was sort of a turning point when the M&A market got more challenging and with rate hikes and inflation and concerns about the macro economy, it's definitely M&A volumes have dropped off considerably. I think year-to-date, volumes are down 30%, 40%, 50% depending upon if you're looking at announced deals or completed deals. I do think things feel a little better here recently. I don't want to predict that we've turned the corner. There's been other moments over the course of the last year where you could look at a period of time and say things feel better only to then be surprised by a regional bank crisis or something else that things sideways again. But look, we continue to remain optimistic. I don't know when the M&A market will fully return. I do know there are still massive demand for M&A from the private equity community from the corporate community. There are many reasons why transactional activity will return and will return, I think, in a major way, what's difficult to predict is whether that's going to happen now, a couple of quarters from now or even further out. But I do think it will return, and most importantly, we're positioning our firm for a big return.

And on the April earnings call, Ken mentioned the pipeline was down around 20%. Now that we're a couple of months past that point. Do you have any update to share on how pipeline has evolved?

I don't have an official update. I will say things feel better. So I think whatever the numbers were a couple of months ago, if we looked at them today, I think they would be better than they were a couple of months ago. But again, I don't necessarily want to say that's a straight line up from here. But I think we're remaining optimistic. We are in front of clients. Our clients are expressing an interest to transact. The question is going to be when the environment really promotes and allows transactions that need to happen to get to the finish line.

Just a follow-up on when you say things feel better. What's really driving that? And maybe you could share some color on the conversations you're having there.

Sure. Well, look, we're a couple of months removed from the last crisis, the regional banking crisis. So that helps. That certainly helped the credit markets, credit spreads have improved since then. I think there's a hope that maybe we're near the end, if not at the end of the cycle of rate hikes I think there's a view, an increasing view that while we may technically head into a recession, it's not going to be a really bad recession. Well, I mean a really bad recession, 1 that's signified by massive unemployment and a major turns down in the economy. Again, we'll see what happens. But I think that's the view. I think you're starting to see the IPO markets start to open up or some companies hitting the IPO market and maybe some to follow. And obviously, the equity markets are up 20% this year. So again, I don't -- I'm not predicting that it's over and everything is going to be great from here on out. Who knows what works around the corner. And certainly, there's possibilities of other things happening that make this conversation more challenging or the outlook more challenging. But you asked the question, do I feel a little better today than I did 2 months ago? The answer is probably yes.

And on what's getting CEO confidence a little bit higher? Do you feel like the biggest catalyst might be the S&P now in a bull market? Or is it more about rate levels...

I think when you talk about CEOs and corporates, I think so much of it is economic outlook. The stock market is a reflection of people's view on where the economy is headed. But I think when there's just lots of macro uncertainty, it's hard to get in front of your board and pound the table on a big M&A deal. It's hard when the regulatory environment is murky too. And I don't -- that's a headwind that is there and may not dissipate until the next election, we'll see. But I think the macro -- when you were talking about corporate M&A, strategic M&A, macro is critical. When you pivot to sponsors financing costs, obviously, are a critical factor, and we saw over the last year, a pretty big increase of financing costs, which takes time for the market to digest.

On the -- let's dig into the macro a little bit, and then we'll go to financing costs. On the macro side, investors are thinking through a really wide range of economic outcomes. One would be higher rates for longer with a soft landing and other would be recession that maybe comes with freight cuts. Which of those 2 outcomes do you think is better for M&A activity?

Look, I think stability -- M&A needs stability. And so I can't remember which of your things is more of the stable view, but I think -- look, I think higher is okay as long as kind of it's within a -- rates are within a band and spreads are within a band. I think that's okay. I think a soft landing is clearly preferable to something that's more dramatic. And so that kind of environment feels to me like conducive to a quicker return to the M&A market.

Then let's talk about the financing side that you mentioned which is more important for the sponsor group. Fundraising activity is light, but on the other hand, this group needs to put capital to use over time. It's their business model. What do you think will get things going with sponsors and how big of a drag is this tighter financing environment?

Yes. Again, I want to -- on the question of the fundraising environment is clearly harder, but these firms have still raise massive amounts of money and are still raising massive amounts. So yes, if you talk to any sponsor, they'll say it's harder to get money out of LPs, et cetera. But that just means some firms that wanted to raise $20 billion are raising $16 billion. It's still kept in perspective. These are still massive pools of money that they're raising not just across private equity strategies, but across [ dried ] ops strategies, core strategies, direct lending strategies. And so when you look at the whole gamut of pools of money that alternative investment managers have to facilitate deals, it's massive, it's growing and it's here to stay. So -- but what all the sponsors want and they're hearing it from their LPs is they want distributions. And the only way to get distributions or for transactions to happen, i.e., selling portfolio companies, recapping portfolio companies, doing creative financings around those, putting them into continuation funds. And those are all areas where we play. And that's why I'm really optimistic that sponsors are going to continue to drive a big upturn in M&A volumes eventually once kind of the macro and the rate things settle, because they're in the business of doing deals. They're in the business of putting money to work, and they're in the business of returning money to their LPs, all of which needs to happen. And our firm is very well positioned to take advantage.

When you say you eventually think through worst case outcome, maybe we have more macro volatility, financing gets even tighter, how long can this group stay, that could it be 3 years? Or is that...

No, I don't think so. I don't think so. I do think, look, 1 of the exercises sponsors go through, others go through is when there's a big move in rates or a big move in the macro environment or in the stock market, it takes some time to kind of reset your expectations of what your portfolio company is worth. You may have marks that you've communicated to LPs. So it's not unusual for people to say, well, let me see, is this downturn -- upturn in rates or downturn in the economy or a downturn in sentiment? Is that temporary? Or is that going to last for a while? I think if it becomes something that's going to last for a while, I do think the pressure to get money back, the pressure to put more money to work and raise money, but you only do that if you get money back to LPs is you can't sit around forever. You can't hold these assets forever. And so I think it does take time for expectations to resettle and recalibrate, but that will eventually happen.

When you think about the bid-ask spread and valuations, how narrow is that gap relative to a difference? And do you see that quickly narrowing? Or is that still an issue?

It just depends on the company. And again, there is -- and again, I don't want to -- there's no activity. There is activity happening. I think right now, most of the activity we see is sort of, of the highest quality companies within the sponsor portfolios, the companies where they sit, the sector they're in, the management team, the performance even through some of the uncertainty will still allow the sponsor to still exit at a really good outcome. And so we are seeing some activity along those lines. And sometimes those processes are a little different. It's not let's go run a big long drawn-out auction because there's some risk around completion. And so having more bespoke, tailored conversations, targeted conversations, creative conversations is kind of more of what we're seeing.

On the corporate side, how big of an impact of tighter financing there?

Look, it has some impact. But look, a lot of corporates, it's not just about financing costs. They have plenty of access to capital, whether they're investment grade or using their stock. And so it's less sensitive to the LBO math that you'll see for a sponsor. For corporates, it's really more about, is this the right time to do it given some of the uncertainties and I get it through regulatory. Is this the right deal to do given what's happening in the strategic landscape. If I don't do it now, well, 1 of my competitors do this deal, and I'll lose it. And so maybe that's moving up my time line because I worried competitor X is going to buy this company unless I get to it.Those factors tend to weigh in a lot more than incremental cost of financing.

Is there anything you're seeing on the structure of transactions that can maybe be more creative in getting them to the finish line?

Yes, more -- as I said, more bespoke, more creative, a lot of times, bringing in people who you know that -- where you can kind of sit down and have a really creative conversation around a win-win transaction. And again, we're in the middle of a lot of those kinds of conversations because we're not in a market where you can run an auction and have certainty that a deal is going to get done, right? And so nobody likes to put an asset on the market and have risk of failure. And so a quieter targeted creative conversation to see if you can get something done in a tougher environment has been much more relevant over the last 12 to 18 months.

What about corporate cash levels? How are they holding up? And how are corporate thinking through the right level of cash and whether they tap into that to maybe...

Look, I think with corporates, there's always kind of the debate about dividend, share buybacks and M&A, right? And I think it's less than of having the availability of cash because corporate profits have still been pretty good. It's about what's the best way to deploy that cash, right, along a spectrum of those things. And I think a lot just depends on the sector, the space, what's happening from a technological perspective? And where is your stock price? Is there more of a -- or a better return to buy your stock back, given what you know about your company and assets versus embarking on M&A, which inherently has some risks.

Right. Let's talk about your technology investment banking expansion. You recently made some hires there. Can you give us some color on how it's going, what some of the rationale there was?

Sure. Look, we've been in the technology business for a while, but I think we've always felt that we were underweight the opportunity, the tech investment banking opportunity, especially in software is massive. And we, unfortunately, despite our best efforts, just didn't have the critical mass. We had some very, very good people, but not enough of them. And we -- despite our really rapid growth since we started the company, have missed out and haven't gotten our fair share historically of maybe the most important fee pool and investment banking, which has always been something we wanted to rectify. So this team was a team that we had gotten to know 4, 5 years ago. They were at UBS. We tried to hire them a couple of different times when they were UBS and couldn't get there. But that was the process where we started to get to know each other. They learned about our culture. They got to meet a bunch of us. We likewise got to know them. And I always felt that this was the perfect fit for us. Culturally, the way they approach the market. Interestingly enough, that team is very sponsor-focused and our existing technology team was more corporate focused. When you looked at the spaces within technology, there was almost no overlap. They were heavy in software and in ad tech and digital infrastructure and payments, and we were in comms equipment and some other areas that were in digital media. And so when you put it together, it was almost a beautiful complementary fit of rounding out our sectors and covering not just companies, but sponsors. As I mentioned, we got to know them when they were about to go to -- they ended up going to Silicon Valley Bank to do an entrepreneurial thing, and we tried to get them then too. They decided to do that much to our consternation, but we stayed in touch. And when Silicon Valley Bank collapsed as quickly as it did, we moved in very aggressively. Again, we knew them, which helped a lot. They knew us. They had other opportunities, but we quickly were able to come together and not just hire 11 MDs and 35 people, but the beauty of it was if we went to another firm right now and hired 11 MDs and 35 people, I guarantee there'd be lawsuits and we'd be spending the next 2 years dealing with that. But because of the special circumstances around what was going on in SVB and the bankruptcy, we were able to reach a mutually agreeable settlement with them that released everybody from any threat of litigation and enabled us to get our -- the bankers. I mean, they literally -- most of them were working at SVB and a week later with our firm. So there was no discontinuity with clients. When we go hire bankers from other firms, they almost always have 60, 90, 120, 180-day notice provisions and non-solicitation provisions, these bankers were able to literally not lose any contact with our clients and start on our platform. And there was a bunch of mandates that they were working on, and we came to an acceptable -- mutually acceptable arrangement around how we were going to split some of those fees. So very unusual for -- to be able to hire that many bankers without upfront consideration with no threat or lawsuits and to collect fees right away, and to not have them lose touch with our clients. So really unique situation. We're incredibly excited about the team. They've hit the ground running. They're fitting in beautifully with the company. And our existing pack bankers are super excited about the scale and connectivity and leadership that, that group is bringing. So it's -- I think it's going to be a home run for us.

Great. And just as a follow-up on hitting the ground running, collecting fees right away. Are these bankers fully ramped day 1? And how does that compare to how long it typically takes to ramp up?

Well, the ramp-up is much faster. And again, they didn't -- they're pretty -- they're not fully ramped up at -- well, they're just getting to know the other bankers and the product bankers and our M&A people and our capital markets people. And so there is getting to know the firm and getting settled, but the good news is they've never lost touch with their clients. And so there wasn't a period where they had to call their clients and say, "Hey, I'm going to another firm, I can't talk to you for 6 months, I'll call you 6 months in a day". That didn't happen. And so I think their ability to continue to compete unhindered is great. There's been amazing reception from clients that they've gotten that we've gotten. The number of e-mails and texts, I got, saying, congratulations, that's a phenomenal team, it was overwhelming. And -- and yes, look, it's not -- it's still -- we're still in a tough market, right? So I don't want to suggest the tech M&A market is booming right now. It's still a tough market, but I feel really good about how they've integrated and they're off to the races.

When you typically do a hire, is it that 6-month period after this phone call where you start to see this the ramp accelerate? Or is it...

Yes. I think what we typically say is look, it takes a number of months for them to get to the firm. And then it takes 12, 18, 24 months for them to get up and running, introduce their clients to our platform, get some deals signed up, get deals closed, it takes a while. And so we've been able to substantially accelerate that with this group. And look, it's not the only hiring we're doing. We -- over the last year, we had 30 new MDs, 8 of those internal promotes, which is a pretty typical amount for us, but 22 of them, so half of the 22 came from SVB, half came from other places. They've helped to fill out important positions in health care and health care services, in private funds advisory and capital markets in Europe. And so we're really excited about that group as well, industrials, we hired a banker from Credit Suisse. We have more announcements coming. And we're really excited about. Look, we -- for those of you who don't know us, I think we've been saying for years now, and people say, well, why don't you have any debt? Why do you keep the balance sheet so clean? Why aren't you doing more of this and more of that? And we've always said, we want to keep the company flexible, you want to keep resources and powder dry because there will be a downturn at some point. There will be a dislocation at some point. And just like in the financial crisis, we see those opportunities as the opportunities to really hire the best talent consistent with our culture, be aggressive when others are retreating, be kind of go for it when there is chaos. And this is a perfect example of why we've kept our powder dry to be able to be aggressive. And the SVP team is sort of a perfect example of that, but it's not the only example of that, and we continue to be aggressive, again, for the best bankers and just as importantly consistent with our culture. We want to be part of what we're all about.

So I have a few more questions on the environment. But before we get to that, this is a good segue into talking about expenses since we're discussing hiring. So in April, the firm guided to an 80% comp ratio for the full year. Can you give some color on how you're managing comps? How much contribution to comp these new hires are contributing to? And at what point do you start controlling comp more aggressively and just not let it be as much of an output?

Sure. I mean, look, what we didn't want to do, I just mentioned that we kept the powder dry to be able to go on offense. Well, if you're in a tough revenue environment, what you don't want to do is then have an unnatural barrier, which is compensation ratio to then limit your ability to go on offense, right? You've had all this flexibility, you wanting on offense, all the value creation opportunity. You don't want to let comp ratio, which we take seriously. We always take it very seriously. It's part of our thing with our investors that we're not going to be -- we're going to be shareholder-friendly when it comes to compensation ratio. But you can't do that when you see this massive growth opportunity in front of you in a tough environment. And so what we said is for a period of time, we gave a target for a period of time, we're going to focus on growth. We need to continue to barely pay our existing talent, right, at the junior levels, at the mid levels, at the partner level, especially the people are producing, it would be self-defeating to not pay those people who've been doing a great job on our platform and continue to do a great job. And so that all means in a tougher revenue environment that you can't keep the 60% and not do damage to the firm. And so we've set for a period of time, we're going to transition. Our goal is to get back to that once our new hires ramp and once the market improves, and that's the goal.

And is the hiring a significant contribution to the 80%...

It's a combination of hiring and revenue.

Yes. Got it. So is there any point where you start controlling comp more aggressively relative to ratio or...

Yes. As I said, my expectation is that the return on the investments we're making and the return of the market will solve the comp ratio together. That's what should happen. Again, it -- when does it happen? I -- we'll see. But that's -- we can -- I can clearly see the most likely scenario in my view is that, that happens, where our existing talent feels like they've gotten paid well and fairly through the investment period because look, what you can't do is state your existing talent, "Hey, we're going to cut you back so we can invest in these people, right?" Both sets of people need to feel good about that, and our shareholders need to feel good about that. And so what we're trying to do is balance all 3 of those constituencies and kind of bridge us through a period where we can get back to the kinds of ratios that we've historically operated under, which we think are fair ratios of the bankers relative to our investors. Does that make sense?

Yes. No, that's very helpful color. On the non-comp side, are you still comfortable with the $40 million quarter-on-quarter...

Yes, we are. We are. Yes, we are. Maybe over time, that ticks up a little bit with headcount, right? But I think for now, we feel pretty good about that.

Great. Let's flip back a little bit to the strategy. So we talked about leaning into investment banking, technology sector. Are there any other sectors that you're maybe beginning conversations with and winning clean and more on?

Yes. I mean, look, there are other spaces, health care, you can never have enough great health care bankers. So we're always talking to people in that space. We're always talking to people in a lot of these spaces, there's tech elements and technology changes that are happening and new crops of companies that impact certain spaces, that's foreshadowing. I think a set of hiring, we're going to be announcing soon. There's talent in Europe that we're always looking to add there, more critical mass in Europe is good and especially in some countries. And look, even in spaces that are really built out, we just added to our media team in sports, for instance. Sports is an area that we're doing a lot of work in that we're very focused on. We see a massive opportunity there and already doing a lot. So we hired an MD to help elevate our sports franchise recently, private funds advisory, capital markets. So we're making investments across the board. Again, in -- I think in all of these areas, these are fee pools that are important, they're growing, and we're hiring talent that I think is going to be highly productive.

And what about the outlook for the different sectors? Are there any of that? Do you see a rebound in M&A happening more quickly?

Look, we can go through them all. I still think that the spaces that have been good spaces where there's dynamic growth and tech, health care, media, lodging, leisure, those kind of areas, I think, are going to be big. Obviously, AI is something everybody is talking about. We'll see where the investment -- the revenue opportunity is in terms of banking some of those companies. I think AI has an interesting opportunity for companies like us on the cost side. Too early to say what that means. But I do think there are scenarios where we can use AI to be more efficient in terms of our delivery of the best service to our clients.

What about the regulatory environment? Is that impacting any...

Yes.

Sectors more than others? I mean we all know that it's tough right now. Where is the biggest headwind?

The regulatory focus seems to be mostly tech, health care, right? There's lots of deals that you all know about in those spaces that seem to be getting most of the attention to the regulators. But it's not just there. I mean look, it's -- and it's not just the deals you read about, it's not just Microsoft, Activision or Illumina that are obviously right in the crosshairs of the regulators. But now every conversation you have where there's even a remote risk of a regulatory issue. It starts to impact the conversations and the likelihood of getting transactions done because if a deal has a 10% chance of getting in the regulatory crosshairs and it getting blocked or challenged, then we now need to have a conversation about risk sharing and who bears the brunt of that? And what do this side need to do versus this side need to do to remedy that and pay breakup fees? It introduces a whole -- a whole set of issues and conversations, which you have to deal with, which you may or may not get through in order to get a deal to the finish line. So it has a chilling effect not just on the deals you read about it. It has a chilling effect on the deals that people don't even attempt because there's a high likelihood they're going to get challenged. And then it even has a chilling effect on the margin on deals that have a low likelihood of getting challenge, but you have to deal with a set of issues that are uncomfortable to deal with.

So how far down the deal size spectrum, are those concerns?

Yes. Obviously, the biggest deals are getting the most scrutiny and the deals in those spaces like health care and technology seem to be in the crosshairs. But look, we're working on deals in the middle market, where the lawyers say, I know this sounds crazy, but like that deal could get a second request. And then once you get a second request, who knows what happens and you start going down the rabbit hole of people seeing go send some things. And look, generally, I think some of our people can get through those things, but it does make it more challenging. No doubt about it.

Right. Let's take a pause there. We have a few minutes left. Are there any questions in the audience? We have a mic.

Yes. I have a question just philosophically about comp and investing through the cycle. When you look at your compensation ratio historically, and we're going through this period, and I understand you're investing. But it seems as if shareholders almost take a disproportionate risk of the downside and don't really get a lot of the upside. So most people think 2021 was this crazy good year that we'll never experience again, yet your comp ratio was a little bit above the average between 2016 and 2018. When we get into a better cyclical environment, are you going to continue to invest? Or is it possible that you'll show more leverage there so that everybody participates in a better environment?

I appreciate the question. And look, part of the reason -- look, our goal is to always show our investors leverage in the model and be fair about returning to our investors, the benefits of leverage in the model, right? And -- then you get into the question of [ RIO ], is it 60 or 58 or 59 or some other number? And if your revenues are higher, should it be 56 and like we can debate all of that. But I think if you take a step back, if we've been public, we've returned, I don't know, $31 a dividend to our shareholders. I think that it's hard to argue that's not a good return of capital and a responsible return of capital to our shareholders. We've grown the firm significantly. We've tried to be thoughtful every time we've tweaked or modified. And obviously, this year was more than a tweak. The compensation ratio, we've done it all with the mindset of long-term value creation. We've all done it from the mindset as being major shareholders in the company. I appreciate the question, and you can always have a debate on the margin about what -- on the margin, what the right return is, I do think unequivocally not letting the compensation ratio in a year like this hinder your ability to do game-changing hiring, I think, is the right decision. I don't know if I answered your question, but that -- but again, I think if you look at it in totality for a company that's bought back a bunch of shares, returned $30 of dividends, grown the company, kept a clean everything, whistle clean balance sheet, no hidden anything. I don't know. I think it's a pretty good -- very good track record of being shareholder friendly.

So we have 2 minutes left, and we haven't touched on restructuring. So maybe we could just end with what you're seeing on the restructuring side, how steady and large is the pickup in activity there? And when should we see that start to hit your P&Ls?

I think there is a -- there's definitely improvement in restructuring activity, volume conversations. There's been an upturn in bankruptcy filings. For instance, this year. We've been involved in some of the most important of those. Our teams are busy. And I think if you kind of look at this major set of maturity walls that are really a remnant of all of the deal and LBO activity that kind of happened in '18, '19, '20, '21, et cetera. You have major maturity walls coming up in '24, '25, '26. A lot of those companies, there's change happening in those industries, technology change, structural change. A lot of those companies, unfortunately, aren't going to be able to refinance through those maturities. And so I think there's going to be a lot of not just bankruptcies, but a lot of balance sheet restructuring, recapitalization activity around many different names. I think it's just going to be a drawn-out cycle with a lot of activity over a bunch of years, and we're really well positioned for that.

So when you enter into a restructuring contract. When does that hit your P&L? Is it a 1-year lag, half year lag?

Restructurings are funny because -- not funny, but they're unique in the sense that -- it's the 1 area where once we really start digging in and really start spending time, we do generally get retainers. So that creates a nice kind of steady income stream for oftentimes many months, sometimes years before there's an event. They do tend to take a long time, even out of court deals tend to take a long time to happen. And so -- and sometimes that just means you're working on deals for a while before there's the back end of it. But the good news is, oftentimes, you're collecting retainers along the way, which help.

Great. Well, Navid, thank you so much.

Thank you, Devin and I appreciate everything. Thanks for having me. Great to see you.

Thanks.