Perella Weinberg Partners (PWP) Earnings Call Transcript & Summary

All right. So up next, we have Andrew Bednar, Partner, CEO and a member of Perella Weinberg Board of Directors. Andrew took over as the CEO January of this year, but has been a partner since the founding in 2006, and was Co-Head of the U.S. advisory business until 2013. Thanks a lot for joining us, Andrew.

Thanks for having me.

Maybe we can just start with a macro question for you. I think a lot has changed over the past year. So I think just an overall perspective would be helpful and then maybe your views on Europe versus the U.S. as well?

Yes, sure. I think you don't need me to tell you that the M&A markets are down this year. I think that's been well documented. And I think with 3 weeks left in the year, I think that will still be a true statement versus '22. So we'll have a down year. But I think the data is very different from the dialogue. As I mentioned yesterday on air with CNBC, the dialogue really started to increase meaningfully with our clients back in the second quarter. That dialogue has continued to pace. The progression has been very nice. A little bit of pause here and there, some for rate chatter during the summer that we would be higher for longer. And a little bit for sure during October, November because of events in Middle East that caused people to pause but not terminate discussions, not put things on the shelf, just sort of pause and have a moment of reflection before proceeding. So we're on a really nice progression with clients and engagement with us as well as engagement with counterparties. And I think that we look back and see that clients declared the M&A waiting game over back in the second quarter. And that usually you need dialogue to have transaction announcements. And so dialogue is usually a very good leading indicator of future announced M&A activity. So we do see that progression leading to announcements as we head into '24. I don't see it as a rocket ship lift-off the way that we saw the recovery of the M&A markets late 2020, which set up a fantastic 2021. I don't see that. But I do see a nice progression coming out of 2 down years off of '21. You asked about Europe and the U.S., you want me to comment on it?

Yes. No, that would be great.

So U.S. is leading Europe out of this particular trough. We're seeing the announced activity in the U.S. increase versus a continued decline in Europe. The dialogues are very similar. It's just the timing of conversion to announcement just is lagging. When I look back at the data from the last few decades that we've been looking at M&A volumes, it's not unusual for Europe to lag. I can't really explain that phenomenon. It's just been in our markets for a long time. But I do expect that with the dialogue, again, being similar in Europe to the U.S. in terms of activity and intensity, I do think Europe does begin to come out of trough, but right now, they're still troughing.

Got it. So maybe just one on what you're hearing when you're with clients, when you're in the boardroom, what's top of mind today as we move past that trough?

So our clients are still focused on creating value for their stakeholders. And as long as market participants look at revenue and growth and margin as key drivers of value, our clients are looking for ways to grow revenue and to grow margin. And often that means you're looking at existing portfolio and you're looking at whether that mix of assets and businesses is going to help you grow and drive margin. And you see a lot of divestiture transactions, a lot of spin-off transactions in this particular part of the cycle. So people are focused on those types of transactions. And then there are larger scale mergers. There are company sales. And so as long as, in the public company arena, at least for our clients that are public, as long as markets drive toward revenue growth and margin growth, there will be a pretty steady appetite for M&A-type transactions where you're buying and selling things. What we don't see as much and what clearly is down, and it's partly a reflection of credit conditions is there is less sponsor-driven activity. There are fewer traditional take-privates, the sponsor activity is more structured, more bespoke. It's still out there. It's not 0. But it is lower than historical norms, and it's accounting for a smaller portion of overall M&A than you would expect given trends over the last decade or so, again, if you look at the longer-term trends. So I think you'll see private equity increase in activity as we get some settling of credit markets. I think that there's plenty of capital, so capital isn't a constraint. The constraints are credit and valuation and just finding targets that make sense. But I do think that you'll see private equity be a larger portion of overall M&A activity as we head into '24.

Wait, sorry, you just said private equity will be a larger portion?

Versus '23. I think private equity will tick up a little bit. '23 is unusually low. When you have a rate cycle like this and you have pace of the rate cycles and then you'd had some portions of the year where credit markets were shut, it's really put a lot of private equity transactions on hold or they've been disrupted. And so I am hopeful and somewhat optimistic that you won't have that type of volatility as well as barrier to getting traditional private equity transactions completed. So I'm anticipating that we will see a bit more activity in '24 versus '23.

Got it. Okay. That's very clear. So maybe just turning to financing conditions, I think the syndicated markets are still somewhat challenged, although maybe they haven't been tested. We've obviously also seen this huge shift to private credit as an alternative, and that's taking some market share. So maybe just your views on financing conditions. And then just on interest rates at this point. Was it really more about the uncertainty versus the fact they were actually rising, and that's what put a cap on some of those financing-related issues?

Yes, I think there were 2 things. One was the pace of the increase, and so it's a very rapid ascent when the Fed began that rate cycle back in March of '22. So that, I think the pace of it was something that caused participants to just hold back. I think also just the uncertainty of where the terminal rate would be, so not knowing where the end game was. I think we have -- so there was a range of uncertainty was very broad. And I think when the range of uncertainty is broad, it creates a barrier to transactions. So I think when you know the range of uncertainty and it's narrowing and you can plan accordingly and do your scenario analysis, I think you can absorb that narrower range of uncertainty and transact in the face of it. There's always uncertainty. So I think it's -- as I mentioned yesterday, it was sort of an overused term in the marketplace, there's a lot of uncertainty out there. I think in 2022 and for part of '23, I think the range was just way too broad, and it did quiet a lot of traditional M&A activity that I think now, going into '24, I think we have a good sense for terminal rate, you get a 60-or-so basis point drop in the 10-year in a month, that's helpful and sort of gives people some comfort that we've probably peaked. And we do see a very significant increase in private credit. We're very active in that market. We like that market. Our clients like that market. That market is not just for private equity takeouts, we're seeing increasing use in exploration of private credit by our corporate clients and by family offices and others. And so I think that is a very exciting part of our marketplace and provides an alternative to traditional syndicated loans and underwritten bond deals and giving clients choice of financing is a very good thing for our marketplace.

So one other big picture one for me, which is 2024 is an election year, not only in the U.S. but in other places, too, which someone reminded me of yesterday. So maybe you could just talk about what that could mean for capital markets, I guess, here and elsewhere? And is it a topic of focus when you're in the boardroom?

I mean the quick answer to that is it's not a focus. I think it's more of a discussion topic about, boy, we really have this choice coming up, which probably occupies most of the discussions at dinner tables in restaurants. So I don't think it's any different in boardrooms in our discussions with executives. I haven't heard a single story where someone said, "Boy, it's an election year, why don't we kind of regroup after November of '24." I haven't heard that at all. So to answer that question. I think where you look at some of the data, it's rare to see like a huge uptick in M&A in an election year, so they usually are flat to down. But this is an unusual period where we're coming off a $5-plus trillion peak in '21, and we've had 2 years now when we're going to be down. That in and of itself is unusual. Usually, it's 1 year, 1.5 year. 2 to 3 years would be a very unusual down market. And so even though it's an election year, again, I said it earlier, I'm expecting and anticipating that we will have a bit of an uptick in M&A for next year, but again, not a rocket ship up, but just a nice progression up.

Got it. Another topic that's somewhat related to this is just antitrust. Obviously, that's been a concern for the better part of a couple of years now. I think there's obviously the FTC challenging deals. There's the proposed change to Hart-Scott-Rodino and then obviously, what's happening in Europe. So maybe you can talk about how much of an impact you're seeing for your business from that. And then if we do see a Republic administration, does that change any of those dynamics?

Usually, a change of administration would change the posture of the given regulator, whether it's FTC or SEC or any number of EPA regulators that are out there. So to answer that question, yes, I think if there's a change in administration, you'll see a different posture and approach. To date for our clients, we just have not seen much of an impact from more aggressive posture of the FTC and the antitrust regulators. What we do see is different planning and that you have to be much more thoughtful about announcing transactions and having your case ready. You have to prepare for more time for sure, even transactions that historically may have been transactions where you would have requested early termination, they would have sailed through and would not have had any speed bump at all, We're in an environment where nearly every transaction is going to get reviewed and so you have to spend time and money and make an effort to make sure that you're presenting a proper case to the regulator. We have not seen the regulatory posture be to kill M&A deals. So the idea that M&A is going to die at the hands of the regulators is just not true. We don't see any evidence of that. Most of the processes we've been through, the regulators are constructive. They are demanding, and we do go through a rigorous process and many would say as you should. And so it just takes some more time and money. The cases that involve these expanded theories of harm have all been either seriously challenged or outright rejected. So it really is coming down to whether there's a consumer pricing issue. And I think there'll be some cases, there always are, that you just can't get through and they will prevail or that the parties will decide not to transact. But this broader demise of M&A just has not happened and clients are managing through it just fine.

Let's get into some of the timing dynamics here for the M&A recovery. It seems like there's been a little bit of an improvement so far this quarter, but obviously, we're still pretty darn close to trough levels. So what do you think gets us to that place where completions are really following announcements in improvement? Is that -- and improving. Is that something that we start to see at the beginning of next year? Or is that a longer-term thing?

I think we and the rest of the sector have been saying that there's been an elongation of the traditional deal life cycle, so from engagement to discussion to agreement and announcement to closing. All of those periods of time have elongated for different reasons. And so there was a calendar adjustment that's occurred in everyone's backlog and looking at announced versus closing. And so you're still, I think, in this adjustment period. But again, unless there is a dramatic change in the success of regulators to block transactions, we're going to see closings follow the recent uptick in announcements, particularly in the U.S., again, Europe is still down. U.S. announcements are up, and you should see those closings occur as you head into '24. The issue is always in what we track in our business is looking at what new transactions we're announcing and putting into announced and pending backlog, not just what we're taking into revenue at closing. And for our business, we are continuing to see an increase in that announced and pending backlog ahead of the sort of industry rate. So we feel quite good about the progress of our business here in the last couple of months.

Okay. So let me just see if there are any questions from the audience. We'll see if we can get them. Let's see. Okay. One more from me, and we'll see if the audience lightens up. Okay. Let me just turn to the other side of the P&L, thinking about the fact this is still somewhat challenging operating environment. Maybe you could just talk to the puts and takes around margins in the near term. And then I think it would be helpful if you could break it down between the comp ratio dynamics and some of the non-comp ratio dynamics.

Sure, sure. So it's a very simple business model. There's revenue, there's comp, and then there's non-comp, and then we pay some taxes and have earnings. And so what we said when we became a public company back in June of '21 is that given our growth and scale and our mission to scale the firm that we would be targeting, we don't give guidance of any sort, but we will be targeting a mid-60s comp ratio. And you're going to have moments in time where because of competitive dynamics, market dynamics, because of retention or investment that you'll move that margin around a bit. For the current year, we have accrued for the first 9 months at a 67% margin. The industry seems to be quite a lot higher than that. And right now, looking at 3 weeks left in the year, we're kind of looking at scenarios for where that's going to end up, and the scenarios are narrowing, and we've been modeling 70% as our annual comp margin, obviously, on an adjusted basis, which is what everyone looks at. And that will mean whatever margin mathematically works out for the fourth quarter, because that's when you have your catch-up and we won't know exactly what that actual number is, but we are modeling in for the full year, again at 70%. And part of that is always some investment and some amount of retention and somewhat our scale and then what the competitive dynamics are, as I said. And I've had these debates with accountants all the time about some of our comp margin is really investment should be viewed as CapEx, but I always lose those arguments. But that's what we've been doing to scale the business. I think as you get to a higher revenue numbers and larger scale of an enterprise, non-comp, for sure, will come down as a percentage. So as we grow the firm and the revenue, we have everyone on this mission of our journey to $1 billion in revenue. And when you get to those kinds of levels, as you go through that journey, you don't need to increase non-comp consistent with the revenue increase. So there's natural operating leverage in these businesses. You'll have some increase in non-comp, but that percentage in non-comp ought to come down as you're building the revenue base of the firm. So that -- that's our very simple business plan, harder to execute, but it's a very simple business model in that sense that we're operating. And it's just a more challenging environment, as you say, because we don't yet have the tailwinds in the business. We still face headwinds with the rest of the industry.

That's very clear. So maybe you could just talk about how you're thinking about balancing investing in the franchise for longer-term growth versus the need to protect margins maybe into 2024 and 2025.

Yes. I mean it would be -- in terms of just looking at comp ratios, I mean, it would be foolish to stick to some specific comp ratio where you're going through some turbulence and you have established this phenomenal team of 65 partners and 50 MDs and we've got all these clients that love working with us, and they've just decided this wasn't going to be a year where they engaged in a transaction or where they needed our services, but that you have a long-term annuity value inherent in the franchise that you've built. So you always have to think about the team and making sure that you're appropriately compensating your team because if they are enticed to go somewhere else because of financial remuneration, it would just be foolish for us not to, again, take care of our team and do the right thing because these are assets that are very, very valuable, but they do have some volatility naturally with the market. At the same time, we are growing as a firm. We're 700 people, 10 offices in 5 countries. We have 65 partners. We have a really terrific recruiting environment that we're in, and we're talking to some fantastic people who would join our platform and build the revenue of the firm. 1/3 of our partners today have been on the platform for less than 3 years. There's investment needed to get those people, those assets up and running and integrated into the firm and hopefully providing what I view as nonlinear growth opportunities where someone comes in, not just with their revenue and their clients, but actually becomes part of our firm where there's opportunities to expand the joint revenue opportunity once we're partners working together and covering clients together. So you do need investment. We're unlikely to have like a breakout investment year where we decide to hire 25 partners. And that's like creating another new firm overnight. And I think for us, we look at what type of professional fits our business strategically, financially and culturally. We're opportunistic, but also disciplined and there's that trade-off. We own 51% -- we as a partnership and employees own 51% of the firm. So we care a lot about how we compensate our team, but care a lot about our equity value and growing equity value and getting wealth creation for our teammates. And so we're very aligned with shareholder interest in that sense, which we think about all the time.

So maybe a philosophical. I think there's a lot of discussion among peers as to what happens over the long term in terms of normalization of comp ratios and non-comp ratios. But I guess, is there any reason why you shouldn't be able to get them back to where they were, and obviously, as you scale, why they couldn't come down over time?

Yes. I think over a longer period of time, once you get to scale, you can see some of the more scaled players in our industry and where those comp ratios have been outside of this year in sort of aberrant markets, I think they're, again, much higher than they've been historically. So they're out of the traditional band, but I don't think they stay outside of the traditional band. And so you just -- you need more scale in the business, so that when you're investing for growth in the future, you can't ask shareholders to pay for all that, but you also can't ask the current team who's producing the revenue to pay for all that. Because if you did that, you're going to lose that team. And so it is a really delicate balance. But as you scale, you're able to meet your growth targets and also compensate your team well, at the same time creating wealth because your earnings model is growing because you have this notion of a range of compensation. And as I said earlier, you're not increasing non-comp at anywhere near the rate that you can increase revenue. So you have natural operating leverage and earnings ought to grow.

Excellent. I'd like to turn now maybe to strategy. I think you have an interesting perspective in that you've been at the firm since the founding, but you've now been in the CEO role for about a year. Maybe you could talk about the changes in the firm since you've taken over CEO, lessons learned and then maybe expand on some of the investments in hiring that you've been focused on. And then as we look ahead, maybe let's start with this part, but where do you see the best opportunity to build in M&A?

Yes. So maybe just a quick history lesson on the firm, 20 seconds, which is that we started the firm as very clearly an M&A advisory firm, and we were a group of senior bankers from various firms, including one that's very prominently featured here today. And we had great clients. They were very supportive. We realized a little bit after the financial crisis, which was, perversely enough, a very big benefit to the firm. Unfortunately, a very difficult time for the world but for us, we were able to really build our firm and franchise and establish real trust and credibility in the marketplace. We realized sometime after that period that we needed to change strategy a bit and not be so product-oriented. So around 2010, we very deliberately decided to build out our industry coverage model, and that's what we have today. We have 5 key industry groups. We are organized as industries. We get support from product experts as well as regional experts to help cover clients. So we're a very client-centric model. And that allows us to get very, very deep and also have opportunities to add on to existing core. So in healthcare, you add all sorts of subsectors in around healthcare and tech is the same thing, energy, same thing where you cover upstream, midstream, downstream, energy transition, renewables, et cetera. So I think that model gives us a very large growth opportunity. Within that, we've also -- we also evolved from purely an M&A advisory business to include restructuring and liability management. And we've expanded that service line to now include debt advisory, particularly around private credit, which has been very active for us, capital markets advisory as well as shareholder engagement and shareholder activism, which is a business that we've been getting demand from clients to have deeper capabilities there. We've recently hired 2 partners, terrific, very, very experienced partners in that arena. And that's an example of where we do get that geometric growth that I mentioned because they bring expertise in clients and experience, but also in our system where they immediately plug into 65 partners and 50 managing directors who cover clients, they're able to offer those capabilities in our client-centric model immediately, which, again, is a very exciting part of adding product capabilities. And -- so we're -- the strategy of the firm is to provide advice, number one. First and foremost, we help clients address complex strategic and financial challenges. I have no interest in straying from that business model. So we're not interested in getting into investing and starting funds and businesses that are far afield. We're not a teaching hospital or an exploratory firm in that sense. We have a very large market opportunity in what we do really well. We've established a reputation for trust and for expertise in our markets, both here in the United States and in Europe. And we're going to keep pursuing that very, very clear strategy and business model to really get to our journey to $1 billion and stay there and grow from there, though, you do need some tailwinds in the market. So that is one thing that we're not in control of. We have to accept the conditions as they are and do our best within all those conditions. But again, from where we started in M&A to now a broader product set also allows us to navigate through choppier waters because we have a lot of ballast in the system with different advice markets that we can be involved in beyond traditional M&A.

So you talked about some of the product capabilities you built out. And I recognize that you might not want to give us all the answers here. But when you look ahead, what's next? What are the adjacencies that you think are most exciting as you look ahead over the next 3 to 5 years?

So we're constantly thinking about our growth opportunities. And I think they're in our 5 sectors, so there's no magic to that. And because we're 65 partners and 50 managing directors, we just have a scale today that when you think about our algorithm to get to $1 billion and how we get there, I think it's a very clear path. I think it's very achievable and verifiable and it all works. And you can see partners and MDs that we will hire in all of those sectors because there are so many subsectors today. You can't walk around and just say, I'm a technology banker. Those were the days when I first started in the business back in 1994. Today, you have to be much more specialized. You can draw analogies from the medical profession where you just don't go in and see a doctor anymore, you get to the point of what the issue is. And it's the same thing in financial services and what we do. People want experts that know their industry know the issue and bring financing expertise or bring healthcare expertise in devices or in services or in energy and energy transition in wind or in battery or whatever, and you have to have those experts. And so we're thinking about all those add-ons and all those sectors, but you're right, I'm not going to give you the road map.

Fair enough. Let's turn to one adjacency where you have had a lot of success, especially this year. Financing and Capital Solutions has performed quite well. It seems like some of that is driven by restructuring. Maybe we could talk about the outlook for restructuring into next year. What's been driving it? It seems like it's more liability management than the Chapter 11-type activity. But is that -- has that started to pick up? And then when you take a step back, what could turn this from a good restructuring cycle into a great one and, I guess, the likelihood of that occurring?

Right. So...

That's a lot of questions.

It's great, though. Restructuring is a part of our Financing and Capital Solutions business. Restructuring is really where I always say, you're calling 911, you got a problem and you may have to go into bankruptcy. And unfortunately, there are companies out there, and it's a bit more idiosyncratic today than, for example, during COVID or during a financial crisis or during retail Armageddon, it's not a -- I don't think it's as systemic, but there definitely are pockets of distress and there's probably more pockets of stress, and that's where we think the opportunity is to help clients avoid bankruptcy entirely, get ahead of maturities and help them navigate through their capital structure challenges and their capital needs to the extent that they're in need of raising capital versus just restructuring the existing capital structure. So what's happened in the restructuring is that it's a little perverse where restructuring bankers sometimes might be rooting for, you say what could cause this to be a real restructuring cycle, it's just bad things, which nobody in this room would really want. And I think you don't need that in order to have a thriving Financing and Capital Solutions business. And so the idea that these businesses are entirely negatively correlated and countercyclical, that's just not the case because the Financing and Capital Solutions business now is much broader than traditional restructuring. So both businesses, M&A, traditional M&A and Financing and Capital Solutions can thrive in a particular market. One can do better than the other. Obviously, if you have a 2021 ripping market in M&A, it's going to outpace Financing and Capital Solutions. And if you have something like COVID again where that's where we spent most of our time helping companies work through liquidity and their balance sheet and maturities and bankruptcy and all of that. So -- but you don't need those extremes to have a thriving business. There's sort of that -- there is a sweet spot which you could see both businesses doing very, very well. And the real magical moment is where you have situations where you're doing an M&A transaction, and you're bringing in expertise around debt advisory and you're raising a couple of billion dollars in acquisition financing for which we receive a fee. And if it's in the private credit arena, even more attractive for our particular line of work versus going to traditional syndicated bank markets. So there's a lot of moving pieces and the fee pools are large in what we do. And so having that range of products -- and again, I lost this battle a long time ago, I call them services, but nobody wants to talk about services, they want to talk about products. So we talk about Capital Solutions and Financing products as well as an M&A product, but really, we don't sell products. So we're really not a bank that sells products. We're an advisory firm that's solving problems for clients. That's what we do.

Great. So just one more for me, which is on capital return. I think you have slowed your capital return substantially year-on-year. Maybe you could just talk about your capital return priorities, the balance between buybacks and dividends. And then I think there may be an unlock of some equity ahead, so just how that factors into this dynamic as well.

Yes, we have always said since the day we went public that we would return excess cash to our shareholders. And as I said earlier, we are 51% of the company as partners and employees. So we're very interested in that. We have to always think about what excess cash means and we do have needs for cash in the business. But generally, it is a cash-flowing business. But for example, this year, I wouldn't say we slowed our return of capital, we just changed the form of it. So we were not as active in market operations this year because we have natural built-in share buybacks in the way we net settle RSUs. And because of how we went public and phased in our stock-based compensation program, in the first year, we didn't have much opportunity to net settle, but as the years go on, we have more opportunity to net settle. So rather than chasing market prices at any one time through open market operations, we kind of know what the net settlement looks like, and we were able to in fact, retire shares through that mechanism. We've continued our $0.07 a quarter dividend. That's continued to pace. And then this year, we had I think, very good uses for capital around investment as well as some actions we took around staff reductions where we wanted to redeploy capital toward investment and more productive businesses. And so we did have some staff reductions through the course of the third quarter this year and into the fourth quarter.

Okay. So I think with that, we're out of time. Andrew, thank you so very much to see you.

Thank you.