Moelis & Co Q4 FY2020 Earnings Call

Good afternoon, and welcome to the Moelis & Company Fourth Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Chett Mandel, Head of Investor Relations. Please go ahead.

Thank you for joining us for the Moelis & Company fourth quarter and full year 2020 financial results conference call. On the phone today are Ken Moelis, Chairman and CEO; and Joe Simon, Chief Financial Officer. Before we begin, I'd like to note that the remarks made on this call may contain certain forward-looking statements, which are subject to various risks and uncertainties, including those identified from time-to-time in the Risk Factors section of Moelis & Company's filings with the SEC. Actual results could differ materially from those currently anticipated. The firm undertakes no obligation to update any forward-looking statements. Our comments today include references to certain adjusted financial measures. We believe these measures when presented together with comparable GAAP measures are useful to investors to compare our results across several periods and to better understand our operating results. The reconciliation of these adjusted financial measures with the relevant GAAP financial information and other information required by Reg G is provided in the firm's earnings release, which can be found on our Investor Relations website at investors.moelis.com. I will now turn the call over to Ken to discuss our results. Ken?

Thanks, Chett, and good afternoon, everyone. Our fourth quarter revenues of $422 million were up 89% from the prior year and represent our largest quarter of revenues since inception. Full year revenues of $943 million were also a record and up 26% from the prior year. The strength during the quarter was driven by a significant increase in completed transactions with our M&A franchise recording its highest level of activity in firm history. Our full year revenue growth was powered by year-over-year increases across all of our products and regions as well as higher average fees earned per completed transaction. We produced record levels of capital markets and restructuring activity and near records in M&A despite the softer deal-making landscape in the first half of 2020. With a focus on expense discipline, we brought this top-line strain down to the bottom-line exceeding our operating margin target, while returning a significant amount of capital in a very tax-efficient manner to our shareholders. I'll now turn the call over to Joe, who'll take you further through our financial results and then I will discuss our business and outlook.

Thanks, Ken. Starting with expenses. Our adjusted comp ratio was 45% for the quarter and 59% for the full year. Our fourth quarter non-compensation expenses of $27 million translates to a non-comp ratio of 6%. For the full year, we reported a non-comp ratio of 12% largely due to low levels of travel and related expenses as well as continued expense discipline. We achieved the full year pre-tax margin of 28%, exceeding our 25% target. Regarding taxes, our normalized corporate tax rate for the year was 26%, in line with prior quarters of 2020. Also consistent with prior years, we may recognize a tax benefit in the first quarter of 2021 related to the annual vesting of RSUs later this month. For purposes of quantifying the excess tax benefit, the breakeven share price for this vest is approximately $31 per share. For each dollar difference between the vesting and breakeven price, we expect the impact to EPS to be approximately $0.01. Our Board declared a regular dividend of $0.55 per share representing an increase of 44% from the prior quarter and an 8% increase from our regular quarterly dividend amount pre-COVID. We've now increased our regular dividend and declared at least one special dividend in each year since becoming a public company. In addition, we repurchased 1.2 million shares during 2020. We remain committed to returning 100% of our excess capital. And lastly, we continue to maintain a fortress balance sheet with substantial liquidity and no debt. We ended the year with cash and liquid investments of $375 million. And I'll now turn the call back to Ken.

Thanks, Joe. The achievements of 2020 go beyond just our financial performance. We invested in the future growth of the business by adding 13 managing directors during the year across important products, regions, and sectors. We expanded our capital markets business which has already become a more substantial contributor and an important part of our advisory strategy. Also, we recently added a new Head of Private Funds Advisory, combining our existing primary funds placement and secondary businesses to help us capitalize on the broad opportunities we see in private equity. In addition, earlier this year we promoted eight individuals to Managing Director and our pipeline of external talent remains robust. In conclusion, we believe that our platform is uniquely positioned to deliver innovative solutions for our clients. The resiliency of our people and the intense and focused effort of our bankers during 2020 have led to the highest level of new business activity we have ever seen, which is why I'm so confident about the firm's future growth outlook. And with that, let's open it up for questions.

We will now begin the question-and-answer session. Our first question comes from Devin Ryan with JMP Securities. Please go ahead.

Hey. Great. Good evening, Ken and Joe. So I guess this is the first quarter north of $400 million in revenue and then really the first quarter north of $300 million in revenue. So just given that, it was such a, I guess, outsized quarter and I think above expectations as well, it would be great if you could just maybe unpack a bit of what drove the strength? It just seems like a lot of things came together very quickly. So whether it was capital markets activity or restructuring or just deals that kind of closed quickly ahead of maybe potential thoughts around tax changes? Just love a little more flavor for what happened in the quarter to get to these numbers.

I believe the performance was largely driven by strong activity across all sectors, particularly in mergers and acquisitions. We mentioned at the end of the second quarter that we noticed a significant resurgence in M&A, partly due to a good backlog from before the COVID period which quickly picked up momentum. Factors such as stock market performance, low interest rates, and overall market enthusiasm contributed to the acceleration of M&A activity. Additionally, restructuring had a solid year, though it aligned with our typical percentages from previous years. Both areas performed well. The fourth quarter is generally a strong season for a company like ours, and while the year-end dynamics were normal, I didn't notice any unusual rush or distinct advantages. It was the usual mix of transactions that carried over and those that gained speed, without significant tax-related variations.

Yes, it was a significant revenue quarter. Let's shift our focus to the recruiting landscape. Six to nine months ago, the expectation was that 2020 would be challenging, which could create recruiting opportunities as competitors focused inward. I'm interested in how the recruiting environment has changed and what kind of conversations you're having, along with your expectations for the upcoming year. You had a nice increase in Managing Director headcount last year from both recruits and internal promotions. I would appreciate some insights into the current discussions, where you're looking to expand, and how the fact that most firms had a strong year and likely solid compensation impacts this situation.

Yes, I agree with you. Nine months ago, I thought there might be an opportunity to leverage our strong balance sheet and liquidity like we did during the last crisis in 2009-2010, when we significantly grew the firm amidst a chaotic banking environment. I mentioned that could be a possibility, but it wasn't the case as the Federal Reserve intervened quickly. By our June quarter announcement, we indicated to the Street that we were seeing a significant and certain increase in M&A activity. Currently, recruiting is quite strong, as there are individuals looking to make a move. I still believe the boutique environment and the dynamism around the innovations we are showcasing, including our capital markets activity, are drawing people to our platform. This trend is not unusual; it's very much in line with previous years.

Got it. Okay. I’ll leave it there. I appreciate the color.

The next question is from Ken Worthington with JPMorgan. Please go ahead.

Hi, good evening or good afternoon. In your deck, you commented I believe that 25% of the MDs have had that title at Moelis for less than three years. So how do we think about the production of these newer MDs as they remain in that position for four to six years and seven to ten years? And I guess the real thing we're after is, what sort of revenue pickup are you sort of expecting from this group as they mature over the next handful of years?

Well, I do think we continue to emphasize internal promotion. Eight people this year, which is pretty substantial for us. It might be our most, and those people are on the way up. They are developing franchises. They're quality relationships that are just going to get better. By the way, a lot of it is that the world is changing so rapidly that you want to have these young up-and-coming managing directors who are developing businesses in parts of the economy that almost didn't exist 10 years ago. So it's very exciting to have that training and inward focus of where we're developing talent on our own and bringing them up. They definitely do improve in productivity fairly rapidly between sort of the first and second year of promotion and even out to the fifth, sixth, and seventh year. It's really hard for me to delineate that. It will be sporadic by person, but we definitely expect to see continued productivity. And lastly, also, the integration of the whole franchise is just getting better and better. And when COVID hit, I think the fact that we have a collaborative culture is one of the things you saw in our results is, we didn't really have to reintroduce everybody. People were passing off the elements, I mean different clients needed different things than they ever needed before. Some needed capital markets, some needed restructuring advice, some needed M&A advice that were never in that part of our firm before and our ability when somebody comes up through the system and they've been working here for 10 years they know everybody. They know who to call. People know who they are, and it's substantially more collaborative than bringing in somebody or your entire workforce without the connections. So Ken, I expect to continue to see productivity improvement.

Right. Is it a stretch to think that three years from now, if this group were exactly the same, the production would be up 50%? Or would it double? Or are those numbers just outside the realm of reasonableness?

If you're referring to that group that has been with us for three years, their productivity could increase by 50%. Overall, that will be spread across the entire group. However, especially for the new promotions, I cannot definitively confirm that number scientifically, but instinctively, I feel it is a reasonable estimate.

Okay, awesome. And then maybe going to the more plain vanilla, in restructuring, have you been working through that pipeline at a more accelerated pace that would sort of make sense given the more constructive environment? And then I guess what I'm maybe more after is how does the replenishment of the restructuring pipeline match up these days with the pace that you're completing those restructuring mandates?

Like a book-to-bill ratio you're trying to come out of a banking with a book-to-bill. I think our restructuring retainers and assignments are still at all-time highs. We had a very good year. But it was in line with the percentage of the revenues that they've always done. We had a great year in M&A and we had a great year in restructuring. And our restructuring backlog and retainers are at their all-time highs.

Awesome. Thank you very much.

The next question is from Brennan Hawken with UBS. Please go ahead.

Thank you for taking my questions. I wanted to follow up on that. That's an interesting point, Ken, as I don't want to delve into the restructuring, the mandates, and the retainers being at peak levels. Do you think it's reasonable to expect that restructuring revenue will remain stable or even increase in 2021, or is that too optimistic? Will it likely be a positive factor in the first half, but without more mandates coming in, will we see a slowdown in the second half? Is that a fair assessment, or how should we consider the various factors at play?

The market has a way of keeping you grounded when you try to make predictions for the year. It seems stable for now, but much depends on the market’s direction. The economy is improving, although many companies have taken on significant debt to navigate through COVID, and some may struggle if the economy does not recover fully. Currently, our backlog is at an all-time high. I prefer not to speculate too much on the markets because they tend to surprise you. For now, I would describe the environment as stable and suggest monitoring it closely.

Okay. That's fair. And tell me about it on the market humbling you. I hear you. So on the capital front, so you had indicated when you guys initially had cut the dividend that you were being conservative. And clearly, you have put your money where your mouth is by bringing the regular dividend up back where it was above where it was pre-pandemic. So with the regular dividend now restored actually above its prior level, how are you thinking about weighing capital returns as far as the form buybacks versus specials versus other forms of capital return?

We're flexible. We were buying during the year, but with the blackout periods, it became difficult to access a lot of capital. So, we decided to issue a $2 dividend in December because our strategy is to not hold onto capital. We deferred a dividend out of caution to ensure our bankers could focus on their clients, especially considering the potential severity of the virus, which turned out to be challenging but not as bad as expected. Our businesses performed better than I anticipated. However, our first priority was to protect our resources and then quickly return value to our shareholders. Once we had the excess of $2 per share, we paid it out immediately. We have now raised our dividend because we believe our business is strong enough to sustain a level above what it was before COVID. I still expect that we will generate substantial excess capital, and we plan to be flexible in our approach between share repurchases and dividends, with the goal of returning your money to you as quickly as possible.

Okay. That's fair. Thanks for the call.

Next question is from Jeff Harte with Piper Sandler. Please go ahead.

Good morning, guys, a very strong quarter. Along those lines as we look at how good it seems M&A activity levels are across the products and really everywhere, we've had a couple of ramp-ups like this since the great financial crisis. But each time, it's kind of stalled out before reaching new cyclical extremes, understanding that there's not going to be a clear answer to this until we're through it. But do you think things will be different this time that we could actually see new cyclical highs in a really robust frothy environment? And if so why would it be different than the last couple of head fakes?

If you're expecting me to make a bold statement while everything is going well, I'm not going to do that. Markets can be unpredictable. There are positive factors right now: low interest rates, economic recovery, and government spending boosting liquidity. Our balance sheet remains strong and unleveraged, preparing us for unexpected events. We have businesses positioned to capitalize on market changes. I'm not going to make definitive predictions about market peaks, as suggested by Irving Fisher. Instead, I believe there's considerable interest currently. As I mentioned in a call earlier, it's unreasonable to expect that your business strategies from January 2020 and January 2021 should remain unchanged, especially after experiencing COVID. There have been shifts in go-to-market strategies, including decisions on leverage, liquidity sources, and the businesses you choose to engage with. I've never witnessed such a rapid reevaluation of strategies across the business landscape. That's where we come in, assisting businesses in rethinking their balance sheets and market approaches. This is why I believe there is a lot of activity happening right now.

Thank you. Regarding expenses and the potential for positive operating leverage, you mentioned aiming for a 25% operating margin. However, that seems quite conservative considering you've exceeded it in six of the last seven years. As we look ahead, should we begin to consider a higher run rate for positive operating margins moving forward?

I want to provide a tentative response. Some of the changes we’ve seen are due to reduced travel and expenses, and I believe some of these changes could be long-lasting. However, I can't accurately predict the exact extent. I genuinely think we will see a permanent decline in travel and entertainment costs, particularly in more routine areas. While meeting clients in person is valuable and can enhance revenue, I feel we are missing opportunities there. Revenues might have performed even better; for instance, some of our 2020 revenue stemmed from business activities back in 2015. We need to resume those client interactions since personal connections are irreplaceable. However, I anticipate that not every expense related to travel for minor tasks will continue. Overall, it seems likely that some of the savings we’ve achieved will persist, potentially allowing us to rethink our approach to margins in the long term. We will need to wait and see how this develops.

And I guess, just related then, I'm done, how are you guys thinking about kind of non-comp expenses at least a quarter or two out? Do you have any more insight as to how quickly you think those could come back or not come back? Any help for us there?

I think what we are seeing right now is that there's a slight uptick in travel. I think $30 million is still a good baseline to be focused on. And I don't know beyond a couple of quarters where it's going to be. I don't know if I can project out to the second quarter. But I think $30 million plus or minus is probably a good range to be working with in the next couple of quarters.

Interestingly, I want to mention that we don’t have significant lease expenses to anticipate. Almost all our other costs are as they currently appear. The main factor that may change will be the size of our personnel, but for the most part, everything else is well-managed. The unknown will be whether travel will recover to its previous levels.

That's right.

Okay. Thank you.

The next question is from Jim Mitchell with Seaport Global. Please go ahead.

Hey, good afternoon. Maybe just a question, I don't know if you've had the time to think about this, but Senator Klobuchar is planning a bill to give any trust enforcement a little more teeth, is that a worry for you? Have you had any conversations with CEOs that are concerned about it? Or is that just really a mega deal issue, that's not too concerning?

I'd put it in that category. I mean if you're involved at a specific large transaction, I think you want to be very careful about this stuff. I saw something on early termination of the 30-day period, which could end up just delaying some transactions by slight margins. Again, I think a lot of our business is in the size transaction where I don't believe that bill that you're referring to would have a big effect. But yeah, I haven't spent a lot of time being that worried about it. I suspect there'll be a transaction in which it gets focused but that will be specific to the transaction.

Okay. That's helpful. And maybe just on getting back to the margin discussion and maybe talking to the comp ratio given the more positive environment you talked about recruiting being sort of an average year with revenue outlook pretty positive. Is there an opportunity? Or can we expect that you can get back to sort of your prior targets closer to 58% comp ratio or is there still headwinds on that front?

Well, two things. First of all, I don't think it's an average year for hiring. I just said that there's not panic in the market. So it's the same environment. That doesn't mean we won't be aggressive into it given where we think our business is. I just want to be clear on that. We may choose to be aggressive. It's just not a weak market for people like 2009-2010 or a strong market for obtaining people, number one. Number two, I don't understand the question of headwinds. We're returning 28%. I think it's the industry-leading margin of every revenue dollar and pretax to our shareholders. And that's what I'm focused on. I'm a shareholder, if I can return that kind of margin to our shareholders the mix of how we do it up top. I think we're right within our range and I'm very happy with if we can get into those kind of pre-tax margins, that's what I'm aiming for.

Okay. Fair enough. Thanks.

The next question is from Manan Gosalia with Morgan Stanley. Please go ahead.

Hi, good afternoon. Could you talk a little bit about the SPAC opportunity here? Clearly, a lot of capital being raised, and that should help the activity. So, how are you thinking about that opportunity for the industry overall and for the firm?

One of the reasons we strengthened our capital markets is to take advantage of the SPAC opportunity. We have already underwritten primary offers for SPAC deals, which represents a significant institutional market. Our strong relationships with sovereign entities have positioned us as a desirable placement agent and underwriter for these SPACs. Additionally, our M&A and private placement teams provide support for the PIPE and de-SPAC processes, which is quite promising. Our investment in capital markets, including hiring a dedicated team in the third quarter, is already showing positive results. I believe in the viability of the SPAC market, which has a regulatory advantage over traditional IPOs, allowing for a reduction of seven to eight months in the process and increasing certainty for investors. Moreover, there has been a 50% decline in the number of publicly traded common stocks compared to 20 years ago. This reduction is largely due to private equity and late-stage venture capital organizing capital and questioning the value of entering public markets. They benefit from access to five-year projections, thorough due diligence, and governance checks before investing. SPACs are now providing public investors, including large mutual funds, similar access, enabling them to engage closely with management and conduct due diligence. With around $1.5 trillion in private equity and approximately $300 billion to $350 billion in SPAC funding available, there’s potential for restoring the stock count to its historical numbers from 20 years ago, suggesting a promising market ahead, which is why we have invested in our capital markets and coverage model.

That's great color. Thanks for that. And then separately, if you can comment maybe on what activity is doing outside the US, clearly we're seeing activity ticking up pretty nicely in Europe. So maybe you can give some more color on what you're seeing outside the US and how your share in those markets is tracking?

Yes, we mentioned that we observed strength in all regions. The US continues to be impressive in adapting quickly, especially in a COVID-like scenario. Europe is showing steady strength, and we are beginning to see an increase in activity in Asia after a period of inactivity in China, particularly during the latter part of the last administration. We're noting more engagement in China and Hong Kong, as well as positive results from our Brazil office, which had a solid fourth quarter in terms of sessions and backlog. Overall, we are witnessing growth across regions. Historically, during times of turmoil, the US tends to be the first to act decisively, but it appears that other regions are responding similarly.

Great. Thank you.

The next question is from Michael Brown with KBW. Please go ahead.

Hi, Ken and Joe. So wanted to just start with a question on traditional M&A side of the business. So I got your outlook comments on the restructuring business on the recruitment activity. But I guess just wanting to complete the circle here with traditional M&A. So Ken, I understand the markets are humbling, but M&A activity has certainly been intense. That intensity seems to have continued certainly since the end of 2020. So how are you feeling about M&A? Could you kind of characterize your outlook for 2021 relative to prior upswings in M&A activity and how would you characterize your backlog now relative to prior periods as well?

This is the strongest backlog we've ever had to start a year. Again, I want to be careful. Somebody said to me, should you annualize the fourth quarter? And I said, yes, only if you want to lose your job as an analyst. The fourth quarter is always seasonally strong and this one had more to it. But this is the strongest backlog we've had; there is a lot of activity out there. And our workforce is as good as it's ever been. When I look through the players we have in position and what we did in 2020 to move people and to expand in sectors that we wanted to be in, at the top, I know you guys look at the gross numbers and sometimes the MDs don't change as much as the ins and outs. But it's the team you put on the field and whether you're in the right positions to win. And I've never felt stronger about the team we have on the field and whether we're covering the right places with the right people and collaborating to do it. So it's a good backlog and it's a great team and the system is working as well as it ever has.

Okay. Great. I just have one follow-up question. Did the fourth quarter include any significant pull forward from deals that closed in the first quarter, or was it a relatively straightforward fourth quarter?

I'm going to let Joe address that. However, I would mention that it seemed clean, although there are always factors to consider. For instance, last year, some items were moved from the fourth quarter to the third, and there were also items from the first quarter shifted to the fourth. Overall, I didn't notice anything out of the ordinary, but Joe will provide more details regarding the numbers.

Yes, it was a couple of transactions and I think it added up to something around $30 million.

Okay. Great. Appreciate the color.

And our final question comes from Steven Chubak with Wolfe Research. Please go ahead.

Hi. Good afternoon.

Good afternoon.

So wanted to start off with a question on comp expense. I mean, you've always provided a lot of transparency around the comp algorithm. Based on your previous guidance for 2020, I think you alluded to fixed comp somewhere in the range of $340 million to $350 million and a 20% variable comp ratio. And that would imply comp dollars of $533 million not to get too precise, but you came in 5% above that. I know you've invested this past year in external hires and have an increase in internal promotes. I was just hoping you could provide updated guidance on what's a reasonable expectation for fixed comp dollars in 2021 given some of those additional hires and whether we need to contemplate any additional changes to this algorithm as we look out for the remainder of this year?

This year, we are generating 28% of our revenue for our shareholders, which I believe is the leading industry margin. I don't think anyone else is achieving that. Our comp ratio is aligned with our goals, and if we can combine these elements, that's our target. We will discuss this in detail, but we will not provide guidance for 2021. If I could achieve 28% pretax in this revenue environment, I would consider that favorable. I am confident that these margins and metrics are leading in the industry. Therefore, we will not offer any guidance for 2021.

Okay. Fair enough. Had to try, Ken. And then just I wanted to unpack some of the commentary on the restructuring side. You noted that your expectation is for restructuring revenues to be stable plus or minus. I know you don't want to make any bold predictions there. But certainly, that's a more constructive message than what we've been hearing from some of your peers especially given some of the tightening of credit spreads and bankruptcy seems to be declining. So, that message is certainly encouraging. I was hoping you could speak to maybe some of the idiosyncratic factors that could support a better restructuring outlook that you're indicating. And are there other parts of the business that we should think about that could be impacted just by tough 2020 comps given the strong revenue year that you just had?

Yes, I believe we are stable. Our stability is supported by having more retainers compared to last year and a larger backlog at the beginning of this year. While I understand your question, I prefer not to comment on other companies' mixes as they enter their quarters and how those mixes will evolve. Our mix has been heavily focused on M&A and remains stable, contributing to our overall revenue. Additionally, we have increased our revenues by adding personnel and have consistently grown our restructuring revenues for five years. I expect the percentage contribution from restructuring to our overall business will remain balanced. We experience growth each year, so I think it's reasonable to describe our outlook as stable with some minor fluctuations.

Based on that perspective, Ken, and just one final cleanup question. I was hoping you could provide just the MD count to close out the year and whether that includes the full number of internal promotes that you had cited?

As of right now we have 128. I think as of the end of the year it was slightly less, 125. But as of right now, not counting the one announced, I believe we have one announcement in transition. Everybody else is in there I'm pretty sure.

That’s great, Ken. Thanks so much for taking my questions.

This concludes our question-and-answer session. I would like to turn the conference back over to Ken Moelis for any closing remarks.

Thanks for all your attention during the year and we look forward to the next earnings call in a few weeks. Thanks.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.