Moelis & Co Q2 FY2023 Earnings Call

Good afternoon, and thank you for joining us for Moelis & Company's second quarter 2023 financial results conference call. On the phone today are Ken Moelis, Chairman and CEO; and Joe Simon, Chief Financial Officer. Before we begin, I would 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'll now turn the call over to Joe.

Thanks, Matt. Good afternoon, everyone. On today's call, I'll go through our financial results, and then Ken will comment further on the business. We reported $182 million of revenues in the second quarter, a decrease of 23% versus the prior year. Our first half revenues of $368 million were down 31% from the prior year period, which is primarily attributed to a decrease in M&A transaction completions. This compares to a 40% decline in global M&A announcements and a 50% decline in sponsor-backed M&A during the first half of 2023. Moving to expenses. Our compensation expense was accrued at 80%, consistent with the prior quarter. Our second quarter adjusted non-comp expenses were $43 million, including approximately $2 million of transaction-related expenses. I believe that the run rate for adjusted non-comp before transaction-related expenses is closer to $41 million to $42 million per quarter on a prospective basis. Separately, we entered into an agreement to split some fee amount with SVB Securities in connection with our large tech hiring earlier this year. These owed will show up in non-compensation expenses only if designated transactions closed. Nothing occurred this quarter, but I will call out any material expenses if and when they do. Regarding capital allocation, the Board declared a regular quarterly dividend of $0.60 per share consistent with the prior period. And lastly, we continue to maintain a strong balance sheet of $194.8 million of cash and no debt. I'll now turn the call over to Ken.

Thanks, Joe, and good afternoon, everyone. We've been in an M&A recession for the last 16 months. However, in recent weeks, we have seen a healthy increase in new business activity as our clients begin to anticipate recovery. Completing transactions, however, continues to be challenging. Since June of last year, we have repositioned the firm to increase our focus on the largest global fee pools and opportunities. Most notably technology, health care and industrials, which together comprise approximately half of the global M&A fee pool. We have doubled the size of our combined coverage of those three sectors through external hiring and internal promotion in the past year. In addition, we continue to invest in our Middle East coverage efforts. There's been a noticeable increase in new capital deployed by Middle Eastern investors, particularly their sovereign wealth funds. These investors have been playing an increasingly important role in high-profile deals across the globe, and this is a trend that should continue. We consistently rank as a top adviser in the Middle East. Even though we have significantly increased our hiring to date, we expect that on a pro forma basis, our year-end headcount will be up only modestly as we are aggressively rebalancing talent across the business. The strategic investments we've made in talent have been transformative. I believe that the deal backlog feels like a coiled spring. Generally, deals not done don't go away. I don't know when the deal environment normalizes, but I do know that we have prioritized access to the largest fee pools and that our ability to execute for our clients and investors has never been better. And with that, I'll open it up for questions.

Hi. Good afternoon and thanks for taking the questions. I'm curious about what you're seeing in terms of the availability of financing. So maybe first, how is the syndicated loan market today versus earlier in the year? And are you seeing financing availability improving more in any particular sectors, geographies or deal sizes?

I'll start by bifurcating. The investment-grade market has been fairly accessible and open. Rates have changed, but it has been open almost continuously. I think the leveraged finance market or private credit and ordinary financing in public credit markets has become more available. The rates have moved, obviously, fairly significantly, but I think especially the private credit market has become pretty aggressive in seeking out transactions. Rates and terms are difficult, and that's what makes transactions still pretty fragile. I said the activity level has picked up fairly dramatically, but the ability to close those transactions is going to be affected by the difficulty of getting financing that allows deals to make sense on a financial basis. I think across regions, the US has probably loosened up the most. Europe is probably still a little more difficult. And in sizes, I don't see a big difference through sizes, possibly the mega deals, the mega deals we have to write a very large check are probably still more difficult to do. But I think through the smaller to mid-cap to the higher end of the mid-cap range, I don't know that you see a big difference in availability.

Okay. Great. Thank you. And then just a follow-up on the private credit element. You mentioned private credit is more accessible, what portion of deals do you think or do you see that are accessing private credit today versus maybe go back a year ago? How much more available is or how much more are you seeing private credit use today than in the past?

Ken, I'm going to answer that. It's funny you say on deals. What's really interesting about private credit is they've become a solution to balance sheet problems and complex arrangements inside companies. M&A is going to be the driver of the substantial part of the recovery in our earnings. But there are significant balance sheet problems that have to be addressed, ratings agencies, maturities. And so when you asked me that question about private equity, they're improving their share significantly of the deals themselves, but I think you're actually seeing them show up in almost what I call the liability management side of the world, solving problems that touch on both our M&A, but more on our capital markets and restructuring, and they're stepping into a very large role in that area. I think you're going to see them be very aggressive in that.

Good afternoon and thanks for taking my question. Ken, I just wanted to take the other side of this M&A recovery debate, given your perspective on the issue over so many cycles. When you think about this cycle, what are the biggest risks that you worry about in terms of what could slow down or impair the M&A and capital markets recovery?

Cost of capital difficulty. Look, I'm not calling the bottom of the cycle. It is interesting to me that about six or seven weeks ago, and I think it was right around the time the market got convinced the Fed was going to skip a rate increase. The active skipping sort of implies that you're really closer to the end than the middle. Our new business review committee, that's the first stage of us seeing deals jump rather significantly. And again, I know the gut feel we have around the organization is that we are as busy as we've ever been. Now I do think that pipeline, those new business or committee submissions in which people are going to attempt a transaction are probably as fragile as they've been, and that goes to your question, which is you have still a difficult regulatory environment and the capital cost to complete a transaction are difficult, expensive and uncertain. So the act of trying to get across the bridge from wanting to transact, and having an idea of what I want to do to completing it is very different than, let's say, our new business activity jumped almost more than it did in number of submissions in the early parts of the 2021 rebound. The difference then was the Fed was on the way to zero interest rates and money was flowing through every possible opening into the market. I still think today, money is difficult. How those two things will organize themselves and how they will resolve will determine whether this cycle takes off.

Okay. That makes a lot of sense. Maybe you could just speak to the sort of activity that you're seeing in restructuring this quarter. Has your view of the opportunities that changed in restructuring given the somewhat better macro backdrop in certain parts? And then maybe if you could contextualize what percentage of revenue was from restructuring. I know you've given that various points historically.

We experienced a notable year-over-year and quarter-over-quarter rise in restructuring. It represents around 20% of our total revenue pool, and our backlog in restructuring has also increased significantly, as reflected by our monthly retainers being up by about 70% to 75%. These retainers are typically strong indicators of our upcoming success fees in restructuring. I believe our backlog in restructuring is robust and continues to focus on liability management. Unlike the financial crisis of 2008-2009 when cash flows plummeted and companies needed to fully restructure, the current environment is more about managing liabilities. Recently, we announced a transaction for Carvana, which serves as a clear example of liability management. This trend continues to drive our restructuring efforts, which we now refer to as Capital Advisory. While EBITDA cash flows and revenue are not drastically declining, they may not be sufficient to meet maturities or provide refinancing options in this market.

Good afternoon. This is Brendan O'Brien filling in for Steven. I just want to ask on the M&A inflection. While the green shoots that you and your peers are citing are encouraging, given the lag between deal processes getting launched to announcements to the actual fee events, it feels like revenues will not be in to pick up in earnest until 2Q realistically of next year. Would be great to get your perspective on when we could actually see this underlying activity begin to hit revenues in your view if we continue along this more positive path. And if the softer revenue environment persists beyond 1Q of next year, how we should be thinking about the comp ratio?

Again, compared to 2021, that didn't happen, especially when financial sponsors return because the time from transaction to completion is much quicker. You're correct about strategic transactions; if we were to engage in discussions or reach an agreement today, it could extend into the first quarter. However, many private transactions tend to occur much faster. I agree with you. I don't think that will happen because financing those transactions is more challenging. Investors aren't freely providing funding, and access to capital isn't the same as it was in the previous interest rate environment. It may take longer. However, if this truly is the beginning, and again, I'm not asserting that, there seems to be a sense that some companies have been waiting for about 16 months and are now eager to implement their strategic plans; they have the capability and are ready to act, whether that means selling or acquiring a division. On the flip side, there are companies that feel pressured to take action. They may have waited a long time, with the environment remaining unchanged, pushing their motivation to act. But if this marks the beginning and a new business review committee environment comes into play, I don't anticipate it should take too long, although it could. If it does, we'll need to assess what the revenue situation looks like then for our compensation ratio.

That's great color. Thank you, Ken. I want to just touch on the dividend really quick. You're able to build cash this quarter despite the negative earnings trend, which is encouraging, but cash remains at fairly low levels from a historical perspective. The biggest source of cash strain comes when you pay out bonuses in 1Q of next year. Given the revenue environment is likely to remain at least relatively subdued over the next couple of quarters; I want to get a sense of how confident you are in your ability to sustain the dividend from here?

I see no problem with the dividend. Again, I think we've improved the go-to-market of the firm significantly with what I call a significant restructuring of our market-facing managing directors. We have no debt, and we have $190 million plus of cash on the balance sheet. So I don't see any problem with the dividend.

Hi, this is Ben Rubin, filling in for Brennan. My first question is based is kind of similar to the follow-up that you just got regarding capital. The environment remains challenging. You guys have $195 million of cash and liquid investments on the balance sheet and have been very successful in recruiting. Would you be willing to take on external funding or debt to help fund your growth aspirations and/or continue to fund the dividend at these levels if it came down to that?

Yeah, those are two questions. To fund future growth, yes, but we have $190 million in cash right now. By the way, there is another liquid investment that you didn't include in that. We have 23 million shares of an investment we have in our Australian subsidiary that's not completely liquid, but it trades and is a source of capital if we ever needed it. We have not discussed really going into debt to do either of those two. Look, if the right opportunity came along, given we have zero leverage, would I go into a line of credit for a couple of million dollars to accomplish something that would change the nature of the organization going forward for the next decade? Yes. But I don't see a reason why we have to do that given our profile.

Got it. No, that makes sense. And then my follow-up is also related to the comp ratio, 80% you guys just gave. It's a result of the success and the recruitment and the 19 MDs obviously already hired and two more additional come on. Question for you is, what type of impact do those additional hires, especially at the senior level, have on the different components of your fixed comp expense? Are you making any adjustments to your approach regarding incentive comp or your policies because of the higher amount of fixed comp relative to those new hires? Thank you.

No. Our approach to compensation will stay the same. We significantly exceeded the compensation ratio. The reasoning behind this is that our new investment in 20 additional Managing Directors benefits our equity investors. I believe they shouldn't bear the cost of this investment from their current outputs. If that happens, we may struggle to retain our current Managing Directors. Therefore, we chose to divide how we compensate existing Managing Directors for their contributions while allowing for expansion. I hope this will lead to a unified team within 12 months, where everyone is a continuing Managing Director. We are quickly seeing this evolution. Our technology backlog has greatly improved, and we are already announcing deals as a result of the recent addition to our tech team. I'm pleased with the results we're observing in real time.

Hi, good afternoon. This is actually Connell Schmitz stepping in for Ryan Kenny. My first question is on the backlog. Can you size the backlog versus the call back in April? And then on the SEBI-related mandates, is there any sizing to the number of deals and volume of deals associated with that revenue sharing agreement?

On the backlog, our gross backlog is up pretty decently from the last earnings call. The gross backlog is also up near the highest levels it's been. I handicap that as having more fragility to completion. So I don't want to say the two numbers are completely comparable given the environments. What was your second question again?

It was just on the SEBI-related deals. We know there's a revenue sharing agreement with the 40 or so bankers that came on. Is there any way to size the potential deal flow that could come from that?

There's confidentiality related to that.

As Joe said, we will actually call them out when they happen, so you'll see them on a real-time basis.

That relates to my follow-up question as well, I guess, on the non-comp. We have non-comp over $43 million this quarter. That's an all-time high. Is that the new run rate we should expect? And can you follow up on any puts and takes that will affect that number from here?

Yes, in my opening remarks, I indicated that $43 million included $2 million of transaction-related expenses, which I can't predict. I look at the underlying run rate of $41 million this quarter as persisting at $41 million to $42 million absent those transaction-related costs.

Hi, Ken. Hi, Joe. How are you?

Hi.

Good. Referring to Slide 17 in your presentation, I appreciate the way you've framed it. You illustrate all the fee pools and your market share. It's clear that technology represents the largest fee pool, yet Moelis has the smallest market share in that area. As you noted, you’ve approximately doubled your client-facing managing directors and now have 15 MDs in that category. I'm curious about how that sector might evolve in a recovery scenario. Would the combined efforts here yield results greater than the sum of its parts, especially since you often connect through your sponsor network or the other way around? There might be opportunities for increased revenues beyond what each individual unit could achieve, and you're potentially bringing in a group that's as large, if not larger, than what you had before. I’d love to explore that further; I know it's not an exact science, but any insights on that would be appreciated.

Yes, a couple of things. First of all, I talked about it as double because I rounded it, but it's actually 2.5x. We had 10 managing directors, and now we have 25. It was very hard to build up a tech effort one person at a time. It goes to your 1 plus 1; does it equal more? If you don't have enough expertise to make yourself important, especially the group that we hired was much more sponsor driven. In fact, they were almost 100% sponsor-driven. Our group prior to that was almost 100% strategic driven. You can imagine, first of all, the cross flow of information between those two is very helpful to drive new business. My goal in this is to be as important to what I think are our largest growing fee pools in M&A globally, which will continue to grow and be very significant. I do think there's a benefit to being an important supplier to them of quality idea flow throughout the organization. They are all tracking it and looking for important suppliers. There's always a decision to be made on the allocation of some transaction. The transaction might be in homebuilding, and your tech team might have shown them 10 good ideas, none of them executed upon. But you'll get leaned in on some other part of your organization because as a firm as a whole, you are important and a very significant supplier of idea flow. The answer to that is, yes, I do think that one plus one should equal more than two in that event, especially with sponsors, who are a large corporation that transacts in multiple different spaces that I think has become very sophisticated in keeping track of how you're calling on them.

Okay. Thanks, Ken. I'll leave it there. Appreciate it.

Well, I appreciate the support and everybody getting on the call. I look forward to talking again in three months.

This concludes today's conference call. Thank you for joining. You may now disconnect your lines.