Moelis & Co Q4 FY2023 Earnings Call

Good afternoon, and thank you for joining us for Moelis & Company's fourth quarter and full year 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 to discuss our results.

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 $215 million of revenues in the fourth quarter, an increase of 6% versus the prior year period. For the full year, our adjusted revenues of $860 million were down 11%. The revenue declines were driven by a decrease in fees earned from M&A, partially offset by an increase in restructuring and capital markets fees. Regarding expenses, our full year compensation expense ratio is a little less than 83%. As a reminder, our first quarter compensation ratio will likely be elevated as a result of retirement eligible awards, which are expensed at the time of grant. For the full year, we reported a non-compensation ratio of approximately 21%. As a result of our MD headcount expansion, underlying non-comp expenses will be in the $45 million to $46 million range, beginning in the first quarter, excluding transaction-related expenses. As many of the annual vesting of RSUs will occur later this month. For purposes of quantifying the excess tax benefit, we expect the impact to EPS to be approximately $0.01 for each $1 difference between the vesting price and adjusted grant price of $39 a share. Regarding capital allocation, the Board declared a regular quarterly dividend of 60 cents per share, consistent with the prior period. And lastly, we continue to maintain a strong balance sheet with $349 million of cash and no debt. I'll now turn the call over to Ken.

Thanks, Joe. Good afternoon, everyone. While 2023 was a challenging year, we played strong offense and aggressively expanded our business. During the year, we hired 24 and promoted eight managing directors. Many of these new MDs are focused on the most significant global fee pools, including technology, industrials, and our clean technology group. While we expanded our new MD population by approximately 20% during the year, our total employee headcount grew just under 5% as we actively managed our headcount. In early 2024, we promoted seven bankers to MD and have hired three. One hire enhances the firm's coverage of credit funds, and two managing directors we'll join in the coming weeks are focused on upstream energy. While we will selectively add talent in areas where we see meaningful fee pool opportunities, this year we expect to be primarily focused on delivering our expanded expertise to our clients. It's difficult to predict when the M&A environment will fully rebound. However, the Fed's messaging has eliminated the tail risk of future rate hikes and brought into view a high probability of rate cuts in the coming year, which I believe will give rise to an increase in M&A activity. We're seeing early signs of an improvement in sentiment as expressed in our pipeline, which is near record levels at the beginning of the year. Barring unforeseen events, I'm confident that we have seen the bottom of this M&A cycle and that we have positioned the firm well for the coming uplift. With that, I'll open it up for questions.

Great. Good evening, Ken and Joe. I guess I just want to start on the sponsor backdrop. Clearly, a very challenging market in 2023. I think sponsors had their slowest year of announcements since 2013. So, just want to get your thoughts on what do you think a recovery for sponsors could look like? Do you think it's going to be a slow build? Do you see it snapping back? And just really how you see it developing maybe in the next two years relative to 2023. I can appreciate you're now in some sectors like technology in a bigger way as well, so potentially get a bigger snapback. But just love to get some thoughts there. Thank you.

I believe the recovery will be gradual, influenced by when rate cuts occur. These cuts will likely provide momentum as they happen. It's important to remember that only a few months ago, a major bank CEO stated that the community was unprepared for a 7% federal funds rate and emphasized that this scenario was a possibility. Back then, a significant hedge fund was betting against the 30-year Treasury, arguing that the government needed to issue so much debt that rates couldn't possibly decrease. Today, the conversation has shifted entirely to how swiftly we can pivot in the opposite direction, with almost no one discussing the dangers of high rates. I anticipate this will encourage a surge in deal activity. The timing of when rate cuts happen—whether in March, May, or June—will be less significant than the prevailing belief that they are forthcoming. We're unlikely to confront a 7% federal funds rate that could jeopardize deals made last year. We can already see signs of this shift building. Most players are trying to determine the optimal time to enter the market. The private equity sector tends to be more sensitive about timing their investments in mergers and acquisitions compared to strategic investors who usually focus on long-term commitments. In summary, I expect a gradual buildup from this point onward. There's a saying about progressing slowly before accelerating, though I can't recall the source.

Yep. I fully understand. Thank you. And just to follow up on the other business and restructuring, yeah, obviously some optimism around I think the resilience and restructuring and hearing that through numerous earnings calls. You guys noted a year-over-year increase in the press release in that business. And so obviously 2023 had pockets of strength, but it felt like the mandates were building, and so therefore there should be some acceleration in revenues in 2024. So I just want to kind of get a sense of how you're thinking about the trajectory of restructuring. And then perhaps your comment on M&A, as the Fed starts cutting, how that could accelerate M&A, maybe more than people think. Do you think that the Fed cutting could actually surprise people on the kind of fall-off in restructuring just as kind of conditions loosen and it's a better environment? Or do you just think that the maturity walls and just a high absolute level of rates is the biggest driver? So I just want to drill in there a little bit. Thank you.

Going into the year, we think restructuring will be up and because of the size and the scope and how long and the impact of higher interest rates. But look, if the Fed were to cut and begin to cut aggressively, I do think that that would cut off a part of the restructuring market. Look, that's why we built up capital markets so strongly. Most restructurings in this market are very close to being financings. It's a matter of liquidity in the market terms and outlook on financials, but there is nobody in the market who wouldn't rather do a financing than a liability management exercise or restructuring. So, yes, the speed and the aggressiveness with which the Fed addresses the market would definitely change the outlook for restructuring. I still think there’s a fundamental number of companies that are under pressure due to interest rate pressure. But I think it would do a lot to damage the maturity wall if the Fed actually began a whole series of things like, right now we have quantitative tightening. So they could do a bunch of things that would just make credit available and push out a lot of that wall.

Yeah, I understand. OK, thanks Ken. I'll leave it there.

Hi, good afternoon. Thanks for taking the question. Maybe for Joe, I wanted to dig into the compensation ratio and how most of this compensation could react to different environments. So most generated about $860 million of revenue last year, a compensation of $711 million. How clean is that $711 million? So you did a lot of hiring throughout the year. If you generated $860 million of revenue again, I guess maybe first, what does comp look like in that environment for 2024? And if the environment improves and revenue goes higher, how much of the incremental revenue actually gets paid out in compensation from here? So if you make another million dollars of revenue, how much goes to employees? How much goes to investors?

Yes. So the best way to think about it is, I'd say for every $100 million increase in revenue from the $860 million starting point, we're looking at kind of four to five points of comp leverage. So, in other words, if we go from $860 million to $960 million, I would imagine that 83 would turn into 78 to 79. And that progression would just happen along that route until we got to kind of 60 areas, at which point I don't think it goes much around. It doesn't go beyond that.

OK, great. Perfect. Thank you. And then just, again, another simple one for you, Joe, on the balance sheet, what was the compensation payable at the end of the year? And then how much of that payable is satisfied in cash?

Well, the compensation payable is satisfied in cash. I don't have that balance at my fingertips, but that'll be in the K in the next couple of weeks.

Good evening. Thanks for taking my questions. Would love to hear you touched on this a little bit in the prepared remarks in giving a little texture about restructuring. But is it possible to get the breakdown of advisory revenue for 2023 and the fourth quarter as far as restructuring and capital markets and how much that represented?

I believe that for the full year, restructuring has been in the mid-20s, while when we combine it with capital markets, we see a figure in the mid-30s. Our perspective is that we view capital markets and restructuring together because if you can convert a restructuring into a capital market solution, it demonstrates success for your client. The aim is to refinance debt effectively and facilitate its transition. I think the combined annual figure is what I'm referring to.

Yes, a little higher than the mid-30s. But that's, directionally right.

Mid-30s in 2023?

Yes, it's combined. Those two combined. So, 25 areas for restructuring, 10%, maybe 12% on the capital market side combined kind of 35 to 37.

Got it. OK, great. Thanks so much for that. And, Joe, in your comment on the comp leverage, which was helpful texture. Thanks for that. You indicated that bring it down to 60 and then stay there. Ken, when you went public, the general idea was that long term target for comp was 57 to 58. Is that now adjusting and now the new general standard or normalized level is more like a 60 number or is it that in for the next few years, given the quantum of recruiting you've done, it's just going to be a little more elevated and it might take longer to get down to that high 50s?

Now, I think what Joe said that it was our feeling and we'll see what happens, Brennan. But there's been fairly large inflation in the non-managing director, base go to mark, but base run the company vice presidents, associates. So I think our view is that might have eaten up a point or two of your overall ability on comp ratio. But again, where we still think we managed to a pre-tax margin that is 25% or better. That's what we're really aiming for. But we'll see what the competitive environment is and what's out there. But I will tell you that there was significant inflation in those ranks and as inflation is hard to get. It doesn't come back quickly, rid of it.

Thanks so much. I guess echoing Brennan's comments on the comp leverage sensitivity, Joe, that disclosure is really helpful. One of the pieces I was hoping to unpack is whether we should be contemplating that four hundred basis point improvement. If we can underwrite that in a linear fashion, which would suggest the path to low 60s might require revenue generation across the franchise somewhere in the range of about $1.3 billion to $1.4 billion?

I think that might be. Yes, that sounds maybe a little high, but reasonable.

You can get there with a lower revenue level.

Yeah, I think we can. I think we can get there.

Hi, good afternoon. This is actually Charles Smith filling in for Ryan Kenny. First question on the comp leverage. Just another detail. There would be one level of MD hiring and overall headcount. Are you assuming in that four to five percent comp leverage per one hundred million incremental revenues?

Yes, I mean, it's kind of reverting back to a more normal pace than what we've seen in the last two years on the hiring front.

Got it. And then as it relates to be like this quarter in particular, any comments on how that affected the income statement as it relates to revs and non-comp and then just go forward on non-comp?

Now, are you asking about Silicon Valley Bank? Is that what?

Yes, I'm not going to break it out. I just want to say that we think it has been very successful. The group has gotten off the ground quickly, and they didn't experience much downtime. Although it wasn't a great year and the fourth quarter wasn't ideal, we feel very good about the group and their ability to deliver results.

I guess said another way, should we expect an incremental drop off in non-comp as the transaction sharing agreement rolls off?

Well, again, what I described is pre-transaction was like the 45 area. And, that would exclude anything on the SBB fee arrangement, that ends this quarter. So it shouldn't be material beyond this quarter. If it's even material this quarter, actually.

Thanks for taking my follow up. I just wanted to try to drill down a little bit on the MD count because there's a few numbers around and it's a little confusing. You touched on it to some degree before in the prior question. But so the investor presentation says year-end MD is 157. For the press release, you've added 10 MDs, seven promotions, and then the press release also shows 160. So as of now, does the 160 include the two that have committed to join in the coming weeks? And was there in addition to there being some folks departing right around year-end, where there are also some folks departing early in the year? Or was that something else?

And so it's 160 today. That excludes the two that haven't arrived yet. And 157 refers to as of year-end. And as far as like, if you need like a whole reconciliation, let's do that offline.

Great. Thanks for taking my question here. Most have been asked, but I guess just wanted to maybe get a little bit more color on the kind of shadow bank backlog or your pipeline, the visibility that you guys have. So can understand that sounds like it will take a little time for the broad-based recovery in M&A to take form. But can you just maybe give us a quick update on what you are seeing behind the scenes? I think you sounded quite bullish two months ago or so when you characterized that pipeline. So just interesting to hear how that has evolved since. Thank you.

Yeah, I said early on in the call that our actual pipeline is right near all-time highs. And what's really again, I the end of the year last year between when the Fed was late November kind of put out this idea that you could take rate hikes off the table and just start guessing when rate cuts will begin. I think that was why I was bullish. I just felt like that's a statement that is very valuable to anybody in the deal business that you can eliminate the tail risk of a raise. But, you do go into the Christmas season. I feel like when we've gotten back to work in January, our new business review, which is where we actually determine whether we're going to take on business almost pre-pipe has been extremely active. So pipe is high. New business review has been quality and busy quality deals feels like much more real. So I think it's happening in right in front of us now. I think the build-up in M&A is beginning. What I do think you're going to see here a little bit is, private equity that it's very sensitive to when they enter and when they exit and try to maximize much more than a strategic will be. So I do think you're going to find a little bit of institutions trying to attempt to time this thing exactly right. But it feels like everybody's not everybody. A lot of people are stepping up to the starting line and getting ready to move. Right now, there is a large amount of transactions that are getting positioned to move. And since I don't think the next move is a rate hike, I just think that that means it's a question of when they move and not if they move.

Thank you for your question. Ladies and gentlemen, that will close our Q&A session here for today. Mr. Moelis, I'd like to turn it back over to you with any closing comments.

Well, I appreciate everybody's time. We'll see you on the next call. Thank you.

Thank you. Ladies and gentlemen, this will conclude today's Moelis & Company conference call. Have a great day. We'll see you next time.