Moelis & Co Q3 FY2024 Earnings Call

Good afternoon, and thank you for joining us for Moelis & Company's third quarter 2024 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 $281 million of adjusted revenues in the third quarter. Our adjusted revenues for the first nine months were $763 million, up 18% from the prior year period. The year-over-year increase in revenues for the first nine months of the year is driven by growth across all major product areas, and our year-to-date revenue distribution remains approximately 60% M&A, 40% non-M&A. Moving to expenses. Our third quarter compensation expense was accrued at 75% consistent with the first two quarters. Our non-compensation expenses in the third quarter were $48 million, and we expect a similar non-comp expense result in quarter four. Moving to taxes. Our underlying corporate tax rate was 34%, consistent with the prior quarter. Regarding capital allocation, the Board declared a regular quarterly dividend of $0.60 per share consistent with the prior period. Lastly, we continue to maintain a strong balance sheet with $298 million of cash and no debt. I'll now turn the call over to Ken.

Thanks, Joe, and good afternoon, everyone. We've seen gradual improvement in the M&A market throughout the year. Equity market valuations are at or near all-time highs. The Fed has changed course and appears to be committed to lower interest rates, although the pace may be up for debate. At the same time, rapid innovation driven by technology fuels the need for M&A, and these factors suggest we are getting closer to the next upcycle in M&A. In our capital structure advisory business, we continue to experience elevated activity and engagement with clients. We anticipate a prolonged restructuring cycle centered around liability management exercises due to a large amount of non-investment grade debt maturing in the next few years. Turning to capital markets. The rise of private credit has allowed us to compete with the legacy banks on arranging capital for our clients. This market actually appears to be larger and developing more rapidly than we had anticipated. We were early to identify, and we have invested in this secular trend. We continue to experience strong demand for structured capital solutions, as issuers look to grow their businesses or to refinance upcoming maturities. Turning to talent. We recently added a biotech MD who is set to join the firm next month. Our recruiting efforts remain active, and we will continue to selectively add talent in areas of key strategic importance to the firm. Our expertise across products, sectors, and regions has deepened, allowing us to deliver even more impactful, independent, and conflict-free advice. We are well-positioned to drive long-term growth. And with that, I'll open it up for questions.

First question just on comp ratio, kind of near-term and then intermediate-term. Revenue is up 18% year-to-date. I think comp expense is up about 7%. You're already seeing some leverage there, but obviously backlogs appear to be building. I'd just love to get some sense around whether you feel like there might be some positive leverage in the fourth quarter off of this 75% level? And then, how we should think about that relationship into 2025? Should we still think about kind of that guide that you guys have been previously given every, I think, $100 million or so is four to five points? Just how we should think about that connection as we look into 2025 and beyond? Thanks.

I'm going to ask Joe to reiterate, because I think we think the model that we gave you, that kind of algorithm works. And your question about the fourth quarter is, yes, dependent on the fourth quarter revenue. This market continues to show signs of having energy behind it and having a desire or again, I've said this, I think, two or three calls now, but our pipelines continue to be at all-time highs. Our announced transactions are at all-time highs. The amount of activity is very significant, and yet the time to complete the transactions continues to be longer than you'd see in a full-scale bull market. I just don't think we've seen the increase in the speed to market that we might have thought we saw when the Fed first started to move rates. So, yes, the answer is, there is leverage, and I hope the fourth quarter continues on the pace of improvement that we've seen. I think I'll turn it over to Joe for a second, but I think the algorithm he gave you on four to five points per $100 million still holds true.

Yes. I think that's right. It does, barring any significant hiring phase, which we don't expect at this time. I think that the algorithm is still relevant.

Okay, great. That's helpful. And then just a follow-up, Ken, just on the interplay M&A with interest rates. Obviously, we've been talking about rates coming down as a catalyst, but we just had one move, right, and it was recent. We're still pretty far away from, I think, what many people consider a neutral rate. In terms of sponsor reengagement, do you think we need to kind of see where rates settle out to really see reacceleration, or is this just, the rates coming down, people see the writing, and so they're starting to try to progress things with the expectation that by the time you're actually getting to closing a deal, rates will maybe be closer to that neutral rate? I'm just curious kind of how that interplay is working out based on the first move we've seen.

A lot of that question anticipates that I know exactly what the neutral rate is or what the Fed does. Interestingly, the 10-year probably disagrees with you and has moved in the other direction. Maybe that's causing some of the slowdown. But I believe the entire system will move in unison. We find that the sponsors are engaged, which is very different from about 18 months ago when the default assumption was that we weren't going to do anything. It felt like we were just waiting for something to happen. We are currently having active discussions regarding various topics, including liability management, private credit placement, and M&A. There's a lot happening. I still think one of the missing elements is that there are many sector partners in private equity and other sponsors who are actively pursuing ideas and potential transactions. Ultimately, this is submitted to the investment committee, and it may be the slow pace of replacement capital that is holding things back. The entire system hasn't fully resumed where everyone feels they can go out and raise another fund. Somewhere between the transaction partner and the firm’s decision at the investment committee regarding capital allocation, things seem to have slowed down a bit. The exact opposite occurs in a bull market; in 2021, everything accelerated smoothly to completion. It could be that if the Fed continues to lower interest rates, that may restart the whole process, but I think it's a system that needs to move together.

Hi. Good afternoon. This is sort of a pie-in-the-sky question as well. If you go back to the beginning of the year, Ken, you were optimistic about the outlook for M&A; you're still optimistic about the outlook for M&A. At the beginning of the year, you mentioned that Moelis' pipeline was at record levels; we're still at record levels, and the S&P is at sort of record highs. But M&A, the recovery has been fine so far; you called it gradual. If there are no surprises, nothing out of left field, so to speak, could 2025 just be another kind of so-so year, better than '24, but maybe disappointing relative to high expectations? If we have our chat a year from now and activity was so rather than great, what are the likely drivers of expectations that a reality that falls short of expectations next year? Is it just rates? You mentioned that a lot of things are working together. What else sort of comes to mind on what could drive a mediocre rather than like a really healthy recovery in activity levels next year?

That's a great question. I'll clarify my earlier thoughts. I believe that 2025 will be a good year, likely falling between good and very good, assuming no unexpected external factors arise. Activity levels are increasing, and the current environment is noticeably different from a year ago when we weren't seeing the same level of optimism and engagement. One key factor that could impact this is the ability to raise capital in the Limited Partner market. For instance, if there's a new fund available after the previous one, that might depend on capital allocation and whether the last 25% of existing capital can be utilized. This situation may be linked to interest rates, which have certainly influenced the flow of capital, especially into private equity alternatives, while private credit options have gained traction. If I could measure the health of that market, the reallocation of capital back into private equity would likely be the most telling indicator of whether we'll see a mediocre recovery versus a robust one.

I appreciate your thoughts. Thanks much.

It's a bit of an unusual environment for sure, but as we're thinking about the coming quarter, do you expect that we'll be seeing the typical seasonality and a stronger fourth quarter than what we've been seeing here year-to-date? Is the seasonality you think still something we can count on?

Again, I don't want to guide, but yes, the business seems to feel and I'm not sure it's totally about the seasonality as much, as there'll be some deals that always try to close in fourth. That's the little bit of seasonality as people rush to close at year end. But the business also seems to be gradually getting better each quarter, somewhere between a gradual or mediocre recovery every quarter. That could change. By the way, we're going to have an event here in a couple of weeks, elections. I think what Powell does after that. There's a lot of things that could accelerate that. So it feels like things are improving. Let's put it that way. I'm not going to try to guide to a number. And then, I think there are things that could accelerate that.

Okay. Yes, wasn't trying to fish for a number, but thanks for that, the high-level commentary. If we end up seeing some seasonality then and the leverage, as Joe just endorsed earlier on the call, and we have a decent fourth quarter here, it sounds as though you're implying that the 75% comp ratio that we saw in the first nine months, that's not necessarily the way we're going to shake out for the year, and we have to see how solid the fourth quarter can end up being before we can make that call. Is that fair?

Yes. What we look at is what does the run rate as of today get based on this market indicate. And I think that's the conservative way to think about it. If the market gets better, then the comp ratio will get better.

Good evening and thanks for taking my questions. I guess to start, I just wanted to talk about headcount. While your MD count is down slightly year-on-year, your employee count is up nearly 20% with a fairly significant increase quarter-on-quarter in 3Q. I just want to get a sense as to what drove the big step-up in headcount. Is it simply because you need to fill out some of the teams after the significant recruiting done over the past few years or something else?

It's a combination of factors. We believe our ratio of staff to managing directors is somewhat over the ideal, but part of this is due to recruiting senior talent in certain sectors while also retaining junior talent that we value. This situation may create a slight distortion as we hold some teams in readiness. For instance, we recently announced the hiring of a senior biotech banker. These ratios may appear impacted by having a capable team that's not yet at the managing director level, alongside the new MD we plan to add. Additionally, the compensation ratio plays a role. As the timeline for deals extends and our backlog remains, we do not abandon these opportunities. We still have the deals we anticipated six months ago, as well as those we plan to execute in the upcoming months. Consequently, the drawn-out pipeline and backlog, along with the longer durations needed to finalize deals, contribute to an increased headcount because we can't simply disregard these opportunities. We must continue serving clients whose transactions we initially took on 18 months ago and have not yet completed, which is a challenge as our pipeline grows.

Yes. And just one correction, Brendan. I'm not sure what figure you're looking at, but year-to-date, I think we're closer to 12%, not 20%.

I was looking at a year-on-year, Joe. Because I wasn't sure if there was some seasonality in terms of like summer hiring and alike. But yes, no, that all makes sense, Ken. I guess for my follow-up, I just wanted to touch on capital allocation and specifically whether you would consider doing an acquisition to accelerate growth. I know it's something that you've not been interested in previously, but given where you and your peers are trading today, it feels like there could be some interesting opportunities out there to leverage your multiple to do some accretive acquisitions and accelerate growth. Just want to get a sense as to how your thinking has evolved here, if at all?

I'm not. I've never been 100% against acquisitions. There's never going to be I don't see a way that a large M&A deal happens. By the way, I again, I'm a function of where you've grown up in the world. I was at DLJ when Credit Suisse merged. I don't think I can ever do a transaction of that magnitude. What we did with SVB, in my mind, was as close to an acquisition as you can get. We took 50 bankers out without doing an acquisition. I think there are that type of a situation where you might have to accomplish it through, as you said, a purchase. I'm not averse to that. If it makes sense, if it's the right price, if it's the right culture, I think they're very difficult to do. I think the earn-out method of buying those comes with risks. They don't show up for five years. I know that can make your financials look good. I think at the end of 5 years and when earn outs run out, I've seen what can happen. Again, I'm not adverse to it. I'm not saying I won't do it, but it would look and feel much more like an SVB type of thing than it would anything dramatic.

I just want to maybe follow up on the comp ratio discussion. How is the competitive landscape in terms of hiring? Are you finding that the fiber talent is getting tougher and resulting in the need to pay up? And are you also finding a need to pay up to retain your talent? I guess I'm just trying to figure out if there's potentially some more structural pressure on the comp cost as we start to think more about 2025. And of course, I appreciate the comp ratio algorithm that you guys have laid out, but just trying to think about that dynamic right now.

I would say, it feels fairly stable over the last, really 18 months. I think there are people available. I think the market has quieted down a little, but as in all markets, there's always going to be 5%, 10% of people who want to move for whatever reasons. I think the large banks continue, especially with this pressure on what I call as, again, is just any remuneration of lending from going to private credit. I think the regulators have our intent on pushing risky credit off of the major bank's balance sheet and into the private credit market. I think that's what's driving that market. And as a result, I think bankers who would tend to have gone to those banks in order to be able to provide, I call it off-market credit or better credit are going to become more and more available. But I think it's been stable. I mean, it's hard to say, overall, if you go for certain segments and there is a shortage in that segment, you could find some pressure. But I think talent is available and it stayed about, look, the market's been pretty flat. I think the cost of acquisition has been pretty flat for 18 months.

Okay. Great. Just change gears and talk about restructuring. How has activity been holding up there? And when we think about the next 18 months, how do you expect restructuring activity to progress? And what will be kind of the interplay between, call it, traditional restructuring and liability management?

I believe we will focus more on managing liabilities rather than undergoing a restructuring, as the capital markets are currently accessible. Typically, Chapter 11 financial restructuring is pursued only when facing maturity without other options, making it a last resort. Right now, there is aggressive funding available, with risk-oriented capital willing to help create solutions and extend maturities. Additionally, the liability management exercises we are conducting are quite advanced, with major institutions ready to analyze and engage. If a company has a viable business model, these institutions generally provide support. Therefore, I expect liability management to be the main aspect of what we consider restructuring, and I anticipate this will be a gradual and ongoing process. The credit market has expanded significantly over the past seven to eight years, and the amount of restructuring and liability management correlates directly with the volume of issuance from two to four years prior. There will always be a certain percentage of issues, and as the market grows, so too will the liability management sector.

Ken, maybe just a follow-up on your M&A comments or large team lift-outs. Curious how you would characterize appetite for not just like traditional M&A bankers, but maybe some of the non-M&A capabilities. Obviously, private capital advisory and primary fundraising as well are areas that come to mind that some of your competitors have been a little more aggressive in kind of growing. Any appetite there? Do you guys have ambitions to grow in those verticals?

Yes. We have strong ambitions to be involved in that area, as we consider it important. Our goal is to become the most valuable provider of services to the private equity sector and alternative private credit as well. We're evaluating this opportunity. If it materializes, it could resemble something like a special purpose vehicle, in terms of size and structure, and it may also lead to opportunities in mergers and acquisitions or talent acquisition.

Got it. I appreciate the color there. And maybe just a follow up on Brendan's question about kind of headcount more on a sequential basis. It looks like the MD headcount decreased by 5% quarter-over-quarter. Anything to call out there? It just seems pretty elevated, but I know there can be some noise here and clarifications. So I just want to clarify.

Yes. I think what happens is those might have occurred four, five, six months ago. Some that are voluntary or we might give people time. There's also a garden leave if somebody would leave. So I think those are a result of things that might have happened in and around bonus time or after right around that time, where I'm not saying they're all managed, but we manage our headcount. Some of them are not on our things we promote. But I do think that's what happens. It takes time, sometimes four, five, six months for an exit to show up in your headcount.

Just on the comments around longer lag to complete transactions. Can you just give us an update on what's still driving that? Is it all regulatory-driven? Is it just a longer vetting process? And do you expect that lag to normalize as the cycle picks up and sponsors start coming back and forth?

It can be a combination of factors. In public markets, it might involve some regulatory issues, whereas in private markets, regulatory aspects are usually absent in private equity. However, the dynamics are quite intriguing. Large organizations and sector partners might find our product appealing, but the transaction process can be lengthy. Once it moves within the larger organization to their investment committee, it may not align with their capital needs, fundraising timelines, or exit strategies. Various factors influence how private equity positions itself, such as available capital in Fund I and the timing for launching Fund V. During the bull markets of 2020 and 2021, the focus was on completing transactions as quickly as possible to facilitate subsequent fundraising, yet the current fundraising market has been sluggish. If M&A has been challenging, the fundraising environment in private equity was particularly slow in 2023, though there are signs of improvement in 2024, with hopes for a better outlook in 2025. The uncertainty around these projections tends to slow down the process, which contributes to the overall slowdown. It's also important to note that the situation isn't solely tied to deals; sometimes projects are initiated, due diligence is completed, and then they are paused for several months. This is not purely due to regulatory issues, market conditions, or interest rates; it's a multitude of factors that converge, especially when markets are volatile, interest rates are fluctuating, and funding from private sources is unpredictable. So, it's really all of the above. Australia has been a significant focus for us since we started our partnership there, which initially was advisory in nature. They have been very entrepreneurial and established a noteworthy public company in the financial sector. This came about through a reverse inquiry; they reached out to us after going public around four years ago. They indicated they had a buyer for five million shares, and we decided to proceed with it, benefiting both parties. We continue to engage with them regularly and co-advise on any developments in Australia, making this a vital alliance for us. We have no intentions concerning other stocks that were also reverse inquiries that we executed.

I think we've seen a couple of recent successful sponsor IPOs. Is that something that's starting to come up in your dialogues with private equity and do you think that's something that could lead to more activity either in ECM or M&A in that part of the market?

I think there'll be more sponsor IPO. Some of the transactions are large enough that finding an exit buyer is difficult. Very successful large buyouts end up having even larger exits. The IPO market, I think, is an obvious place for them to go. Look, again, with the stock market at all-time highs and interest rates coming down, you would expect to see an IPO market develop. It's actually kind of strange. Nasdaq is at all-time high. It's kind of strange that there is no IPO market. I think if people come to market with the right price and quality product, there will be an IPO market and people will take advantage of it. Yes. I think M&A was about 60% and all the other was about 40%. That's been pretty consistent throughout the year. Thank you very much. Appreciate it. Look forward to talking to you after the end of the year.

This concludes today's conference call. You may now disconnect.