Moelis & Company - Q2 2023

Transcript

Operator (participant)

Good afternoon. Welcome to the Moelis & Company Earnings Conference Call for the second quarter of 2023. To begin, I'll turn the call over to Mr. Matt Tsukroff. Please go ahead.

Matt Tsukroff (VP of Investor Relations)

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 Joseph 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 Regulation 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 Joseph.

Joseph Simon (Managing Director and CFO)

Thanks, Matt. Good afternoon, everyone. On today's call, I'll go through our financial results. 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 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 expense.

I believe that the run rate for adjusted non-comp before transaction-related expenses is closer to $41 million-$42 million per quarter on a prospective basis. Separately, we entered into an agreement to split certain fee amounts with SVB Securities in connection with our large tech hiring earlier this year. Fees owed will show up in non-compensation expenses only if designated transactions close. Nothing occurred this quarter. 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. Lastly, we continue to maintain a strong balance sheet with $194.8 million of cash and no debt. I'll now turn the call over to Ken.

Ken Moelis (Founder, Executive Chairman, and CEO)

Thanks, Joseph, 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, healthcare, and industrials, which together comprises approximately half of the global M&A fee pool. Including two industrials-focused managing directors who will join the firm in the coming months, 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. This is a trend that should continue. We consistently rank as a top advisor 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. With that, I'll open it up for questions.

Operator (participant)

Thank you. If you have a question, please press star one on your telephone keypad. If you have queued up for a question and want to withdraw, simply press star one again. Your first question comes from the line of Ken Worthington with JPMorgan. Please go ahead.

Ken Worthington (Analyst)

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

Ken Moelis (Founder, Executive Chairman, and CEO)

I'll start by bifurcating. The investment grade market, you know, has been fairly accessible and open, just, you know, rates have changed, but it has been open almost continuously. I think the leveraged finance market, both private credit and ordinary financing, you know, public credit markets, bank financing, 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, terms are difficult, and that's what makes transactions actually still pretty fragile. I said the activity level has picked up fairly dramatically, but the ability to close those transactions are 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 U.S. has probably loosened up the most. Europe is probably still a little more difficult. In sizes, I don't see a big difference through sizes. You know, possibly the mega deals, the mega deals we have to write, you know, a very large check are probably still more difficult to do. 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.

Ken Worthington (Analyst)

Okay, great. Thank you. Just to 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, you know, maybe go back a year ago? How much more, you know, available is or how much more are you seeing private credit used today than in the past?

Ken Moelis (Founder, Executive Chairman, and CEO)

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, complex arrangements inside companies. What's really happening in the market now is, yes, 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, you know, rating agencies, maturities. When you ask 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 the.

You know, again, I'll go to 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, and I think you're going to see them be very aggressive in that.

Ken Worthington (Analyst)

Great. Thank you very much.

Operator (participant)

Your next question comes from the line of James Yaro with Goldman Sachs. Please go ahead.

James Yaro (Managing Director and Equity Research)

Good afternoon. Thanks for taking my question. Ken, I just wanted to take the other side of this, you know, M&A recovery, you know, debate, given your perspective on the issue over so many cycles. When you think about, you know, 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?

Ken Moelis (Founder, Executive Chairman, and CEO)

Cost of capital, difficulty. You know, look, I'm not, I'm not calling the bottom of the cycle. I'm just, it is interesting to me that about six or seven weeks ago, I think it was right around the time the market got convinced the Federal Reserve was going to skip a rate increase. The act of 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, jumped rather significantly. Again, I know, you 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 review committee submissions in which people are going to attempt a transaction, are probably as fragile as they've been.

That goes to your question, which is, you have still a difficult regulatory environment, and the capital costs to complete a transaction are difficult, expensive, and uncertain. The act of trying to get, you know, across the bridge from I want to transact, and I have an idea on what I want to do, to completing it, is very different than you know, let's say our new business activity jumped almost. I think it jumped more than it did in number of submissions in the early parts of the 2021, you know, rebound, the beginnings of the 2021 M&A cycle. The difference then was the Fed was on the way to zero interest rates, and money was flowing, you know, through every possible opening into the market.

I still think today, money is difficult. You know, how those two things will organize around themselves and how they will resolve will determine whether this cycle takes off.

James Yaro (Managing Director and Equity Research)

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

Ken Moelis (Founder, Executive Chairman, and CEO)

We've had, we had a pretty significant year-over-year and even quarter-over-quarter increase in restructuring. It's still about 20% of our overall revenue pool. Our backlog in restructuring, I would say, jumped as much, which you can almost tell by our monthly retainers, which are also up about 70%-75%. Those are usually your best precursor to you know, your future success fees in restructuring? We have a strong backlog in restructuring. It continues to be more Liability Management. It's interesting, you do not have companies' revenues or EBIT cash flows falling like you did.

You know, again, I'll go back to the financial crisis of 2008, 2009, when cash flows just fell off a cliff, and everybody had to really go to what I'd call, you know, full-scale restructuring. Today, there's a lot of liability management. By the way, I know I always get asked on the call: What is liability management? I'll just point out, we announced a transaction for Carvana, about 10 days ago, and it's a good example of what liability management is.

I won't say you know, I don't like to talk about clients, but it is a very public example of liability management, and we continue to see that being the driving force around restructuring, which we now call capital advisory, because that's really what it's what it's becoming, which is, you know, EBITDAs, cash flows, and revenue aren't falling dramatically. They're sometimes just not enough to take care of maturities and in this market, provide refinancing alternatives.

James Yaro (Managing Director and Equity Research)

That's very clear. Thank you very much.

Operator (participant)

Your next question comes from the line of Steven Chubak with Wolfe Research. Please go ahead.

Brennan O'Brien (Managing Director and Equity Research Analyst)

Good afternoon. This is Brendan O'Brien filling in for Steven. To start, 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 announcement to the actual fee events, it feels like revenues will not begin to pick up in earnest until 2Q, realistically, of next year. Would it 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? If the softer revenue environment persists beyond 1Q of next year, how we should be thinking about the comp ratio?

Ken Moelis (Founder, Executive Chairman, and CEO)

Again, I, you know, compared in 2021, that didn't happen, especially when you're, when the financial sponsors show back up on the scene, because the actual time from transaction to completion is a lot quicker than that. Strategics, you're right. If we were to enter into a transaction discussion or even as a agreement today, that could take till the first quarter, but a lot of the private transactions go much quicker than that. I agree with you. I don't think that will happen, only because the financing of those transactions just is more difficult. People aren't, you know, I was going to say throwing money at you, but the access to capital just isn't what it was in the, you know, the old interest rate environment. It could take longer.

You know, I think you've extended if this really is the beginning, and again, you know, I'm not calling that, it just has a sense that there are companies. I, by the way, I think it's a bit of a barbell. There are the companies that have been waiting around 16 months, and now they want to execute strategic plan. They have the ability, and they're ready to execute, whether that be sell a division, buy a division, whatever. I think the other side of that barbell is a group of companies that have to do something.

That, you know, might have waited a long time. The environment has stayed where it is. The motivation for that group might be, "Have to do something." I think even that time frame, I hope does not. If this is the beginning and the new business review committee type of environment starts, I don't think it should extend out that long, but it might. If it does, we'll just have to look at what the revenue situation looks like then for our comp ratio. We've had a very unique confluence of events for our comp ratio. I mean, we caused it, I don't want to make it a passive thing, but we've hired 19 people, 19 MDs, managing directors, and two more to come.

It's a very tough revenue year. That confluence of events is causing us to, you know, have to recognize we've almost bought. If you think about it's almost like buying a 15% or 20% firm the size of us with 20 MDs. But we do run that through the income statement because we're hiring them each individually. There's nothing goes on the balance sheet. I think that the method by which we've set the organization up now, we've improved our facing and technology by more than double. We've improved our healthcare focus by 50%. These are by number of managing directors, and industrials by about 50%, and media and telecom by about 33%. I think that should come out in the revenue line, but that's to be determined.

Brennan O'Brien (Managing Director and Equity Research Analyst)

That's great color. Thank you, Ken. I guess switching over for my follow-up, I want to just touch on the dividend really quick. You know, 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, and the biggest source of cash drain is really 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, want to get a sense as to how confident you are in your ability to sustain the dividend from here?

Ken Moelis (Founder, Executive Chairman, and CEO)

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, you know, $190 million plus of cash on the balance sheet. I don't see any problem with the dividend.

Brennan O'Brien (Managing Director and Equity Research Analyst)

Great. Thanks for taking my questions.

Operator (participant)

Your next question comes from the line of Brennan Hawken with UBS Financial. Please go ahead.

Ben Rubin (VP and Equity Research Analyst)

Hi, this is Ben Rubin filling in for Brennan. My first question is basically kind of similar to the follow-up that you just got regarding capital. Obviously, the environment remains challenging. You guys have $195 million, you know, of cash and liquid investments on the balance sheet. You guys obviously 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?

Ken Moelis (Founder, Executive Chairman, and CEO)

Yeah, those are two questions. You know, to fund future growth, yeah, 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 Moelis Australia that's, you know, it's not completely liquid, but it's, it trades and is a source of capital if we ever needed it. We've not discussed really going into debt to do either of those two. If, you know.

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, I don't see a reason why we'd have to do that, given our profile.

Ben Rubin (VP and Equity Research Analyst)

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

Ken Moelis (Founder, Executive Chairman, and CEO)

No, I, you know, our philosophy on comp will remain the same. Really, the, I guess it did change a little bit, by the way, is that we did exceed the comp ratio by a significant amount. The philosophy behind that is that the new investment we're making in, you know, 20 new managing directors is a benefit, the beneficiary that should be the equity investors, the producing managing directors who are on the field. You know, my belief is they shouldn't have to pay for that investment out of their current production. By the way, if you do that, you won't retain your continuing managing directors or your, you know, for long.

We decided to kind of bifurcate it into how can we pay the existing managing directors for what they're producing and make room for the expansion. I hope that's a bridge to, you know, 12 months from now, when everybody is a continuing managing director and we're all one team. We are seeing it pretty quickly develop that way. Our technology backlog has improved dramatically. We're already announcing transactions from the SVB tech team hire. We're seeing it real time and pretty happy with the results.

Ben Rubin (VP and Equity Research Analyst)

That's great color. Thank you for taking my questions.

Operator (participant)

Once again, ladies and gentlemen, if you have a question, it is star one. Your next question comes from the line of Ryan Kenny with Morgan Stanley. Please go ahead.

Connell Schmitz (VP of Equity Research)

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? On the SVB-related mandates, is there any sizing to the number of deals and volume of deals associated with that revenue sharing agreement?

Ken Moelis (Founder, Executive Chairman, and CEO)

On the backlog, our gross backlog is up pretty decently from I forgot which date you asked. Last earnings call, I guess? Yeah, up pretty significantly.

Connell Schmitz (VP of Equity Research)

Yeah.

Ken Moelis (Founder, Executive Chairman, and CEO)

You know, again, to the question earlier on, the gross backlog is actually, you know, and I'm just talking, the gross amount of transactions we're hired to do is up near, you know, the highest levels it's been. I just handicapped that. I think in this environment, you have to handicap that as having more fragility to completion, and so I'm not sure the two numbers are completely comparable, given the environments. What was your second question again?

Connell Schmitz (VP of Equity Research)

It was just on the SVB-related deals. Like, we know there's a revenue sharing agreement with the 40 or so bankers that came on. Like, is there any way to size the potential deal flow that could come from those?

Joseph Simon (Managing Director and CFO)

I can't get into that. There's confidentiality related to that.

Ken Moelis (Founder, Executive Chairman, and CEO)

Okay, as Joseph said, as they, we'll actually call them out when they happen, you know, so you'll see them on a real-time basis. There is confidentiality.

Connell Schmitz (VP of Equity Research)

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? Can you call out any puts and takes that will affect that number from here?

Joseph Simon (Managing Director and CFO)

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

Connell Schmitz (VP of Equity Research)

Okay, that's helpful. All right, that's it. Thanks.

Operator (participant)

Your next question comes from the line of Devin Ryan with JMP Securities. Please go ahead.

Devin Ryan (Head of Financial Technology Research)

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

Joseph Simon (Managing Director and CFO)

Hi.

Devin Ryan (Head of Financial Technology Research)

Good. Looking at slide 17 in your presentation, I like kind of the framing here. You have all the fee pools and kind of your market share, and, you know, obviously, technology is by far the largest fee pool and by far the smallest market share for Moelis historically. Ken, as you mentioned, you roughly doubled your client-facing managing directors. You added 15 MDs in that group. Trying to think about what that business, you know, that sector could look like in a recovery scenario. Really just, you know, is one plus one more than two here?

Oftentimes, you know, you plug in to your sponsor network or vice versa, there's maybe more revenues than, you know, each unit, and you're kind of bringing in a group that's as large as or even larger than what you previously had. Love to maybe just think that through. It's not. I know it's not precise, but any framing around that would be helpful.

Ken Moelis (Founder, Executive Chairman, and CEO)

Yes, a couple things. First of all, it was. You know, I talk about it as double because I kind of rounded it, but it was actually 2.5 times. You know, we had I think we had 10 managing directors, and now we have 25. And yes, it was very hard actually building up a tech effort one person at a time, and it goes to your one plus one, does it equal more? If, you know, if you don't have enough expertise to kind of make yourself important, especially the group that we hired was much more sponsor-driven. They were, you know, 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. That's just within the tech group. As I think I've said many times, my goal in this is to be as important to what I think are the largest growing fee pools, you know, in M&A on the planet, the very large sponsor groups that I think will continue to grow and be very significant, is 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. They've all become extremely sophisticated. They know how many calls you've made, how many ideas you've shown them, how many people have been in their hallway, and I do think that they're looking for important suppliers.

Look, there's always a decision to be made on the allocation of some transaction, and it could be a transaction in, you know, I'll just pick, you know, in home building. You know, your tech team might have shown them 10 good ideas, none of them executed upon. 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 1 plus 1 should equal more than 2 in that event, especially with sponsors, who are literally one large corporation who just transacts in multiple different spaces, but I think has become very sophisticated in keeping track of how you're calling on them.

Devin Ryan (Head of Financial Technology Research)

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

Operator (participant)

There are no further questions at this time. I will turn the call over to Ken Moelis for closing remarks.

Ken Moelis (Founder, Executive Chairman, and CEO)

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

Operator (participant)

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