Q3 2023 Moelis & Co Earnings Call
Ladies and gentlemen, thank you for standing by my name is Cheryl and I would be a conference operator today.
I'd now like to turn the call over to Mr met two crore.
Please go ahead.
Good afternoon, and thank you for joining us for Moelis <unk> company's third 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 that are subject to various risks and uncertainties, including those identified from time to time in the risk factors section of Moelis <unk> 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.
One 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 Dot Com I will 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 $278 million of adjusted revenues in the third quarter, an increase of 19% versus the prior year. The revenue increase was driven by our restructuring business in some particularly large restructuring fee events.
Moving to expenses our year to date compensation expense was accrued at 83%, which is our best estimate of our full year ratio are elevated compensation ratio as a function of our revenue dislocation driven by the still challenging M&A environment and our decision to aggressively invest in talent during this downturn.
Our third quarter adjusted non comp expenses were $50 million, which includes approximately $8 million of co advisor and legal fee expense related to completed transactions, which includes our transitional SPD fee sharing agreement related to certain pre selected mandates our non compensation expenses are expected to remain.
Elevated through the first quarter of 2024, when our SCB fee sharing agreement terminates however, the underlying quarterly run rate continued to be approximately $42 million based on our updated full year projection of income we accrued tax expense to equal an effective rate of one 7% are non deductible expenses are large.
Relative to our pre tax book income over the longer term, we expect to reflect the tax rate more consistent with our recent history. Once normalized productivity can be restored regarding capital allocation. The board declared a regular quarterly dividend of <unk> 60 per share consistent with the prior period and lastly, we continue to maintain a strong balance sheet.
With $297 8 million of cash and no debt and I will now turn the call over to Ken.
Thanks, Joe and good afternoon, everyone. The third quarter marked a significant increase in revenues versus prior quarters in.
In addition, the pipelines for each of our three product areas continue to grow and the total pipeline is near record levels. However, M&A completions continue to be challenging and although our restructuring capital markets business has been quite active the outsized restructuring contribution contribution is unlikely to repeat in the fourth quarter.
Liability management continues to be the main driver of restructuring activity. The team has been a leader an out of court engagements, having advised companies on five of the 10 largest adequate restructuring transactions since 2020.
If the fed maintains rates at current levels out of court restructuring will continue to be a significant opportunity for us.
In order to help our clients not only grow but also help them address liquidity and maturity issues expanding our capital markets business has been a strategic priority for the firm. The team has grown in size and capability and we're advising clients on a broad range of capital markets transactions.
We have significantly enhanced the firm's ability to address the largest sector fee pools over the last 12 months, we've hired 27, managing directors, while still managing overall head count through targeted attrition.
The investments we are making today have dramatically improved the firm's earnings power and with that I'll open it up for questions.
Yes.
At this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad.
I'll pause for just a moment to compile the Q&A roster.
Okay.
Your first question comes from the line of Devin Ryan with JMP Securities. Your line is open.
Okay, great good afternoon, Ken and Joe.
I guess first question I, just want to start on compensation.
Compensation construct so I guess first off Joe you May have said it.
In terms of just the full year, you're running at 83% is that the right way to think about.
The fourth quarter or is.
87% I guess, the right way and then I guess the bigger question is just trying to think about.
This year in appreciating this year is far from normal.
Or how much is kind of competitive dynamics I guess, everybody can kind of think about where we revert back to more normal environment and how much inflation.
You will and compensation is just in the system and I think Thats a question every firms getting asked right now thanks.
Yes, so I'll answer the first part of your question, which has to do with the ratio the 83%.
The target for the full year of <unk> 87 for the quarter was basically the catch up for the first two quarters that were accrued for at 80%.
Addressing your issue.
Well there are two events going on and they're intermingled one is downturn in revenues due to.
A pretty difficult M&A environment.
And yes that would have that would cause a significant elevation in the in the comp ratio no matter what.
But then two things happened this year, we decided and again ive done. This I've been doing this for many years. There are four times in the last 40 years, where I thought.
You could take advantage of significant disruption lengthy difficult disruption in the banker market. The first was wondering.
<unk> was when we founded the company in the Great financial crisis, 10, where we really created the company.
I look back.
I went to Drexel Doj from Drexel Burnham in 1990, and they created a firm.
In the midst of a disaster in the junk bond market. They created a firm that ultimately was extremely valuable off of that franchise and even UBS did that.
After the downturn in 2001.
This felt like that opportunity a huge disruption.
Talent People's desire to stay where they were.
And we took advantage of it we hired 27 people in a year its almost its more than 20% of the existing managing director base and by the way Devin while we did that Youll see that the head count is only up 3% to 4% at the end of the year. So we actively managed a very significant amount of people out.
We don't schedule any of that we run it right through our income statements. So some of that other people might have put as a charge for.
Terminations are one timers.
We're kind of running at all through the income statement.
I don't know the exact breakdown of what it would be but I think the earnings power of the firm has significantly expanded.
And that in a through the cycle normal business that we will be back to our normal comp ratio.
I would say there is there is probably and we'll see what happens over the next year, there's probably a percent maybe two of comp ratio that is going to the junior bet. The junior non Mds that will not be recoverable.
Just because we've raised comp throughout the non managing directors on the street and I suspect that might be sticky.
Got it okay terrific color thanks, Ken.
Just a quick follow up on just the M&A market more broadly.
Let me give a little more texture around how you guys are feeling.
Maybe today relative to three months ago.
One hand, I think October was.
Better months than we've seen in some time for announcements on some larger deals within that but the tone has been a bit better at the same time, there is still a fair amount of macro.
Uncertainties, so love to just get a little defensive whether youre seeing kind of maybe more activity or sponsors engaging more than they were a few months ago and just what the general tone is appreciating that it's still pretty complex and dynamic backdrop. Thanks.
Yes, so youre going to ask me, how I felt today versus two days ago.
Let me say there is our backlogs.
Our pipelines are.
Were extremely strong.
Let me you know about a year ago, I think we talked about having a decent pipeline, but I described it as fragile and I think I felt it was fragile because it was a pipeline gathered during a better.
Interest rate environment that was then facing a bed.
<unk> market and so if you just knew your fragile whether it involves backs are all the kind of things that we're going to be eliminated.
At this point I feel like the pipeline is actually very strong.
There is an enormous amount of deal backlogs that wants to hit the market and.
I've been saying my new analogy for the market.
I don't like to Green chutes analogy, because I've said, the fed has a big weed killer and so I don't know how you manage your green shoots when somebody can just destroy your crop at any moment.
But especially as of yesterday I feel like this market has more and Youll forgive me.
All in love with drive to survive during Covid I'm, not a real formula one fan.
But it feels more like that market, where as of yesterday my favorite part of the show is when rents go down there are five red lights, if you haven't watched it and then the race starts.
But the noise in the amount of energy that is pent up as the lights click.
He is very exciting the cars around the track the engines revving everybody is racing to go but you can't move to the fifth light goes down.
And it feels to me that yesterday.
That was the fourth light.
Clicking off meaning that the fed felt like there.
They're getting to the end there was a real signal yesterday that we are extremely close to the end.
And I do think the pipeline will take off as soon as that last Red light goes off and it'll be quick and it'll be fast and there will be a lot of activity.
Okay.
Great Okay to go back and watch that but.
Thank you very much Greg.
Scott.
Yes.
Okay.
Our next question comes from the line of Ken Worthington with Jpmorgan. Your line is open hi.
Hi, good afternoon, thanks for taking the questions.
Youre, losing money year to date do you expect to lose money for the year unless there is a meaningful improvement in deal activity and does this matter.
I think we will probably lose money because even if the deal activity starts tomorrow.
You are not going to see the closings till the first quarter. The second quarter, we have what we have.
Plus or minus a very little bit from here to year end.
And does it matter.
Sure it matters I mean I'm not.
But.
Yeah.
Affirm that faces I mean half of the 27 managing directors were in the technology hire at our Silicon Valley Bank, It's a fee pool that will be extremely large and relevant for years to come.
And look we didn't we don't get to capitalize it.
We might've bought talent that equals 20% of our firm.
And there is no capitalization of that 'cause it runs right through our income statement we exited.
As you can tell exited a significant amount of people to keep our head count within a 3% to 4% range. While we did this.
And it goes it is an investment that by accounting reasons and our business goes through your comp ratio and your earnings does it matter shirt was extremely difficult decision for us to take this.
The decisions to do this yes, you can imagine there was the debate on this.
As significant do I think that it will pay back.
Streamline well over time and always has in every past cycle you can't create these franchises. When you want to you have to create them when you can.
Okay fair enough.
And then just maybe moving to the balance sheet, we don't have the Q yet so.
About the cash balance given the dividend and the compensation accrual do you guys think youll have to draw down on the revolver or is there enough cash to kind of meet the dividend and the year end bonus payouts.
Yes, we obviously are pretty attentive to that area.
We do not expect to have to draw on the line, we expect to have adequate cash to service the dividend as well as the compensation at the end of the year.
Okay, great. Thank you very much.
Yeah.
Your next question comes from John Zaro with Goldman.
Your line is open.
Good afternoon, and thanks for taking my question.
My questions I take your point on the strong restructuring this quarter not repeating but how is the challenging macro backdrop affecting the medium term trajectory for restructuring.
Was outsized even for the for us for this quarter, but it's at the top end of its range our backlog on restructuring is very good.
And I feel very good about it going forward because our out of court expertise is something that most people. One most of the deals that have been done in the last few years have been capitalized with a significant larger amount of equity than in prior downturns.
So the route to.
For most of these transactions does not straight into bankruptcy. It is to do capital markets to extend runway and liquidity, which we beefed up our capital markets for that and liability management exercises to create room and I think the fact that most of the transactions had so much equity under the debt capital.
Gives you the ability to do innovative solutions without going to court.
So, yes, I'd say I think the restructuring business will continue there are a lot of firms that will continue to have trouble with higher rates, but they do have options and flexibility to address them.
Okay. That's very clear maybe we can just turn to your hiring plans.
I guess should we expect you to continue to hire at an elevated pace into next year I'd imagine obviously it won't be at the at the level you have been hiring at especially earlier in this year, but will it remain elevated into next year.
I don't think nothing like as we've gotten these were a couple of the large sectors. We wanted to address some technology again was over half of the managing directors.
We established an energy transition team, which is.
As a result of the <unk>.
<unk> became a market that we wanted to be in and wanted to be insignificantly and found a great team there.
Michael <unk>.
Freed up some exceptional talent and industrials and we took advantage of that and prior to that we had been very aggressive in healthcare going back 12 months ago.
So I think we've done a very good job in the sectors that we really wanted to turn the firm to address coming to the next M&A cycle. There is there is and I'm not going to say, which one but there is one more sector that we're kind of looking at but there'll be nothing of the magnitude of this we think we've put in place a significant amount of the talent that we have.
To address the markets and if the fifth light goes off won't have the opportunity to us.
I have to wait for them to all watch drive to survive or else I can't continue with the analogy, but yes. It is.
It feels like we're much closer to the start of the race happening and at that point I think it would be tough to find it's going to be tough the talent will get busy.
And people will stay in their seats again, so if that happens I do think we would slow down as well.
Alright, well have to watch the newest season. Thanks, so much.
<unk>.
Yeah.
Your next question comes from the line of Steven <unk> with Wolfe Research Steven Your line is open.
Good afternoon. This is Brandon O'brien filling in for Steven.
Just to start just on the M&A outlook commentary.
You or your views on how quickly activity could ramp next year was maybe a bit more optimistic than what we've heard from some of your peers, which has indicated that this would be more of a stop start recovery.
Want to get a sense as to whether you are saying that we could see a ramp in activity that is similar to what we saw during COVID-19 and I guess circling back to the drive to survive reference what does that lie in your view that can take start activity.
Well that's a good question because youre actually right I think the reason is I think yesterday was a big day I think that.
I took yesterday to be the fourth light to tell you the truth and I might not have the same outlook had been had this call been five days ago. So.
I have just happen to have the benefit of going after the fed yesterday.
It felt to me.
Like they were saying and I believe at that rates have not fully been reflected in the statistics theyre seeing I do think companies are having much more difficult time some of the consumption part of the economy has.
Kept GDP up but I think I think companies are having enormous problems with the higher rates and I thought yesterday I read it.
<unk>.
We are starting to look at waiting to see if these rates have issues that we haven't been able to measure yet.
So I just want to acknowledge that I don't think I would have had the exact same commentary that I wouldn't have thought again to stretch the analogy that the fourth light.
Had gone off on the race.
And I do think so we may be one light away from it where the fed just confirms that we're at the end of the Red cycle. There are several things that can trigger it would it be COVID-19 like <unk>.
Probably not I mean, COVID-19 was triggered by a drop of interest rates I forgot from where it aware, but almost a zero interest rates and a flooding of the capital markets with money.
But I do think it would ramp up.
Pretty quickly because there are a lot of transactions remember COVID-19 only deferred transactions for three or four months I guess it was from like the beginning of March to May be triggered again by July and August.
These are two year backlog of Lps that want capital.
Of sponsors that need to either buy or sell something.
And companies that also want to get into the market strategically sone.
I don't it doesn't feel like Covid in terms of the.
<unk>.
<unk> drop in cost of money, but maybe the backlog of two years.
We'll drive a similar transaction volume.
Alright.
For my follow up.
Restructuring is a big driver of the results this quarter.
That indicated that you don't expect this to repeat next quarter I just wanted to get a sense as to how we should be thinking about.
What was typically.
A seasonally stronger quarter in <unk> and whether that's an indication that we should expect some decline in revenues.
And if you could give some context around how a larger contributor restructuring was to this quarter's results that would be great.
We always say that restructuring capital markets is 20% to 25% for the year, it's probably at the high end of that which is you know 25 or better and for the quarter. It was it was almost 50% higher than that so it was but we don't again.
What quarter of these revenues fall in as a bad way to look at it they just happen to fall in and out of certain periods I'd look at it we're at the high end of the contribution we've had as a firm probably little north of 25%.
If you include capital markets and that it's probably close to a third.
For the year.
A lot of these a lot of these capital raises are finding liquidity for companies that are sort of in a restructuring or how do I get liquidity mode.
On the fourth quarter.
I think you can just take the run rate of the nine months we had.
Again, I'm, not giving guidance, but I think if you look at the year.
It's kind of if you smooth out for the quarters the run rate for the year seems to be have been.
I think the whole year is going to be I think the idea was we just didn't want you to extrapolate the third quarter of the four that we have an unusual multiple when you guys look at Dealogic.
That's probably a bad way to look at it for the fourth.
Okay now that's exactly to us today and thanks for taking my questions.
Your next question comes from the line of Brennan Hawken with UBS.
Your line is open.
Good afternoon, Thanks for taking my questions.
Ken Thanks for making the holiday gift for you very clear some sort of formula one team round sponsored by round up the weed killer type of outfit.
[laughter].
So.
Seriously, though when you think about the.
We all know the environment challenging right and so the comp ratio, yes, it's elevated no kidding youre doing a lot of hiring but you've got an aspiration to get the comp ratio back down to that 60% that we got used to.
So what kind of revenue environment do you need in order to get there given the additional fixed expenses that you've added.
Look.
You can look through from us from the bottom of the cycle to the top of the cycle.
The average revenue per MD has kind of been from $8 million to $12 million.
Somewhere in that.
You could even go seven five to 12.
Normal times.
Through the cycle I'm talking about from the bottom to the top and without people coming in and out I mean, when you hired 27, managing directors, who let's say average start in June youre, not going to get a lot of revenue from those people, but but they are in the comp pool.
<unk>.
We have a mid 150, <unk> managing director, Paul and I believe a better fee facing pool than we've ever had I am not going to you can do the math, but I think any of those numbers that fall into a normal M&A cycle would easily return the firm to a 60% comp ratio and.
<unk>.
And the key was to make sure we're recovering.
The fee pools, theyre going to generate that and.
And that is including technology healthcare industrials I think those are three of the four largest by far.
And I feel like we've done that we've repositioned the firm on the move to do it without having to incur.
M&A type expenses now again.
The Bad news is we don't get to capitalize the cost, but I think the investment is way more efficient.
And we will prove to be a much higher return on invested capital for everybody on the call by the way Brendan I really don't I am not a fan I just want to make clear I don't really know much about formula one I just watched the show it's like that holiday Inn Express thing. So I think I'm, an expert, but I don't know much about formula one.
Yes.
Not with the truth getting the way of a good story here Ken.
[laughter].
Okay, that's fair.
I look back.
At the 2021 was a remarkable one right, which was which where you're you were at the 12 and a half.
But you know what.
2022 typical.
On a trailing basis eight seven and a half in 2026 in 2019 7567, so like if we if we use the.
The upper end of the X 2021 range, we say seven five and multiply it.
About one in a quarter billion. So are you, saying that basically at that level, you could get back to the 60% comp ratio.
Yes, I think Thats I would hope, we do better than that I think we've.
I think we've addressed better fee pools, we substantially improve the.
The firm and our go to market.
I think but if we did that I think we'd be at 60% comp ratio yes.
Yes, we have.
Mind you is out.
I think that's true broadly, but there is elevated fixed costs that are going to go into next year as well. So it might be a couple of points different material you are on the right track and certainly 25 for sure.
Yes got it.
And then when we think about.
The kind of the impact.
Of the additional commitments via this very active recruiting and we just sort of think tactically about the various costs on the cash.
I was just doing a little quick math is it reasonable to think that the commitments.
From all of this recruiting could effectively double what your cash incentive pool would be would have looked like absent this remarkable opportunity.
No no.
We are pretty disciplined we want partners. We hire partners. If you are asking did we did we guarantee.
We are comp, we hold pretty closely to making sure that the.
People entering our system getting comped the same way as our existing group, we like to have.
Equity partners people, who want to see the value of the firm go up so we're pretty disciplined on that.
Okay, but but but it is right it's not like I'm off in thinking that the.
Recruiting would put upward pressure on what the cash incentive pool would look like absent the recruiting right. There there is no known amendments.
Yes, whenever the incentive pool would look like we've hired.
27 more of them and.
Right and Thats, what that is why we are.
The main reasons, we're at 83.
Yep Yep, Okay, and then just last one on that point given that youre going to have.
Some liquidity drain as typically happens in the beginning of next year as the intended to get the payout should we continue you had a nice liquidity build here in this quarter should we continue to expect liquidity to build in the year and so that you're in a position to to cover those demands.
Yes.
Looked at it closely we have no concerns about we have $300 million of cash going into the end of the year. We've looked at it a dozen ways, we've stress tested and we're fine on the dividend we're fine on the bonus pool, we have multiple levers we can pull in.
We think we're in great shape I mean the last.
The low point of our liquidity will be the day, we pay bonuses and we think we're in very good shape to do that.
Alright, Thank you for taking my questions.
Our final question comes from the line of Brian Kenny.
Stanley.
Your line is open.
Hi, This is Colin Smith <unk> filling in for Brian Kenny.
I guess I just want to go back to the sponsor question.
Heard a lot on the narrative on why sponsors will ultimately go.
Go back to transacting and come off the sidelines, but can you just give an update on how sponsors are feeling in this environment.
What's the next catalyst to see sponsors.
Sponsors to transact in.
What kind of pressure they are seeing from <unk> at the moment and any any color you can give there would be helpful.
So the answer is yes, we do think there is a large bit of pressure on <unk>.
Distributing proceeds to Lps.
If people want to raise a new fund theyre going to have to return some of the old invest.
Investments.
Most investments that were targeted for disposition as of about 20 months ago have been on hold and so those might be 2016 investments 2017, or 2018 investments, but there is certainly not supposed to be held for 10 years.
And it might only be three times return and we think people are.
Getting to that point, where they are facing the fact that the realization of what they might have to take slightly different pricing in peak pricing.
And we see it in the fact and when I talk about our pipeline is that there is a serious amount of allocated.
Transactions.
Pending a market to go to market on and I think that that market is when the fed.
Says.
We're done I don't think we need a rate cut obviously that that would be extremely helpful. But.
It's starting to feel like this might have been the last cut or very close to it and when that happens I think there'll be a lot of transactions that will go to market. The amount of capital. Let me say one thing the amount of capital that is accumulating in the private credit system and the creation of funding mechanisms around the banks.
He is also reaching a significant proportion and so the ability to finance is coming back up with multiple bidders to put forth financing.
And the last thing I'll say about my my optimism for the next five years and why Im happy to build into it is I do think that the <unk>.
Large banks are going to continue to face a regulatory challenge of being in the let's give out below market funding in order to get advice business.
And if if they are put out of that business through regulations, and I think the new Basel negotiations and the regulatory environment.
Are pointing to that more and more as a result of what happened with credit Suisse and Silicon Valley Bank I think the regulators are again, starting to believe that the government guarantee deposits of large institutions. So that they can speculate in.
In all kinds of business is not the right structure for capital markets and I think it will be very healthy to have private credit buildup, that's not levered 10 to one but as levered one to one and is not free to.
Use the government backed deposit base to go compete with Fintech companies and independent advisory companies using the government guaranteed money.
And that will be very positive for us.
And I think that's a long term structural tailwind that we'll see over the next 10 years that will continue to drive.
I believe a wedge between advisory businesses and the ability for those institutions to use below market lending two to generate business and has to we're down to the benefit of the independent investment base.
That's really helpful color.
I guess on your point on rates in the near term now, but can you just speak to like volatility and yields over the past few weeks has that impacted the pipeline an elongated deals more so.
And has that affected financing conditions any color that would be helpful.
The deals were slow to get out of the gate I mean, again, I think theres there might've been a signal in the last 24 hours from the fed that you can move from having a toe in the water to a full leg.
But before that and again, it's only been 24 hours. So I can't say I've seen anything change in in the.
And our go to market on these transactions, but yes things were what was happening is transactions were being assigned.
Work was beginning and the idea was we want to be ready when the market is ready for us and a substantial amount of transactions have that sort of structure around them.
And so as I see the market get ready to accept those deals either via the fed by the way I think the turning of the year will be most people between about Thanksgiving and Christmas.
Christmas just try to keep their jobs versus.
Take risks given in the beginning of the year, they think about how to create capital. So I think there could be a lot of momentum around.
The fed decision markets turn of the year, new year, a lot of those things might come look.
This can all change there is a lot of macro events out there that could change that but as of right now it feels like we're heading to that type of transition in the market.
Thank you.
I will now turn the call back over.
Taking the call.
Hey, Mike.
Thank you I'll leave you with one recommendation I think drive to survive as a fun, Joe and maybe Youll understand my.
Then you'll go back and listen to this call lets see if you could make out what I was trying to say, but I look forward to talking to you.
Next call after you've all caught up on there are three or four seasons. So good luck. Thank you.
Okay.
Okay.
Ladies and gentlemen that concludes today's call you may now disconnect have a great day.