Moelis & Company (MC) Q3 2016 Earnings Report, Transcript and Summary

Good day, and welcome to the Moelis & Company Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Michele Miyakawa, Head of Investor Relations. Please go ahead.

Great, thank you. Good afternoon. Thank you everyone for joining us for Moelis & Company’s third quarter 2016 financial results conference call. With me today are Ken Moelis, Chairman and CEO; and Joe Simon, Chief Financial Officer. Before we begin, I’d like to note that the remarks made on this call may contain certain forward-looking statements including regarding future performance 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 or non-GAAP 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. A 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 Web site at investors.moelis.com. I’ll now turn the call over to Joe Simon.

Thanks, Michele. On today’s call, I’ll go through our results and then Ken will provide additional color on the market and our outlook. Following a strong first half of the year, our third quarter revenues of $151 million came in just below the $152 million we earned in the third quarter of 2015. A flat quarter is measured against a record third quarter last year and compares favorably to the overall M&A market in which the number of global M&A completions greater than 100 million declined 18% over the same period. Our year-to-date revenues of 409 million were up 8% over the prior year period. Our M&A activity continues to be strong particularly in the U.S. and continues to more than offset declines in Europe. Our restructuring mandates continue to grow through the third quarter with closings on most new mandates expected in 2017. As we mentioned on our quarter two call, a significant percentage of the typical restructuring fee is earned on completion. Restructuring success fees are expected to be softer in 2016 versus 2015, despite the number of mandates increasing substantially. Moving to expenses and starting with compensation. Our year-to-date adjusted comp expense ratio of 58% compares with 55% in the prior year. The increased compensation ratio is attributable to the additional tranche of equity awarded in early 2016, as well as the modified vesting terms associated with that equity. Our non-comp ratio decreased from 19% to 16.7% for the nine-month period. The decrease in the ratio was primarily attributable to high revenues and lower non-comp costs, such as lower professional fees. We continue to apply a focused emphasis on cost control. Also related to non-comp, I should note that we usually hold our annual Pebble Beach client event in the fall each year. It was in the fourth quarter last year. We did not host the event this year, because the resort was undergoing renovations but we intend to resume next year. As a reminder, our adjusted presentation assumes that all partnership units have been converted to shares so that all of the firm’s income is taxed as if it was subject to our corporate effective rate of 39.5%, which compares with the prior year’s tax rate of 40%. On October 25, our Board declared a quarterly dividend of $0.32 per share consistent with last quarter to be paid on December 7 to stockholders of record as of November 22. Finally, we ended the quarter with a strong financial position; $236 million of cash and short-term investments and no debt. I’ll now turn the call over to Ken.

Thanks, Joe. I’d like to spend a few minutes on some recent firm updates, the current environment and our thoughts on capital allocation. Our global scale is a proven asset in servicing our clients. We continue to look for cost effective ways to enhance our geographic presence. In September, we announced the strategic alliance with Alfaro, Dávila y Ríos, the leading independent strategic and financial advisory firm in Mexico. With this alliance, we now have a presence in Brazil and Mexico, Latin America’s two largest markets. And we entered this market in line with our historical approach, which is to enter markets in highly accretive ways by identifying top tier talent who fit our collaborative culture. Last week, we brought on a veteran coverage banker in upstream oil and gas as a senior advisor. He will join our growing team in Houston and work with our four MDs on the ground there. With comprehensive coverage now in upstream, midstream and oilfield services and given our collaborative model of offering full expertise in restructuring, M&A and capital markets advisory, we believe the opportunity set is large and as you can see a scenario where activity is active in all areas. In fact, for us, the pace of restructuring mandates continues to accelerate. We are well positioned for M&A. And just as an example of activity in the capital markets sector, we were the exclusive financial advisor on a $630 million IPO, the first upstream energy IPO in two years. We also recently announced the addition of a senior advisor with tremendous M&A experience covering companies in the healthcare, industrials, technology and business services sectors globally. My commentary on the market is similar to what we discussed last quarter. While there have been declines in M&A volumes across the board, our M&A dialogue remains healthy. Fundamentals remain in place for continued activity and the current study low growth environment is actually very conducive to M&A. As Joe discussed, our M&A business has been a significant driver of our revenues in 2016, particularly in the U.S. but we’re also seeing growth albeit off of a small base and newer regions such as India, Asia and Brazil. Our restructuring business is picking up nicely with continued momentum in new mandates leading to higher ongoing retainers. We expect the trends that we are seeing in U.S. M&A and restructuring in the third quarter to continue through the end of the year and we will continue to emphasize strict financial discipline. Perhaps most importantly, we continue to build on our track record of strong shareholder returns. Since our IPO and including the dividend we just announced, we will have returned $4.44 in cash per share and we still have no debt and 236 million of cash on our balance sheet. We’ll continue to value all means available to return cash to investors including regular and special dividends and share repurchases. We commit though that whatever the format, we will continue to return all of our excess capital back to our shareholders. Lastly, I’d like to wrap up with a few thoughts on the business. At our core, we are really in the business of creating or really manufacturing so to speak long-term, high quality trusted client relationships. And this part of our business has actually never been stronger. We’re building better, stronger and more high value relationships than we ever have and we are living up to our promise of delivering high value, confidential, independent advice to our clients. Creating client relationships and delivering great advice is what we can control. So when I’m asked how the business is doing, this is the primary reason I’ve never felt better about where we sit right now. With that, I’d like to welcome any questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Devin Ryan of JMP Securities. Please go ahead.

Hi. Thanks. Good afternoon.

Hi, Devin.

Maybe just one on restructuring. It’s encouraging to hear that you’re still seeing pretty good activity there. I’m just curious what’s driving the continued momentum? It just seems like some of the stress that was in the market early in the year has abated. So, I’m not sure if it’s kind of spilling into other sectors or it’s just maybe something we’re not seeing at face value.

Look, there’s a lot of paper out there, so you don’t need to have a large default rate to keep it busy. There’s a lot of issuance of leverage finance paper over the last five years. And I think – look, don’t underestimate, we said it when we went public, we had a fairly small presence in energy. Energy is a big part of what’s driving this. And we have really felt that and we’re very happy with the way we felt that. We think we have 18 players down there. And again, the way we collaborate, they are using our restructuring expertise and driving our restructuring experts in with their relationships and their knowledge base and it’s working exactly the way we hoped. But it is spreading a little bit but I think also we may be a little different because of our last two years getting better and better in the energy market.

Got it, okay. That’s helpful. And then with respect to the alliance in Mexico, just curious how that came about? It seems like a small firm, so I’m just curious why – why not do a small acquisition versus an alliance, so just any thought process there? And then whether you’d be looking to do some other structures like that.

Look, they called us by the way and so it was an opportunity that came to us. I happen to know at least one of the principals from a long time ago on DLJ 15 years ago. And culture fit was great. Mexico is one of those markets that I think is you have to be very plugged in, very local. It’s probably not something we would have entered on our own. But it was a market that I think has real possibilities. And so this was a good way for us to do it. I’m not sure I would have put enough people, 10 or 15 people or 12 to count in Mexico, because I don’t – I’m not culturally aligned. I don’t understand this well as I should. So this is a good way to do it.

Got it, okay. That’s makes a lot of sense. Thank you. Maybe last one here for Joe just on expenses, the non-comps. So the conference you’re not having it this fourth quarter. I think the run rate has still been a little bit lower than you called that maybe $100 million-ish level. So I’m not sure if you can maybe just help us think about what the full year should look like now really with the fourth quarter, excluding now that that conference isn’t there?

Yes, it’s pretty difficult to estimate non-comp with any kind of precision. I think we’re doing a really good job of managing the non-comp costs. There were in the latest quarters several benefits that I’d describe as episodic or one-time. I think that I would expect that again, the underlying run rate is probably something closer to 24 at this point.

Got it, okay. Thank you very much guys.

Our next question comes from Ken Worthington of JPMorgan. Please go ahead.

Hi. Good afternoon. So some common themes here. So energy, maybe talk about the energy pipeline that you’re seeing and if we think about the pipeline on a fee basis and we think about 2017, where is the outlook better for you? Is it M&A or it is restructuring or is that really just too hard to put a finger on at this point?

I’d say sitting here in a static environment, because we know what we have and restructuring is long lead times with lots of retainer, you know they have a lengthy time. So I’d have to say right now it would be in the restructuring market but I have to tell you that our relationships and our connectivity at the Board room is pretty good. So M&A just less predictable and less able for me to know what 2017 is going to look where restructuring – we have a serious of things that we know should conclude in 2017.

Okay, fair. And then we’ve got some distance between us and the Brexit vote, I’d love to hear to what extent Brexit is a big factor in conversations with your European bankers and their clients? And are there some lingering effects of the initial Brexit vote on your business both in terms of opportunities or for pressing some activity? Thanks.

Hard to evaluate that, Ken. I think Europe and the UK were slow going into the vote and they’re slow coming out of the vote. So I don’t know if there were slow going into the vote because of the vote. But it’s been a slow year. I don’t know how it will all play out. I actually think – there are people who think when they actually start to have negotiations that it will have more of an effect. But it’s not dominating any conversations. I don’t believe it’s – there’s nothing I can point to, to say that Brexit is keeping anything that would have happened. Let’s put it this way. I cannot discern that Brexit has changed the direction but it was slow before Brexit and it has continued.

All right. Lastly, also expenses. In terms of expenses, travel costs were the lowest that we’ve seen in three years. I know it’s the summer but I would look at travel costs rising as maybe a healthy leading indicator of good business activity to come. Any thoughts on travel being down, is it just you’re more efficient, ticket prices were down or --?

Yes, that’s a good question. I think overall, the gross spend quarter-to-quarter is actually pretty – it’s pretty even. It was actually the client recoveries that increased significantly in the third quarter and the way we present T&E [ph] is net of those two items. So it was really just a more focused effort on recapturing reimbursable expenses.

And more events closed…

And more events closed in the quarter, which obviously is the perfect opportunity to recapture.

Got it, okay. Thank you very much.

Our next question comes from Conor Fitzgerald of Goldman Sachs. Please go ahead.

Good afternoon. Ken, I heard your comments on Europe being slow in the aftermath of Brexit. I was wondering what borrowing costs are going to continue, and you said all-time lows there, if that’s having any impact and what you’re seeing from corporate appetite or is it just as simple as financing hasn’t been an issue and so lower financial cost are not making or breaking transactions?

You mean Europe in particular?

Yes, Europe in particular.

Look, let me be clear. I didn’t say it was slow post Brexit. It was slow pre-Brexit and it continued. So I just want to make sure like I said there was not a discernable difference in the trend. It’s been a slow environment. I think that obviously at low interest cost, you make deals possible that might not be possible if they were a higher rate. But it’s slow. I think the animal spirits of Europe trying to do what the United States – look, the United States is having a tremendous amount of conversation and dialogue and we had a tremendous amount of activity in India and in China, and yet there’s something in Europe, UK, Eurozone that just seems to be not exciting about M&A. And it could be Brexit related but it started a year ago, if it started.

Got it, that’s helpful. And then if I’m interpreting your comments [indiscernible], the answer is going to be no. But is the U.S. election going to have any overhang from a dialogue perspective or do you foresee kind of once we’re passed the November 8 vote, any sort of inflection or M&A or is it not a material impact?

I’ve not seen a material impact. I can’t think of a transaction that’s on hold because of it. There might have been some capital markets activity that was trying to beat it, but it doesn’t even affect us that much. So I can’t think of much in the M&A market.

Got it. And then I heard your comments on considering all means of capital return. Just want to get your latest thoughts on whether or not you thought the flow was significant enough to support a buyback or if you’d still prefer dividends?

Look, we’d like the float to be better. We think the float is a better asset out there. So it’s never been a preclusion to buy in the stock. We think given the – getting it back as dividends and special dividends and most relevant areas of where the price is, is just efficient and it doesn’t – but we are going to – I think we will start being more active in the stock buybacks. We’re feeling better about our float. It hasn’t been so great since the New York Stock Exchange put us on $0.05 ticks. But we’ll look at it. Right now we’re still kind of leaning to dividends as the more efficient way to do it, but we’re not adverse to stop buyback.

And also our first RSU vest will come up in the – significant RSU vest will come up in the first half of 2017, so that will improving the float and give us more capacity to do that.

Got it. Thanks for taking my questions.

Our next question comes from Ashley Serrao of Credit Suisse. Please go ahead.

Good afternoon.

Hi, Ashley.

Can you just talk about the upcoming promotion and hiring season? It seems like you have made targeted investments I think this year. How are you thinking about adding sectors and what does the current hiring environment look like?

This is always the worse time of the year to ask us that because I think it’s going to be a decent market. There’s a lot of regulatory pressure. If there’s one thing the U.S. election I don’t think will help is relief from regulatory pressure and same in Europe. But starting about October, it goes pretty quiet. People want to finish out their year. They don’t want to get caught having a conversation while they’re waiting to be evaluated for bonuses. So my suspicion is that we’ll have a good beginning of the year, given pressure on especially European banks and some of the regulations in the U.S. come again on the banking industry. But I can’t really tell you that I’m seeing that kind of conversation today because it goes quiet.

Okay. And then any color on how the sponsor community is fairing and how the team that you lifted out of a peer on the fund placement side is doing?

They’re doing fine. They’re doing very well in fact. I think they have eight assignments. I think they’re right on track and building a very good business. And by the way with what’s going on in capital allocation, I feel like we’re in a good position. The alternatives world is definitely pulling money out of hedge funds and private equity and those types of structures are definitely getting allocations. And it’s a good time because they are looking for new teams and new people to invest in, and that’s where I think the private placement groups make a significantly better fee structure, I’ll tell you that than the giant firms.

Okay. Thank you for taking my questions.

Our next question comes from Brennan Hawken of UBS. Please go ahead.

Hi. Good afternoon. Thanks for taking the questions. Can you – apologies if you disclosed this in the comments but where does MD headcount stand at 9/30 and the expectation for where it’s going to be at year-end?

At 9/30, it’s 103. And year-end, I don’t have that in front of me. It’s 103 today. Usually it’s in a lot of changes between September and December 31, but I don’t have an exact projection.

Yes, that’s fair. Okay. Thanks, again. And then I appreciate your comments on being fairly slow in the deal market. How about on the financial sponsor side? Can you give any color on what you’re seeing in that market, just given how important that is to your franchise? Are you seeing sponsors do smaller deals as opposed to larger ones? Is there more financing now that it seems like those markets are opening up?

Let me say two things to that. First, I said it’s slow in the European deal market. It’s very active here in the U.S. I think we said we’re up 30% in M&A. I guess a substantial amount of that is strategic. And at the beginning of my speech, I did say we’re developing more relationships than ever before. I think our vast majority of what we’re doing is strategic and large scale. On the sponsor side, I think it’s probably similar to 2015. I think they’re there, they are participating. If anything, I think they’ve become a little more competitive. That’s probably because the leverage finance market has tightened up pretty dramatically over the year. So they’re doing fine. But I’d say it’s about the same as 2015. I don’t see them doing more activity or discernably more or discernably less from my point of view.

Okay. And then just a follow up on the comment on restructuring. I get it that there’s a long lead time and it’s kind of hard to have any clarity on exactly when we should see this. But with that being said, is there any help that you can give us in thinking about when we should start to see the increase that you’ve noted in mandates not only recently but in recent past starting to hit the revenue lines? Is that more of a 2018 event, back half of '17? When should we think about that ramp or when do you think generally that ramp would come up?

Look, I think a restructuring probably takes and that’s if they go through a chapter proceeding 9 or 10, 12 months from start to finish. So it’s definitely not 2018. From the time I start telling you that we’re having backlog or assignment increases, I think just figure they kind of roll through pretty continuously and they’re sort of 9 to 12 months events.

Okay. Thanks for the color.

Thanks, Brennan.

Our next question comes from Vincent Hung of Autonomous. Please go ahead.

Hi. How’s it going?

Hi, Vincent.

So a bit more color on the 3Q results. Did you see any pull forwards of 4Q deal closings or anything to note when it comes to like the revenue or deal mix this quarter?

No, not really, not materially. Going into the last three days of the quarter we always have one or two things that could go one side of the other of midnight, which is why we hate the question of quarterly revenues. But I don’t know that we – there was nothing that we could think of materially moved from one to the other.

Okay. And so based on what you can see in your backlog and early engagements, do you see any evidence of the so-called choppy M&A where a company with [indiscernible] deal is outside of the core competencies?

No, I think just the opposite. I believe the M&A dialogue and the desire to take action to that against what is a low growth economy, threating your top line, you cannot get the growth organically. And then secondly, there’s a big thing going on. I believe the change, the technology that each industry is facing and trying to figure out where their business is going to be three, five years from now and setting themselves up in a technology format to compete is really adding a tremendous amount to the dialogue. So, I feel the opposite. I feel like the conversations are as strong and as – and that’s why I said, I think it was Brennan’s question. That’s why I think the strategic and we’re so active with strategic right now, because that’s what it’s about. It’s about setting up your company to compete and I can’t tell you how many conversations are going on I think in that respect.

Okay. Thank you. Lastly, just curious to find out, so with all these like super mega deals that get done, do you participate in the bakeoff of these, or are they usually restricted to select groups?

Mega deals don’t usually have a bakeoff. When you’re doing a deal like that, it’s with a trusted advisor. I specifically use the confidentiality if you notice. We go out of our way, we don’t list our deals. We found it to be a real asset and why I think our relationships are where they are today. There’s a real emphasis right now in confidentiality. So those things do not go to bakeoff or – I won’t say every one of them doesn’t, but you’re mostly calling up your most trusted advisor on a confidential basis and they’re determined, that’s what I said. The thing we can control is the creation of those relationships and then the actual transaction could happen at any point in the future from one year to 10 years. But it’s based on the credibility and the culture and the relationship you have.

Thanks.

Our next question comes from Betsy Graseck of Morgan Stanley. Please go ahead.

Hi. Good afternoon.

Hi, Betsy.

I just wanted to touch on how we’re thinking about the pipeline that you’ve got on the M&A side and the restructuring that you have, and what kind of handoff do you think that you’ll have over the course of the next four quarters? And maybe you can speak a little bit on the restructuring side to the kinds of transactions that are driving your inflows at this stage?

Again, restructurings continue to be driven a lot by the commodity sector whether it’s metals, mining, energy, things like that; places that are undergoing kind of deflation. We don’t see a handoff. I think both of them are going to continue because I believe that low growth is driving M&A. People say, are people confident? And yes, they are 100% confident that there’s going to be very little growth. And so they have to take action. And then that low growth can also cause a lot of M&A dialogue but it can also cause even in a low interest rate environment too much debt to catch up to you and cause you issues. So I think we have an environment where I don’t expect a handoff. I expect a continuity of both going forward.

Okay. And then restructurings, like you mentioned, come with retainers and it’s a little bit more backend loaded, 9 to 12 months on average but can go as long as a couple of years. So, I’m just wondering as you’re looking at the restructuring pipeline, are you seeing longer duration type of deals coming through? Is that part of a reason why you don’t see a handoff near term?

No, when I say handoff, I meant because I think restructurings will continue to develop and M&A will develop. But we don’t see a longer duration. Those long deals are often very complex capitalizations. There are reasons for the big long restructurings multiple classes, but a lot of the transactions are moving fairly quickly to deleverage 9 to 12-month cycles. I think the outliers have very large transactions that have very complicated capitalizations that take years to go through.

Okay.

This concludes our question-and-answer session. I would like to turn the conference back over to Ken Moelis for any closing remarks.

I want to thank everybody for spending time with us this afternoon. We look forward to speaking with you and feel free to call our people if you need anything more from us. Thanks.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.