Okay, up next, we are pleased to welcome Ken Moelis, Founder, Chairman, and CEO of Moelis & Company, back to the stage. Since founding the firm in 2007, Ken has created one of the broadest independent advisors in the industry with a growing global footprint. Thanks again for joining us, Ken.
Thanks for having me.
Okay. So I think you've now been at the conference five years consecutively by math, and that's been through some pretty wild times. I guess let's just start with your perspective on the macro backdrop at this point.
Well, everything feels like, if you read what happened with the Fed three weeks ago and, the economy right now... Look, I actually think the economy is on the brink of a recession, if we're not already in one. But for our business, which is predominantly affected by interest rates and the Federal Reserve's policies over the last two years, it feels very positive, meaning that, we might be done with rate hikes. We've gone from people calling for two rate cuts to, I think, certain firms calling for as many as four or five in the upcoming year. I don't actually believe we needed rate cuts to re-stimulate the M&A market and some of the financial services to start kicking into full gear. I think we just needed some stability and no rate cuts.
So, I've become pretty optimistic on the fact that it just feels like, at worst, we're gonna have a stoppage of the rate hikes, and at best, we could have a significant rate cut environment.
Okay. Maybe just, you know, thinking about what that means for activity, does it feel like, you know, we're in for at least, you know, at least the beginning of the year, potentially, you know, a third consecutive year of somewhat weaker investment banking activity? You're in the boardroom with lots of different clients. What's top of mind today?
You know, if you're saying the third year is 2024 going into a third, I don't think it'll be a weak year of investment banking activity. So on the strategic side, I think most of the companies have been relatively unaffected by rates. Most strategics have a game plan, especially investment-grade companies, and a series of strategic things they want to accomplish. And yes, on the margin, an increase in cost and capital changes it, but it usually doesn't divert the activity. On the other side, the financial players, financial sponsors, especially, are very highly affected by entry and exit. I mean, they are involved in M&A activity primarily for a financial outcome, a purchase and an ultimate sale, and a rate of return that's measurable in that timeframe.
So at a time when, as recently as May and June of this last year, you had prominent figures talking about a federal fund, you know, the Federal Reserve going up to 6.5%-7%. That's a very scary time to enter into a transaction because almost no deal pencils out at a, you know, at those kind of levels. Nobody's gonna sell to you at those kind of prices, and then again, you can't finance the transactions at those kind of levels either and, and make them work. Now, you, you do have a tremendous amount of capital invested.
People always talk about dry powder, but I think even more appropriate in the sponsor market is the wet powder, the amount of capital that's already been invested and needs to recycle back to their limited partners. And I do think as you start to see a rate environment where most of the news in front of you sounds like it's either flat to maybe even rate cuts, maybe you even pick up a tailwind of significant rate cuts in front of you, I think you start to transact again. You start to buy companies you want to buy, in order to fulfill your goals to deliver returns to your LPs, and you definitely start to sell assets that you've deferred selling, maybe for two years, waiting for a better environment.
I think you're gonna see both of those activities hit the market.
So maybe just on financing. You know, you've seen a lot of changes in the financing markets over your career. I think the syndicate markets appear weaker, so I'm curious what your perspective is actually on the health of the syndicate markets. People are doing deals, but are they open? And then, what do you think the private credit wave means for deals, and how much more market share will that take, and how does that affect the M&A landscape?
So I think the private market is one of the best things that have happened, I think, to both the economy, the structure of credit in the world. If you think about it, the fact that the government guarantees deposits to several large institutions, and they get to borrow at basically government-backed rates on deposit base, and then get to go into competition with firms like myself, by the way. Remember, there are banks out there now that have mark-to-market insolvency, pretty close mark to market, but still get to borrow at government rates and get to compete with me for talent, which is kinda strange.
I think what's gonna happen, and it started in the global financial crisis in 2008, 2009, people woke up to the fact that a lot of the banking model is giving away below-market risk and recycling that into bonus pool and other activities until the risk hits, and then the taxpayer picks up the bill. The first shot at that was some of the regulatory environment put in in 2008, 2009. Fast forward to last year, you have Silicon Valley Bank, First Republic Bank, Credit Suisse, and it's a reminder that the same processes happen again. They take a different format, but the same process. You're funding high risk lending with 10-to-1 leverage, and especially with short-term deposits, which are subject to liquidity runs. Now, you look at the shadow banking—you quote, "shadow banks" for the private credit.
It's usually 1:1 leverage, much better matched. Government is not involved, so the pricing is market. The pricing is enough to attract the equity capital and the and, it's usually 1:1 leverage and the loan on top of it, and is much more dependable, and it doesn't provoke, I think, off-market lending inside of these banks. Now, so I think this trend is going to continue, and it's going to accelerate, and I because I believe the regulators want it. They should want it. It's good for companies. It's good for high-risk transactions, which the benefit of not having to syndicate and have all this flex around syndication is positive as well.
And lastly, it's going to be very good for, I think, the independent investment banks who can compete straight up for talent, for advice, and not have to compete with large institutions that are giving away risk at below-market rates.
Great. Let's move from the macro to the micro and turn to your strategy. So I think you've had a tremendous year of hiring, right? As a result of some of the disruptions that you just talked about. I think your MDs are up, you know, I think 25—roughly 25 year-on-year, at least as of the third quarter. So maybe you could just talk about where you focus on hiring this year, whether it was the right decision to do so much, and then when you look ahead, what are the next opportunities to build the franchise from here?
This year was a very, interesting year because it really was triggered... Our hiring was almost triggered by, Silicon Valley Bank, collapsing. We had tried to hire the team that went there. It was a very good tech team. They were at UBS. We missed them. They went over to SVB, because the opportunity seemed, again, the opportunity to participate in giving away, somebody giving away low-cost credit while you absorb the banking business, I can understand why that's a very exciting place to be. We had a moment of truth there, 'cause if you think about, Moelis & Company, we really created the business in the crisis of 2008, 2009.
We funded the company in the summer of 2007, and all of a sudden, the financial crisis hit, and we had this moment of chaos where we had to decide are we gonna take advantage of this, or are we gonna shelter in place? And we decided to take advantage of it, hired the best bankers we could, and interestingly, we were private back then, so there was no such thing as a comp ratio to really worry about. I guess you could worry about it, but we were private. I ran the business at 110% of revenues, the comp ratio, 'cause we could hire the greatest talent that was never gonna be available again.
In the crisis, everybody was worried about their job, not just the Lehman and the Bear bankers. Every single banker was worried. Was there something in their company's balance sheet that was gonna... So everybody was open to transition. It took about 15 years again, and all of a sudden, we see the same thing at SVB. And we're public now, but we're unlevered, and we can afford to do it. But the real question was: Could we do it inside of the ratios that we've come here at this conference and told everybody that we would abide by, comp ratio? And the answer to that was very definitely not. We could not do it. But it was the same opportunity as 10 years before, 12 years before.
And so we just decided we're gonna, we're gonna act like a private company, and we are going to do what would normally, in any other business, be CapEx. Normally, you would purchase this company. SVB had 55 people, and total, we hired 14 managing directors, but we had the chance to skip the purchase, which means it doesn't go on your balance sheet, and just hire all the people. The difference is it runs through your income statement. So we saw that again, and then all of a sudden... So we hired those people, and we came out, and we said: We're not going to hit our comp ratio, and we're going to put it, but it's gonna run through our income statement. It was interesting, by the way, my son, who is an investor, in... He does investing.
He basically, he said: "Dad, hey, you may be the only real company that has five out of six analysts with a sell recommendation." He goes, "You know, most companies, you know, they stop at hold, but I've never actually seen a real company with everybody has a sell." And I said, "Yeah, I guess that makes, you know, a very unique position to be in." But again, because we missed the, the statistics, but what we did was take advantage of one of the great opportunities of all time. I mean, it is almost impossible to put together a tech team from scratch. You can't hire them one by one. Does the culture work? Can you go around the street and hire a software banker from this place and a, an AI banker from another place?
The fact that they all came at once was fantastic. And then about a couple of weeks later, Credit Suisse goes down. So we're faced with the same opportunity, not as large, but in a sector we want to be in industrials.... So we might have hired 27 managing directors this year, but probably 2/3 of those came from two unusual moments, Credit Suisse and SVB. And I know that it's going to be one of the highest return on investments you're ever going to see in any acquisition, because we didn't have to pay the acquisition costs. We just had to take the people and accept their compensation. So, I'm very excited by it.
I want to say that one of the reasons we went very vocally and was to be very direct with our investors, that we were going to have a Compa Ratio that would be extraordinarily high. There were two reasons to do that. One, let our investors who have been supporting us for years know, and, and I think we've said to them through the years that we might not hire in a linear fashion. We might trail behind some people in hiring, but when the market, there's always going to be an explosion. We don't know what it'll look like, but when it happens, we want to be unlevered and ready, and then we'll take advantage of it. I think our investor base kind of said, "You told us you were going to do that," and we did.
But importantly, I want you to know we had to do that to send a message to our own people that their comp won't be affected by our plans to expand. It's very important that your own people don't think, you know, that they're having a bad year, and I am, you know, going to take it out of their bonus pool to pay for other people and expansion. So it's worked very well. We've retained almost 100% of the talent that we wanted to, and we're able to increase and really change the nature of the firm for the next 10 years.
Great. So, so what's next, I guess, in terms of where you see opportunities? You've done a good job hiring outside of M&A and building out those businesses. So maybe you just talk a little bit about what the strategy is from here in terms of what's next.
Well, I mean, this is again, it's not going to be linear. People ask me, "Well, you know, will next year be similar to this?" I don't think so. I mean, first of all, we filled in a couple of the very large fee pools that we weren't facing. So again, technology was a fee pool that had exploded in sponsor land, sponsors. It became almost 30% of the fee pool, and 30% of our sponsor revenue was not in tech, so that really matched that. And there were a couple other places where we were falling behind. Energy transition, we wanted to be in. We hired that group, and a bunch of industrial bankers out of Credit Suisse. So we don't have the same white space next year.
There'll be normal hiring because there's always attrition, retirement, turnover to replace. But one of the things is, we want to absorb this group, make sure that we organize and absorb this group. One of the places we do see a big growth, we did a big move and put one of our best bankers on top of our capital markets group. And we continue to your point about private credit, we continue to see capital markets almost... In the last year, you've seen capital markets almost replace M&A in some deals as a way to transfer value.
So people are saying, "You know, no, I won't buy the equity of your company, but I will put a $500 million, 15%, you know, mezz security." And in essence, what I was saying, this is going beyond just growth capital in capital markets. It's now bridging into transference of value through instruments like prefs. And I thought we really needed to bring together our M&A method of thinking with our capital markets method of thinking. I think more of that will go on, by the way, because of trapped capitalizations, overleveraged situations. But what happened, by the way, in the last sponsor environment in the last five years is... Again, if you went back 15 years ago, a lot of the LBOs, private, privatized with 30%-35% equity.
So if you had a problem, you ate through the equity pretty quickly. In this last cycle, a lot of these deals were put up with 50% equity, sometimes more, 40, 50, 60%. So you could have a company underperform and still have enough of a part of the capitalization that you can infuse capital and keep you know provide runway capital liquidity. I think that's why you're not seeing the amount of bankruptcies that we saw in the last financial crisis. These were better capitalized firms. So I do, I do think our capital markets activity will continue, that's one of the places where I see a significant change in growth.
So you sound pretty positive on M&A for next year, generally. I guess the question is, are some of your peers that have talked about January being an important month, correct? Is it going to happen right away in 2024, or is it going to take a little bit longer? And then the other side of that is: What does normalized look like this time around? 2021 was such a, you know, an extreme year. What are we going to get that same peak? I mean, obviously at some point we will, but is that this cycle, and how long as well?
So I think you could see January could be a pretty fast reboot on M&A. And the reason is, again, the last time I spoke about this was the day after the Fed sort of said we're not going to raise. And I think the 10-year went down 10 basis points, but like from 480 to 470 or 490 to 480. Well, in that time period, every single measurement of the economy has shown slowing. Every single measurement of inflation has confirmed this. The 10-year, I think, hit as low as, you know, 411 today, 412, and this is a very significant decrease in the cost of capital and an inference.
Again, I think in the last three weeks you've seen people go from a no-cut 2024, to as high as a possibility of five rate cuts by some analysts. So it's a pretty dramatic change. I think our backlogs are at the highest level. They just passed what we call our pipe past the highest level it hit, even including 2021. So you have, and I think other firms are seeing that. You have a strong desire for people to hit the market. That's why they're in the pipe. They wanna hit a good market. And it just seems to me everything that you could have wanted to happen in the market is happening.
So if you have this in your pipe and you don't like the fact that the 10-year is down 10, you know, 70 basis points, and that inflation seems to be receding and that people are calling for rate cuts, I just think you're gonna see a lot of people, a lot of execution on that pipe. Again, you go back a year ago or 18 months ago, a lot of the pipe was entered into in a good market, and then all of a sudden you come into a bad market. So, you know, you enter the pipe wanting to execute a deal, then you see the Fed raise. That, that's a pretty fragile pipe. It. You know, a lot of that isn't gonna conclude.
This pipe, and not just mine, but I think others on the street, was probably discussed and entered into during a pretty rough time, during a time when you weren't sure what the Fed was gonna think, and now you're kinda coming down into a market where financial conditions are easing and getting well. So I think it could start and happen quicker than you think. There's two years, it's hard to believe, but come January, it will be two years that the Fed has been in this rate hiking cycle. That's a lot of backlog. That's a lot of deals that didn't get done, that need to get done for their LPs. So there's a lot of pent-up demand in that. And to your point, what is normalized run rate? I think that's gonna be a very interesting question.
The economy has grown significantly since 2019 and even 2020. Again, I tell the story when we, when we hired our tech team and Jason Auerbach, who runs it, went through his coverage model, and he might have put 1,000 logos on the board that his 14 managing directors cover. I'd say I probably knew what two of those companies did. I don't think I heard of 950 of them. And I'm and I'm in the market. I mean, I think I'm up to speed on what's going on. This is the creation of companies. Think of all the money that went into VC company creation in the last three or four years. GDP itself, I looked, I think from 2019 to today, is up 25%. So it's a much larger market.
There is a huge backlog of transactions that, you know, take the, the orphan SPAC market, the venture market that needs to consolidate, the LBO market that needs to be recycled on capital. The interesting question is, everybody's talking, and they're sure that 2021 is the outlier, and I say we could look back, and I'm not saying this will happen, but 2022 and 2023 could be the outlier, and 2020 and 2021 might be normal. I'm not sure... You know, I think, again, I'm not saying that'll happen, but I will tell you that it feels like there's a lot more companies and a lot more to do, and a lot more, you know, size of market to cover today than it did five years ago.
Well, that's a pretty, pretty positive outlook, potentially. Maybe we could just turn to restructuring. Maybe let's start with liability management. I think that's your capital markets business. You've talked about how that's been supported by liability management or liability management adjacent business.
Yeah.
Maybe you could just talk about where we are on the you know, the liability, how strong liability management is today. Can it continue at this level? Could it pick up into next year or, or are we past the peak?
Liability management is strong, and I think it stays at this level, because there's so much debt issued in the five years prior. You know, I don't have the graph in front of me, but the acceleration in leverage credit has been fairly significant. And look, we were at a period of time there where there was 1% or 2% default rates going into this cycle. So, you know, can we get to 3%-5% default rates? Probably. Or three... There are companies that are gonna be in trouble. Regardless of what happens with the Fed and what they do now, there are companies that have bad balance sheets, they don't have the growth to overcome it, and they're gonna have to do some liability management.
And I believe that's gonna be 3%-5%. I don't think it spikes. During the financial crisis, it did spike to as high as 10% or 12%. A very unusual, quick up and down. I believe this stays as a solid recycling of companies that are in trouble. But again, it's a great business. I love being in the business. I think it stays. It was very elevated for us in the third quarter. It was very good for us even for the full year. I think on an absolute basis, it stays and grows a little bit from this, but the real money is gonna be made in the 95% of the companies that are not in crisis.
Remember, 5%, 3%-5% might be in default mode or close to it, and we're gonna try to intervene there. Liability management just means trying to intervene before a default happens, and you have to go into chapter, which we think we're very good at. But you know, the big game is gonna be in the 95% that want to do M&A, and again, I would almost hope that our restructuring revenue shrinks back to 20%-25%-
Right
... of our revenue.... not because it goes down, but because M&A goes up so significantly.
Okay. So, maybe just one more on restructuring and M&A, tying those together. You have a pretty constructive outlook for next year. Does that mean that you still think we're going to have an environment where restructuring is strong and M&A is, you know, getting better over the course of the year?
Yeah.
Is that possible? And then I guess, just on Chapter seven, Chapter 11, has that picked up at all?
Chapter 11s have picked up, but I think there's also actually the creditors. I think there's more of a desire to stop these things before they get to Chapter 11. There was a time when some of the big credit firms that you probably know by name used to tremendously fight with each other, inter-creditor, and that caused a lot of the Chapters 11 'cause, you know, if somebody above you was getting a nickel and you were getting a nickel less, you'd, you know, take it to the grave. There's much more creditor cooperation to keep companies from going into Chapter 11. So I do think liability management, which is the act of trying to get everybody into an agreement before you have to go into a court, is that's why it's accelerating so much.
That will continue to happen, and again, I continue to believe that will be a substantial and pretty stable part of the business, just 'cause so many companies are overlevered and have bad, bad balance sheets. It's just a matter of when you have to address it. But I do think that won't stop M&A. You know, I think M&A will accelerate, but there won't be enough to bail out the companies that got themselves in trouble on balance sheets. I think they'll have to continue to do liability management.
Okay. Just one more on the business side, which is just thinking about fundraising. You know, your fundraising advisory business is, you know, private equity is moving from a zero-rate environment to a higher rate environment. How does that... I guess, what does that mean for fundraising, for that part of the business and therefore for your business? And then the secondaries business seems to be taking off. So, you know, how do you benefit from that?
We're fundamentally not, except for very special positions, we're not in the primary fundraise business. We thought that business was going a little commoditized. And you'll see the really good firms that are up to fund six, seven, and eight, they don't wanna pay anybody to raise their money, and those are the easiest to raise money for. And then the smaller funds, which will pay, are very difficult to get done. So it's the business model changed over the years on the primary funds. What we have been focusing on is the secondaries, continuation funds, innovation around ability to stay invested in assets that you want, and we are build ing on that. So on the primary funds, I know that's been a very tough year on the market.
It'll probably be another tough year, tough six months, I think, till the distributions start. What I think is happening is people are liquidity is one thing. I think people also want to test the marks. They want to see an exit based on the marks that they have been marketed to. So you're going to see some credibility once the environment changes, and I think that'll restart up. But look, I still think primary fundraising for small, new entities is a lot of hard work, and most of the big asset allocators are consolidating and wanting to give their money to the big brand names that you probably have speaking here.
Okay, two last ones for me. Just thinking about the margins, your favorite question, how are you thinking about the, the puts and takes around the operating margins into 2024, 2025? And just, you know, maybe if you would just break down across the comp ratio versus the, the non-comp ratio.
I think our non-comp ratio is about where it's always been. I know we had. There are a couple of weird things. You know, we, we—when we hired the team from SVB, we had to agree to pay them back for some that we, if we executed some of the deals that they had an engagement, we'd split some fees with them in order to let our team work on it. And it's funny, that does not run through comp, that runs through non-comp because it's an agreement. So we had a couple of weird items on our—but I think we're gonna be at the same levels for that, same dollar amounts, and that, you know, so that should get down again to 15, 16, as we get our revenue up.
On the Compa Ratio, look, I, again, that's very dependent on revenue. And once again, I believe we're gonna return. If we can get a normal full year in, I think we'll get right back pretty close to... You know, we might not get there in the first year, again, because remember, the revenues for January have already been determined. Whatever our revenue is for January was determined by the deals we closed in September and October. It takes three, you know, just consider about three months to close a deal. I mean, not every transaction. So, look, this thing's turning very quickly. Are, you know, the deals in November and December are starting to come. December is never a big year for actually complete, you know, for completion. Well, that's not true.
It's a big year for closing, a big month for closings, but not this year 'cause of what was happening in September. But it just depends on how fast that ramps up. But I think sometime between January first and the middle of the year, you're gonna see a run rate of revenue, a run rate that looks to be well north of what I would call middle of the cycle average revenue per MD. I think our MDs are better, our fee pool, our facings of fee pools are better. And so again, it gets blurred.
People ask me on a one-year basis, and I said, "I'm really building a company for five, 10 years." And the fact that I don't know if January or February will match what I think is gonna happen in June and July. But I know by at some point, you'll start to have a run rate that is well in excess of what we need to get back to full comp ratio, full margin.
Okay, last quick one from me, which is just thinking about capital return priorities, and then, you know, you do have a substantial dividend today. Margins are obviously lower. Just how are you thinking about whether there's any possibility of leverage, you know, just to support the dividend?
Well, there's nothing in our cap plan. We don't think we need to have leverage to support the dividend. We don't even need. We have a big position in our Australian subsidiary, by the way, about $80 million of market value that we keep on our balance sheet. We're not even. That's not even in the plan. We think we can pay the dividend out of cash flow from operations. By the way, we think we bought a company about a third the size of Moelis & Company on our income statement and have no debt, and we think we can do that out of cash flow and pay the dividend. And we think that was a unique opportunity.
If we had done it as an acquisition, we'd have absorbed some form of term loan or something would have happened to pay for the $300 million-$500 million of value that that would have cost. And we just did it right through the income statement. By the way, the return on investment of that, the ROIC on these hires is could be close to infinite, depending on how fast... Remember, most of what we most of the investment is in bonus pool, paid in February, March, the following year, you hire them. I will say teams like our tech team showed up by the middle of April or May first, and are probably gonna produce cash in excess of the cash costs to pay their bonuses in February and March.
That doesn't cover all the overhead of the firm and everything. I just say the return on investment, when you don't have to put up the capital to purchase the company, is pretty spectacular.
Great. Okay, with that, I think we're out of time. Thank you so much, Ken. We really appreciate it.
Thank you, James.