Summary
- Last quarter we covered, MC was still benefiting from high amounts of activity from sponsors.
- They had already noted elongated transactions.
- They're still talking about elongated transactions driving declines, but what it really means is transactions are paused.
- MC has quite a lot of exposure to sponsors, and it's showing in the current revenue declines. Restructuring is still a latent effect that could save 33% of peak revenues when online.
- One of the most respected franchises in the advisory space, probably a buy.
Published on the Value Lab 11/1/22
Moelis ( MC ) is a company we've followed and appreciated a while now. Cracks are showing with their dependence on sponsors, but we remind investors what they can do if things get even worse macroeconomically thanks to their restructuring exposures. If they get better, well then there's nothing to worry about - their capital markets-oriented businesses would come back online with the return of certainty. Overall, they remain one of the most respected advisors in the world, and while they're swinging in revenue, they're in a valley regardless of where things will go.
Q2 Note
Next earnings are coming soon, and we expect things to be very much in line as in Q2 which is also fighting against tough comps and is beginning to experience more of recessionary pressures.
In Q2 the salient points were the following:
- The elongation of transaction periods from last quarter apparently have gotten bad enough where they've effectively been paused in a lot of cases. Revenues have declined 34% YoY. Part of this is that the comps from 2021 were very strong, but certainly activity has slowed down substantially, or normalised depending on how you look at it.
- In Q1 the strength was being held up by sponsors, mainly those who wanted to sell off assets or lock in better financing terms as uncertainties mounted, looking to allocate massive stores of drypowder. Strategic concepts were coming in, and the hope was that asset managers would be coming in from different strategies bringing engagements to MC. That hasn't happened. Besides the death of the megadeal as the LevFin markets have effectively closed, asset management has gotten very conservative in general. There is activity and opportunities exist for sponsors to invest, but the leverage lever for returns is basically not there right now, and therefore the risk-reward has changed substantially for sponsors. In various alternative asset strategies buyers and sellers haven't been able to agree on prices, and terms from the financing side are also still in flux. Sponsors turned out to not be a source of resilience.
- Another issue for revenues is that sponsor facing business, which is the one that is especially slowing down, clears faster and has higher velocity in the mix than with strategics, and this is because strategic deals are often larger, public and therefore subject to a lot more regulatory hurdles. A PE deal might take a month to close, while strategic deals between 6 months to 1.5 years. This mix effect results in less share of more quickly completed deals.
Bottom Line
The Q&A was very useful in the last call. Let's talk about two things:
- Why are LevFin markets closed? This is what you'll be hearing a lot from the advisors out there. Basically, some debt out there that was priced for the previous environment is on clearance sales right now from bank balance sheets as they look to shore up their capital position. Simply put, it's hard to get new debt issued for new deals when private credit has so many opportunities to buy fire sale-priced debt from lender balance sheets. Once that clears, it is possible the markets open. In general, capital safety is higher now than in 2008-2009, so we aren't looking at contagion, just digestion of a persistent new interest rate environment. Still, the impact on sponsor business is very real.
- Restructuring is an important business for Moelis. According to the last quarter this could end up accounting for about 40% more revenue than what we're seeing today when it comes online. Restructuring is still dormant so this is a latent effect that can protect MC if things get worse. We think Moelis benefits if things get either better or worse from here. We're at a local minimum for the business. Obviously, the preference is for things to recover so that M&A activity is still reliable and strong. Activity isn't so slow where further declines wouldn't be possible as rates rise.
Overall, MC trades at pretty low levels. EBITDA is moving back to 2020 levels, and without more intervention and bailing out of zombie institutions that may need restructuring, the next wave of recessionary pressure would be good for Moelis, and would see low M&A levels like in early to mid-2020 but with a more serious restructuring component. It is also possible that with all the drypowder in markets things recover for the company and restore income back to 2021 levels once LevFin opens again. Overall, we think the company is troughing, and will worst case plateau at these levels in a very serious economic scenario. We like MC.
For further details see:
Moelis Is Feeling The Sting Of Falling Sponsor Activity