Source: SEC Filings
The above extract of Moelis & Co.'s (NYSE:MC) income statement might be confusing to certain investors. On a 3-month basis, the company seems to increasingly profitable. Net income more than doubled from $14m to $32m during the three months ended September 2013 and 2014. However, the company suffered a $5.7m loss in the nine-months ended September 30 2014, but earned a net profit of $36m during the same period in 2013. Expenses in the nine months ended September 30 2014 were an astounding 99.4% of revenue.
Note that all amounts are in thousands of USD.
On the surface, this may seem like the company is in trouble; Moelis was profitable in 2013, but not in 2014. For a young company such as Moelis, this raises some concerns.
Source: SEC Filings
However, if we turn to page 35-36 of the company's 2014 Q3 report, we find that the expense problem is thankfully, not here to stay. As a result of the company's initial public offering in April 2014, Moelis rewarded its Managing Directors with acceleration of vested equity totaling $87.6m, amongst other similar compensation benefits. All in all, these benefits amount to about $100m in expenses. By adjusting for these expenses, costs are at 73% of revenue, a level that is relatively normal within the investment banking industry.
Therefore, I believe it is crystal clear that the company's operating profitability has not gone down the drain, but was clouded by unusual expenses that are non-recurring. Most companies only go public once, after all.
Source: SEC Filings, author's own estimates
As seen above, company revenue have increased 30.3% on a 3-month basis ending 30 September 2014. This was driven primarily by the buoyant M&A environment, leading to Moelis' increased dialogue with corporate clients evaluating a wide range of strategic alternatives.
As I have detailed in a past treatise, investments banks derive a substantial, if not all of their revenue from monetizing the relationships they build with their corporate clients. Hence, increased dialogue with said clients is clearly a good sign.
Given that corporate cash balances are still at a record high, with its growth showing no signs of slowing, I expect the M&A environment to continue to prosper going forward. Despite the Federal Reserve ending their easy money policy, global interest rates still languish at record-lows. Considering the abundance of access to capital, and that investments banks such as Moelis are essentially middlemen for capital, it is clear that the company still has a myriad of opportunities to grow.
Another factor that further cements my belief that the industry still has room left for growth is the continuous record-highs achieved by market indices such as the S&P 500. The broad market index recently breached the 2000 milestone, indicating that corporate America as a whole is growing in value. Given that companies regularly use stock as a currency to acquire or merge with other companies, and that investment banks such as Moelis are the brokers for such transactions, it is a not a stretch to say that Moelis has a bright future ahead.
Hence, I have projected Q4 revenues to grow at a similar pace (30.3%) from $128m to $167m, with full-year 2014 revenues coming in at $542m.
Compensation and benefits increased on an absolute basis, increasing from $64m in the 3 months ended September 2013 to $68m during the same period in 2014, but decreased on a relative basis from 65.8% of revenue to 53%. Compensation in investment banking is famous for not varying much as a percentage of revenue, hence I have projected them to equal 55% of sales for Q4, or $92m. On a full-year basis, compensation and benefits amounts to $392m.
Occupancy, professional fees, communication technology & information services are relatively small line items as a percentage of sales. In addition, they do not vary much; I see no reason for them to, either. Hence I have projected them as a simple average of the 3-month period ending 30 September 2013 and 2014. Thus, occupancy is expected to grow to $5.2m, or 3.2% of sales, with the full-year amount coming in at $15.4m or 2.9% of sales. Professional fees is expected to grow to $6.4m or 3.8% of sales, with the full-year amount coming in at $21m or 3.9% of sales. Communication, technology and information services is expected to grow to $5.4m or 3.3% of sales, with the full-year amount coming in at $17m or 3.1% of sales.
Source: SEC Filings, author's own estimates
Similarly for travel & related expenses, I have projected it to be a simple average of the two periods, for the same reasons. Travel & related expenses is expected to grow to $8.1m or 4.8% of sales, with the full-year amount coming in at $27.5m or 5.1% of sales. Regarding depreciation & amortization, I have averaged them over the absolute values of the two periods ($571k and $542k), given that the company has indicated no plans to open new offices. Thus, depreciation & amortization is expected to be $557k or 0.3% of sales, with the full-year amount coming in at $2.1m or 0.4% of sales.
As noted above, $4.9m of one-time expenses in included in the "other expenses" line item and hence to normalize the figure, I have simply used the 3-month ended 30 September 2014 figure as a guide to project the Q4 figure. Hence, other expenses is expected to amount to $3.3m or 2% of sales, with the full-year amount coming in at 3.2% of sales.
As a result, total expenses is expected to grow to $121m or 72.5% of sales, with the full-year amount coming in at $493m or 91.1%, largely due to one-time expenses mentioned above. EBIT is thus expected to grow to $46m or 27.5% of sales, with the full-year amount coming in at $48m or 8.9% of sales.
For the reasons mentioned above, I believe that this low profit margin is merely temporary, and expect future EBIT margins to come in at around the 25% to 30% level.
In conclusion, although the company posted a net loss in their first 9 months of 2014, this loss was largely due to one-time expenses stemming from its IPO. Key industry drivers such as record M&A volumes, high corporate cash balances, low interest rates and stock market highs will continue to drive Moelis' revenues and profit in the near-term. Investors are advised to ignore the company's disappointing results in the first nine months of 2014, as on the surface, they are misleading and do not truly represent the company's operating ability. The investment banking industry as a whole still has room left to grow; investors would do well to sit tight and ride it out.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.