Moelis (NYSE:MC) recently posted Q1 FY15 operating results. Said results were disappointing when compared to prior year figures. Q1 FY15 revenues fell to $99.4m, down 13% y/y. Adjusted net income was 28 cents per diluted share, compared with 36 cents in the prior period.
Recent weakness is not what it seems
Although it true that the company's first quarter FY15 financial results were disappointing, the recent weakness is not what it seems. Tough comps played a factor (Q1 FY14 results comprised of 22% of full-year revenues - historically they comprised of 15%-ish), though they do not tell the entire story. Deal flow continues to be strong (completed M&A transactions increased y/y), but credit-sensitive deals are experiencing prolonged delays due to the regulatory pressures. As a result of the housing crisis, several new regulations have surfaced in order to curb lending, affecting credit-sensitive deals. The most notable of these regulations are higher capital adequacy ratios, which generally force banks to lend less overall. Ken Moelis had the following to say about regulatory pressures:
Look as I said, some of these processes they get rolling in September, October, November they don't happen immediately. And so when the market changes a little bit it's like you would have a bit of a mismatch on expectations and I think it just takes a little time and it comes together. And we're seeing that.
Earnings Call Transcript
Therefore, the key takeaway is this - deal flow continues to be resilient, but it is taking slightly longer for deals to complete, resulting in a weak Q1. The "lumpy" nature of investment banking means that investors should not judge Moelis solely on quarterly results. Moving into Q2 and the rest of FY15, expect revenues to pick up, as deals that were delayed in Q1 get completed.
Tailwinds remain intact
In a prior article on Moelis, I mentioned that there were several key industry drivers that act as major tailwinds - record M&A volumes, high corporate cash balances and management confidence, the era of shareholder activism, low interest rates, and record-high stock market valuations. I also explained how these tailwinds impact investment banks in another article.
The majority of these tailwinds have either improved or remained more or less intact. M&A volumes continue to make new highs - increasing to $902b in announced M&A, the strongest Q1 since 2007. As M&A volumes keep increasing, this is also representative of the high level of confidence management has in inorganic growth initiatives. Corporate cash balances continue to increase, with tech companies such as Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG) (NASDAQ:GOOGL), and Microsoft (NASDAQ:MSFT), leading the charge. Shareholder activism has continued to prosper in 2015, according to research.
The S&P 500, a reliable proxy for the US market, has continued to hover around 2000, showing that corporate America as a whole is generally overvalued relative to historical levels. As issuing stock is a mainstay of M&A, high stock market valuations bode well for investment banks such as Moelis. The US recently posted near-flat GDP growth as corporations continue to struggle to increase their top- and bottom-lines.
Due to sluggish growth across the board, expect companies to continue looking for ways to cut costs and improve profitability. Most notably - Procter & Gamble (NYSE:PG) has looked to shedding a large number of its brands to improve performance. A fellow SA contributor, Musings of a Banker, wrote a piece detailing the consumer giant's strategy - I have also wrote an article on the company's plan. P&G is an example of how companies are becoming increasingly desperate to achieve growth and increase profitability. Many executives continue to explore inorganic initiatives in order to improve operations, and this should allow M&A volumes to continue increasing throughout the year.
Restructuring segment should begin to ramp up in the near-term
Moelis' management mentioned how its restructuring segment is currently comprised of a small percentage of its top line, mainly due to the current low default rates. However, I expect the segment to contribute a more meaningful percentage to total revenues in the near-term, as oil prices continue to remain at depressed levels. It is no secret that many smaller oil companies are experiencing difficulties and are close to default. Considering that Moelis' restructuring team is known to be the best in the business, the company should no doubt benefit going forward.
Managing director growth
As detailed earlier, the investment banking industry as a whole still has a lot of room to grow. Moelis continues to lay the groundwork - increasing MD count to 99 compared to 87 at the time of the company's IPO. Though a larger headcount would put a pressure on profitability (CFO Joe Simon expect comp ratio to increase to 54), I am of the opinion that the pros outweigh the cons here - a greater number of MDs would place the boutique investment bank in a better position to capitalize on the growth of the overall market.
Despite poor Q1 results, I continue to be bullish on Moelis. M&A and other corporate advisory work is lumpy by nature, hence a single quarter of results is not representative of an investment bank's ability to operate. Furthermore, regulatory pressures have extended timelines on credit-sensitive deals, resulting in a significant number of deals being held up. I expect these deals to complete as the company goes into Q2. Tailwinds continue to strengthen or remain intact, which bodes well for the company in the near-term. Although restructuring has not been performing well, the segment should pick up as oil prices remain at depressed levels. A larger headcount is yet another positive as it allows the company to increase its penetration within the regions that it operates in. I continue reiterate my bullish stance.
Disclosure: The author is long SPY.
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