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Thursday, April 24, 2014

Moelis Reflects New Industry Trends



Roy C. Smith

Moelis & Co., one of Wall Street’s newest merger boutiques went public last week, making it the fifth one to be publicly traded. The offering illustrates three new and important trends in today’s investment banking business.

Despite a weak market that forced a reduction in offering size and price, Moelis, raised $163 million and emerged with a market capitalization of $1.3 billion, about the same as old-timers Evercore and Greenhill.

Most of the money raised will be used to redeem some of the $300 million of capital invested in the firm to date by early backers.  Ken Moelis and his two co-founders will control 97% of the firm after the offering through special shares with 10-1 voting rights.

Migration of Talent

The first is that experienced merger professionals continue to migrate to boutiques like Moelis and Perella Weinberg (formed in 2006, but still privately owned). Today boutiques altogether employ around 2,000 merger advisers and generated advisory fees of about $2 billion in 2013, about the same as Goldman Sachs, the M&A market leader.

The boutiques offer much richer compensation prospects than the major banks. Moelis paid out 65% of revenues in 2013 as compared to 37% at Goldman Sachs, but also offers employees ownership of stock that the market capitalizes at a higher price-earnings ratio than the major banks’ (Moelis’ P/E ratio is 24, Goldman Sachs’ is 10).

These prospects are tied directly (and solely) to the global M&A business. The boutiques are expecting this business, operating now at only about 50% of the peak volume in 2007, to bounce back with economic recovery. At Goldman Sachs, where senior banker pay is tied to firm-wide performance and subject to bonus caps or regulatory constraints, M&A fees comprised only 6% of revenues for 2013.

And, boutiques claim to offer a more collegial, less political working environment that is much less likely to be disrupted by unwanted media or regulatory attention.

Unbundling of Financial Services

The second is that the boutiques have been enjoying an increasing share of M&A advisory work, which is a reflection of clients’ desire to unbundle the all-in-one financial services model of the major banks.  Clients want advice from several sources.

The boutiques are now big and global enough to keep up with the major banks. They are equipped with deep industrial expertise and their rainmakers know many, if not all, of the heads of the major companies in particular industries.

Altogether, seven merger boutiques were among the top twenty advisers in completed M&A deals in 2013, representing approximately 18.5% of the total transactions reported by advisers. (Because multiple advisers are often used, the value of transactions reported greatly exceeds the actual value of transactions completed). In 2007, the record year for completed merger transactions, only 4 boutiques were among the top twenty advisers, then accounting for 12.2% of the completed deals. In 2013, eight of the ten largest M&A deals had boutique advisers, up from three in 2003.

The unbundling is not in mergers alone. The market share of all global investment banking transactions (bond and stock offerings, syndicated loans and M&A) of the top ten banks declined to 70% in 2013 from 94% in 2006. This has occurred at a time when the major investment banks have been under prolonged duress from increased regulatory constraints, scandals and litigation, and pressure on their stock prices and compensation ratios.

Fewer Conflicts of Interest

Boutiques also offer themselves as uncomplicated and familiar people to work with, with few, if any, conflicts of interest.  

Because of the many different lines of business at major banks, including other client engagements, trading positions, and affiliated hedge and private equity fund activities – all now interpreted more stringently -- conflicts of interest invariably appear.  The Delaware Chancery Court’s highly critical rulings in two recent merger cases (Del Monte, 2011, and El Paso, 2012) held corporate directors liable for closely monitoring their advisers for conflicts of interest, These have made many corporate boards more cautious when hiring big bank advisers:

One way to address conflicts with an adviser is to hire more than one. Over the past decades, companies have increased the number of advisers they employ on transactions, often using two or more.

The Big Banks Resist But are Under Pressure

Giving merger advice is less an art, if it ever was one, than a well-perfected professional process. There are lots of competent firms offering the process, including the boutiques, but the industry leaders have not backed away and remain well entrenched.

The top five advisers handled 54% of the deals reported by the top twenty firms as they have for most of the last decade. It does appear, however, that the boutiques are taking market share away from the others.

That is not to say that the boutiques will continue to do so in the future. Big banks have multiple relationships with clients who trust and rely on them, and including them as merger advisers is an easy way to reward them for accumulated services.  Highly professional teams are always available at these firms, even when a star banker leaves or retires. At the boutiques, holding the firms together after the star fades is never easy so relations may be less solidly entrenched.

Still these three trends are powerful ones that reflect the considerable pressures now being felt by large “systemically important” global investment banks.  New, non-systemic, non-bank boutiques, including hedge funds and private equity firms are being formed all over the market to compete with big banks, not only in investment banking and credit provision, but in trading and investment management as well.

Some of this because the big banks are under considerable pressure to reengineer their business models and, while doing so, they may be seen to be weakened enough to encourage challengers.  Thus competitive pressures compound the regulatory constraints imposed on the systemically important firms.

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