Moelis: Hit Hardest By M&A Stop, Should Gain On Certainty (NYSE:MC)

Published on the Value Lab 1/13/22

Moelis (NYSE:MC) is one of the highest quality M&A and strategic advisory pure-plays on the market. 2022 was a rough year from them as headline grabbing M&A came to a total halt, meaning MC had to rely on other advisory. However, we think the conditions are brewing for a substantial recovery in their business. While they are more sensitive to the requirement that markets are stable than other more diversified peers, they’re a good way to expose to the sector given their pretty low TTM multiple. We think 2023 should give results consistent with the 2022 midpoint results from the very high to the very low. They’re not a bad buy now. However, operating leverage in the sector has us looking for those same multiples elsewhere.

MC Dynamics In Context

The big loser this last year was sponsor facing activity. Sponsors allocated like crazy in 2021, and now they’re losing money on that huge weighting. Moreover, they have worse debt capacity than a corporate player, which has a business and assets to back their debt. Therefore, they rely on LevFin markets, which were in upheaval as rates continued to rise from June onwards. Very little activity happened with sponsors, and the effect is big as sponsor deals usually close 10x faster than a corporate deal, which moves slowly with lots of red tape. The IPO exit also became unviable for a lot of sponsors with plans to realize their investments in the growth equity markets.

MC revenue declined over 30% on a 9 month basis and more than 50% on a 3 month basis, which is quite below the benchmark we’ve been using for all companies engaged in strategic and M&A advisory. Mid-market companies did much better, but Moelis with its marquis list of clients and exposure to megadeals saw a big hit. Moreover, restructuring activity remained pretty muted despite everything, picking up perhaps a bit after the end of the latest quarter. MC has a good franchise, but there just didn’t seem to be as much need for restructuring as expected based on later-dated reports from peers.

Restructuring could be big for Moelis which is cross functional, but we think the economic conditions are more likely to evolve such that M&A advisory and strategic advisory pick up again instead. Inflation and inflation expectations are easing. Inflation expectations in particular is down to June 2021 levels – when only the first alarms of inflation were being sounded. Lapping 2022 figures soon, inflation should ease further. These dynamics have long been reflected in the yield curve, where rates would come down a lot to just above 3% from the current (likely) peak above 5% as lowered inflation could justify some easing. We go as far as to say that a soft landing is possible when looking at continued, positive development in the jobs market.

Bottom Line

A soft landing isn’t even needed for MC to see some recovery. With some certainty in the markets, LevFin can act again, and sponsors can start allocating again at new, more predictable costs of capital essential for larger deals relying on leverage. Corporates are also likely to move again too. Strategic advisory has proven non-cyclical across peers, and should continue strongly too. MC doesn’t engage in ECM and DCM, so those businesses which have been decimated and depend on stronger assumptions don’t need to be worried about here.

The trailing multiple is around 11x in PE. That’s pretty low. If 2023 results average at a midpoint of the dramatic 2022, then the 11x will hold as a forward multiple too. Earnings yields are pretty good at 9% especially as rates are likely to retreat somewhat, at least according to the smart, bond market money. With the outsized impact of sponsor activity on deal velocity, Moelis should see dismal quarterly results, worse now than even 50% declines, reflect the TTM picture more closely in 2023 as certainty restores the MC business. While the factor of certainty is a factor with a high probability of occurring, we may stay out of this one due to its binary nature. There are other stocks with the same multiple for less out there.

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