Ken Moelis on Private Equity and Investment Banking

By Prince of Wall Street on April 21, 2008 | More Posts By Prince of Wall Street | Author's Website

A few weeks ago Ken Moelis, former Drexel, DLJ, UBS rainmaking banker, was interviewed on Bloomberg about the leveraged loan market and the changes he expects to see at investment banks. Few people are as well placed as Ken Moelis to make such forecasts and his commentary is fascinating. He also answers questions about his new boutique, Moelis & Company, and its phenomenal recent performance. He also throws some criticism at UBS, his former employer. He criticizes the financial conglomerate model because lines of authority and decision making are difficult to discern. The Prince knows that this news is slightly outdated but he does not think many people saw this interview.

Here is a link to the video that aired on April 9, 2008

On investment banking in general:

“Investment banking is an incredible business. A very unique business in which you empower some very smart people to take unusual risks. Almost no other business in the world allows you to empower people on a day-to-day basis to take risks.”

On the leveraged loan market in response to John Mack’s rosy picture:

“To give John Mack his due, maybe we are in the 9th inning, but that means they shut the game down. What you are really asking is when does the next game start and I think we may be in the 9th inning of the last game and we might have to wait a year before baseball season actually starts again. Because there is no more backlog being created and there are no more commitments out there and so yeah we may be ending the crisis point in leverage credit but the floodgates will not open again for a long-time. I think it takes a long time for these cycles to reappear; people learn lessons, boards of directors, risk managers. It will happen again but it will probably be five to six year before we get anything like what we at 9 months ago.”

On private equity’s edge in the boom:

“There was a real arbitrage, I believe, going on between the public equity market, which was being pretty irrational, and the private finance market. What really happened was the security that was being under priced was leverage. It was being given away in too large size at too low rates. And what a lot of the private equity firms were really doing, I’m not sure they thought about it this way, but they were using the arbitrage of cheap credit which allowed them to actually pay 25-30-40% more than public equity markets. Because what we are finding out is the debt was giving them that ability by pricing themselves too low or too aggressively.”

On Moelis and Company’s edge and the M&A market without LBOs:

“First of all, let me defend us [Moelis and Company], because you said we don’t have a balance sheet and I was joking. I think we now have the strongest balance sheet on Wall Street given what is going on. I‘m not sure that anyone has what you would call a balance sheet anymore from the old definition. The interesting part is that M&A, I think is going to be down but nothing like what were feeling like in New York because of the finanacial panic that we are seeing here. The rest of the country is really not experiencing quite the same pressure that the financial are and I think you are seeing strategic deals come back. We just put a company up for sale this week and we did get 20 bids from financial sponsors. So I think if you have good product people will find a way to finance it and purchase these companies.”

On the investment banking business:

“We are going down, we will be down 30 to maybe even 50 percent in the short run and I think the street got staffed up to support what was a slight bubble in M&A. I do think that people will have to downsize but it will be a healthy market. Remember, if we went back just to 2005, we sort of had a very big spike in volumes in 06 and 07. So if you go back to 05, we may have to go back to staffing levels of 05. It’s not the end of the world…Look, I think across the board you are going to see these firms have to reduce by anywhere from 30 to 35 percent of headcount. A lot of the financial products are going to go down more than M&A, some of the actual leverage lending itself and mortgage products and I do think you are going to see a significant retrenchment on Wall Street.”

On relationship investment banking:

“What we are really doing out there, that is leading to our success, is that we’re going back to relationship investment banking. I think that there was a lot of distraction here put on leverage and how much you could lend people and at what rates and I really think the CEOs and these companies want long-term relationships. People who are willing to say no to them when you should say no and will know that they will still be involved with that company 3, 4, 5 years from now when they might do a transaction. And I think that Wall Street really has to get back to that and we hope we are leading the charge in that direction.”

Sounds like a page out of the Accidental Investment Banker or Goldman Sachs: Culture of Success.

On how Wall Street firms will survive a private equity fee diet:

“Well I think the good ones are going to manage back to remember who their client relationships were. I think they are going to have to go back out, remember that their client is a relationship not a counterparty, and I think they are going to have to remember that about their own people too. I think some of these firms have gotten used to moving paper around in size and forgot that the people within their own organizations are the true assets. We used to say that the assets went up and down in the elevators at these investment banks but now the assets are piled up in CDOs and warehouse facilities and that’s the problem. So I think you are going to see the firms go back to relationships with their own employees, the ones who do it right, I’m not sure that everyone will get there as quick as they should, and we might actually see some deconglomeration of these financial institutions.”

Given the first quarter M&A numbers all of what Moelis describes lays out sounds correct. In the first quarter M&A activity by volume was down 22% to $861 billion globally versus Q12007. U.S. activity was down 28%, to $318 billion, reflecting lack of credit for acquisitions and the related hiatus of financial sponsors. Also consider that Yahoo-Microsoft at $45bn and Phillip Morris’ divesture by Altria at $111bn make up 50% of U.S. M&A thus far. M&A fees are also down 28% globally in Q12008 versus Q12007.

The recent wave of layoffs have predominately been in departments that are close to the credit crisis, i.e. structured product groups and leveraged finance product groups. While some layoffs have occurred within investment banking division with deal volumes dropping more layoffs will be coming. Certainly product groups like leveraged finance have already been cut and will continue to be cut but even coverage groups will be trimmed. Many banks are even beginning to reexamine their M&A groups, normally considered the safest and most prestigious groups within most investment bank. The investment banking divisions at major banks are going to be facing significant headwinds over this year and possibly even through 2009. While these headwinds will certainly lead to some restructuring of the divisions, The Prince agrees with Moelis, that some downsizing will take place.

However, those predicting cuts similar to those that occurred in 2002 in the wake of slow M&A from 2001 to 2004 will probably be wrong. Moelis is right on point when he says we are going back to 2005 staffing levels. Much of the headcount that was focused on financial sponsor transactions will be directed towards the middle market, deals with foreign buyers, and hostile transactions. This makes sense considering that DB, GS, and MS all have their global M&A group heads based out of Europe now.

If you are curious about what Moelis and Company is up to check out this great article from Dealmaker (free subscription required).

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