|Illustration: Tracie Ching|
It is a highlight in the life of any entrepreneur to take a business they have founded into public ownership on one of the world’s leading stock exchanges. For an investment banker, launching your eponymous advisory firm on the NYSE is an even more extraordinary moment: one that brings up old memories along with new perspectives.
Ken Moelis opened the doors of Moelis & Co in July 2007, one month before the great market convulsions that marked the bursting of the sub-prime mortgage crisis. He always intended it to be much more than a boutique designed to monetize the relationships he had built up over a career advising companies.
“I didn’t spend 30 years working my way up in this industry at DLJ and UBS to then set out to build something small,” Moelis, Euromoney’s Banker of the Year for 2014, relates. And by the time he came to IPO the firm in April this year, it had advised on $1 trillion-worth of deals, including three of the 10 largest M&A transactions announced last year and four of the 10 largest recapitalizations and restructurings in 2013.
How did it feel for a banker who has spent a working life pitching ideas to clients to find himself on the receiving end? “Choosing the lead banks for the IPO, sitting on the other side of the table for once and being pitched to, was a little uncomfortable,” Moelis says.
|Awards for Excellence 2014:|
Banker of the year
In the end, the experienced investment banker did what so many corporate clients have done before him. Moelis chose Goldman Sachs and Morgan Stanley to lead the IPO. “It came down to those exact same considerations you always say it does. Goldman had spent a lot of time working with us. I have good relationships with senior people at Goldman and I had got to know James Gorman and developed a good relationship with Morgan Stanley. You go with the bankers you have a good relationship with, who have covered you consistently, that have worked the details, come up with helpful advice before the IPO process even began, as for example Goldman did on certain tax changes that might have impacted our ownership structure.”
The deal was launched in the last day of clear blue skies for equity markets in April before dark storm clouds blew in from the border confrontation between Ukraine and Russia that brought a brief but fierce squall of risk aversion and volatility. Moelis remained calm. He knew that, given the firm’s work at the centre of markets dominated by big financial investors, some of whom had supported the firm as early-stage private equity backers, he needed to do a deal that worked for them as new buyers and existing owners. He trimmed the size of the initial offer, cut the suggested price for the stock below the initial range of $26 to $29 and launched at $25, reasoning that the obvious earnings potential from the booming M&A markets would see the deal home even as other IPOs struggled or were pulled.
Was pricing his IPO below the range a difficult call for the head of a young investment banking firm? “I figured we might get a sloppy deal done at $26 or a tight deal at $25,” Moelis shrugs. “Wall Street is our neighbourhood. These investors are our friends. It wasn’t like we could just take the most money at the highest price, walk away with it and never see them again. No, that was not a tough decision.” The stock jumped to $26.15 on the first day and was trading at $30 in late July: a pretty close to perfect result.
Moelis, of course, had done this kind of thing before.
“I was reminded of the very first time as a young investment banker I had introduced the road show for a company that was going public. It was 1982 for EMC Insurance. We launched the road show at the Palace Hotel in New York. I was 23 years old. My family came to see me introduce the CEO.”
But 32 years later there was nothing the slightest bit sentimental or emotional about the decision to list Moelis & Co, its founder tells Euromoney. “My ambition was always to build the company, not particularly to take it public as some final goal.” Doing an IPO was not the realization of a long-held dream, rather a purely practical decision and one born of a dark vision for the future of banking.
Students of the history of Moelis & Co should remember that while the firm opened its doors just as the financial crisis was breaking, and recruited heavily in the darkest days in 2008 and 2009 in the US – and then in Europe during the sovereign crisis in 2010 and 2011 – the business plan was first conceived even as the old model of investment banking advisory as a sales tool or even camouflage for highly leveraged principal position taking by universal banks was still enjoying a full-on bull market.
“I did not quit to form Moelis & Co, I quit to get out of what Wall Street had become,” Moelis says. He hunches, thinking back to a period of banks selling synthetic products to synthetic customers in a system built on huge disguised leverage to account profits up front without costs. Everyone has their own memory of when they realized how big and ludicrous the bezzle had become. For many it was the arrival of CDO squareds and cubeds. For others it was leveraged loans with no principal repayment dates and allowance for capitalized interest payments in kind.
What was it for Moelis? “I thought the bell ringing was when banks started to bridge the equity on leveraged buyouts,” he says. This was the corporate equivalent of sub-prime: lending companies the equity down payment on the capital structure for deals, allowing them to pretend they had capital underpinning their loans when really they had more debt weighing them down. It’s difficult to think now how banks could even conceive of that.
“When I told UBS my intention to leave in late 2006, the investment banking business was absolutely booming. It must have looked like a crazy decision to quit and the response felt like: ‘Well, sure. Don’t let the door hit you on the way out,’” Moelis says. “They were so unconcerned that while I was on gardening leave they let some of my team work up a business plan with me. Those colleagues later had to remind me: ‘Ken, we still haven’t resigned from UBS. You have to actually invite us to be part of this.’”
|Advisory work on deals for Hilton Hotels, Anheuser Busch, AMR Corporation and Dubai World have cemented Moelis & Co’s global credentials|
Moelis, then 48, had begun to muse about the kind of ideal firm he would like to work for over the next 20 to 30 years of his life along with some like-minded souls. He sounded out other founders of boutique firms, but the true early confederates were Jeff Raich, Navid Mahmoodzadegan, Elizabeth Crain, his COO at UBS and now COO at Moelis & Co, and Kate Ciafone, now head of IR at Moelis.
The plan was to create not a boutique for a few 50-year-olds to share office costs and generate a payday from a last handful of mega-deals, but rather an institutional-scale investment bank offering unconflicted advice in M&A, restructuring and capital markets, but without securities sales and trading. Ideally it would be global in its scope so as to work for big international companies, and built to endure, recruiting graduates straight out of business school alongside mid-level and senior bankers.
Moelis says: “In the investment banking business you have to work every single detail for your clients. They’ll very soon notice if you are not on the details. I still wake up at 3am worrying about seemingly small things. ‘Did I return that call? Did I thank that person for their work?’ And that is why this is also a business of enthusiasm and of energy. In a business like that, you want young people with you. They keep you creative.”
Moelis and his colleagues decided that from day one they should recruit graduates, reasoning that, as the old investment banking model collapsed into crisis, here was an opportunity to build an integrated company where talented young people could come and feel that the firm would train them, imbue them with its culture and develop them to the point where they could lead it.
|The banking industry is still on a long march to |
a very different structure in which financing
and advice is likely to be further separated
A cornerstone of that culture is that the firm operates a single profit-and-loss account from which all discretionary bonuses are paid after painstaking reviews of the work bankers have done on acquiring new customers, nurturing existing relationships and executing transactions that generate current revenue.
The key to avoiding the mistakes of the Wall Street that Moelis had desperately wanted out of in 2006, he decided, was never to strike individual side-deals to pay bankers a percentage of the revenues they generate.
The model of rewarding bankers for sound and diligent coverage work and for delivering good advice – including not doing deals that might lead to no revenue this year – was obvious to the great investment bankers of the past. They knew that clients would reward them eventually. After all, these clients were not paupers.
“Of course revenues matter,” says Moelis, “but over the long term. You have to reward all the effort, not just all the revenue. And remember revenues come from relationships of trust that take time to develop. People continuously underestimate just how much top-quality business still gets done in this world on nothing more than a handshake. So, how do you reward a banker who has given the best advice to a client, which may be to do nothing? Do you give him nothing? Because if you do, that’s a real culture killer.”
He says: “I believe Moelis & Co has the best talent on Wall Street. Equally I recognize that the head of every investment bank thinks the same. The real differentiator is the cultural soil that you embed that talent into.”
At its heart, this is the partnership model that used to characterize the ownership of investment banks 30 years ago, but echoes today only faintly in the title of managing director that roughly equates to making partner back in the day, and still persists only at the large international law firms.
Moelis says: “One of the greatest aberrations of what Wall Street had become versus other professions was that Wall Street was one of the only places where wealth was expected to be created more through current compensation rather than by long-term equity ownership. Time and again you see it at the big banks: an inherent conflict between the bonus pool participants and the banks’ shareholders. Our pitch to recruits has always been to become owners. But that means that wealth takes time to accrue and comes perhaps two-thirds through equity ownership and only one-third through current compensation, which creates long-term alignments among partners that we think results in better advice for clients.”
Today, Moelis & Co employs some 500 investment bankers. When it opened its doors in 2007 it employed less than 1/10th that many: between 35 and 40. Almost at once the crisis hit and the opportunity arose to attract top talent to join founders such as Mahmoodzadegan who had been global head of media investment banking at UBS; Raich, previously joint head of global M&A at UBS and a veteran of DLJ; Todd Wadler who had covered financial sponsors at UBS and DLJ; and John Momtazee an investment banker at those firms covering broadcasting. Moelis says: “These were great bankers that I had thought might never move from their established firms, who now found themselves wondering if their firms would still be the same places to work as in the past, or whether they would even survive. This is why we were aggressive. We knew this may have been our one chance at unique talent.”
While Moelis’s vision for the ideal investment bank to work at looked conceptually appealing, hiring top talent still was not straightforward. The one-firm P&L sounds nice enough, but it proved a tough pitch for bankers cast out on to the street after traders in departments of their banks they had never heard of dealing in obscure securitized credit instruments had blown their firms up. No one more profoundly mistrusted the financial industry than the very people who worked inside it.
Many bankers wanted to work somewhere that they got directly rewarded for the revenues they brought in minus the expenses they incurred and some charge for the minimal risks they took: exactly the kind of commission shop Moelis had set out not to build.
Moelis had one secret weapon. Between leaving UBS, gathering his core team round the vision for the new firm and opening its doors, Moelis had done a substantial institutional fund-raising round, securing backing from roughly 10 of the largest US institutional investors. Though the amounts from each investor were moderate, indeed minuscule as a proportion of their funds, the firm suddenly looked very strong when Moelis disclosed this. “I used to joke that when we opened we were the best capitalized firm on Wall Street. But it really was a selling point that we were financially very sound and probably the least risky place any banker could go to work at. Still today, we have no debt, a strong balance sheet and extraordinary financial flexibility.”
Enough bankers were persuaded that the firm quickly got into its stride. In the first year, it advised Hilton Hotels on its $26.5 billion sale to Blackstone, and Anheuser Busch on its $61.2 billion sale to InBev. In 2009, it advised Dubai World on a $8.5 billion project in Las Vegas with MGM Mirage and then, on the back of that assignment, drew particular attention for being appointed sole adviser on Dubai World’s $26 billion restructuring.
This eventually required valuation and restructuring on some $60 billion of debt in a deal that announced Moelis & Co as much more than just a US-centric M&A advisory boutique but rather an international firm with other skills – even in a still-subdued M&A market – including not just classic corporate bankruptcy restructuring but advanced analysis and valuation of illiquid, structured and impaired debt instruments.
There were plenty of those buried around the system to keep the firm busy.
This year, even as the M&A business booms and the firm reports record trailing six-month revenues, deal highlights range beyond M&A. Sure, it has done big cross-border M&A deals this year, advising Lixil of Japan on its $3.5 billion acquisition of Grohe Group, the biggest Japanese acquisition in Germany. In December 2013, it advised the unsecured creditors of AMR on that company’s $29.6 billion Chapter 11 reorganization that led to an eventual $17 billion merger with US Airways, despite the initial reluctance of AMR. In February this year, it ran the bidding process through which RBS evaluated and sold off assets and liabilities related to its structured retail investor products and equity derivatives businesses to BNP Paribas in a £15 billion deal.
If Moelis’s aim was simply to grow the firm, he has certainly achieved that. The firm has 15 offices across north America, Europe, the Middle East, and Asia and most recently opened in Latin America in Brazil. It has a joint venture in Australia and a strategic alliance in Japan with SMBC/Nikko.
Rivals started to take notice, especially of the determined push for growth in 2009 in the US and later in Europe. The wise old heads among established investment banks determined that such a rush would sew the seeds of the firm’s downfall and that Moelis would trip himself up by recruiting too many mediocre people who would then fight for claims on weak revenues.
Moelis says: “In common with everyone who ever set up a business, we have never been short of people telling us what things we were doing wrong. But there is no perfect playbook for how to build a new firm, especially given the unique circumstances of the financial crisis. We decided at the outset to ban the phrase: ‘This is the way we have always done it in the past.’ As one by one, Wall Street banks ran into trouble it was clear that all decisions should be made from a clean sheet of paper. After that, you learn as you go, and one lesson is that mistakes are inevitable in recruitment as in everything else. If you get a disappointing performer, then you just manage that person. If you hire someone that threatens your culture, that’s much more of a problem and you must act decisively and fast.”
In the early rush to establish scale, Moelis regularly hit two obstacles, one of which frustrated him to the point of rage, one of which rankled over time. The first was that as a new firm offering a different model of investment banking he would occasionally try and recruit a banker only to find a TARP recipient bank dangling a two-year, multi-million dollar guaranteed bonus. He did what Americans do. “I called my congressman.” With what message, Euromoney wonders innocently. “With the message: ‘Are you kidding me!’”
|Ken Moelis, as the leadership battle to take over from Ben Bernanke (above) progressed: 'I watched the political manoeuvrings and knew the political, regulatory and social pressures on the big banks were going to get even more intense'|
The second obstacle was less infuriating, but equally aggravating: “I would find myself trying to recruit a banker with say a couple of million dollars of wealth tied up in unvested stock in his current bank, and saying: ‘Look, we’ll offer you 0.25% of the firm. That’s worth your invested stock.’ And they would say: ‘Based on what?’
“So the idea of having a currency to recruit talent put a clearer market value on and eased the transfer of ownership in the firm. We talked about it [an IPO], even drafted a plan, but it wasn’t clear we would do it, even going into 2013.”
Then, 12 months ago, something changed his mind. Moelis says: “It was at the time of the leadership battle to take over from Ben Bernanke as chairman of the Federal Reserve. I watched the political manoeuvrings and knew that far from being diminished, all the political, regulatory and social pressures on the big banks were going to get even more intense.”
President Obama, himself no friend of the banking industry, failed to smooth the path of his preferred candidate, Larry Summers, into the job and instead it seemed that Elizabeth Warren, at the populist end of the Senate banking committee, carried the day with her support for Janet Yellen. The implications hung in the air for a continued hostility to the banks, still today being subject to punitive financial sanctions.
“Sensing that, I called my COO and said: ‘You know that IPO I said we probably weren’t going to do? Well, dust off the plans. We’re going to do it as we are going to need a public currency to take advantage of the growth opportunities that will come,’” Moelis says. “I believe we are still in the early innings of the regulatory onslaught against the big banking groups.”
Moelis & Co now presents as a revenue growth story with improving margins and market share in an M&A business at the start of a new boom.
Moelis says: “Ever since the IPO, the number of people who want to talk to us has improved, as has the ease of those conversations. We no longer have to start by explaining who we are and what we do. People are no longer quite so surprised at the size of the firm.”
Moelis is enough of an investment banker that he wants to win every which way. The IPO has given the firm its currency and improved its visibility just as the M&A boom kicks in. It hasn’t much circumscribed his and his senior management team’s ability to control their destinies. Outside shareholders don’t have enough voting rights to override the inner circle, if it ever came to that. Not that it’s likely to, according to Moelis. He paints the success of the firm’s IPO not as a confirmation of the already apparent boom in M&A but of the firm’s business model. “I met shareholders who said: ‘We think you’re doing something different, more sustainable, more value-added.”
He’ll continue to build when there’s good value to be found from investing. Moelis long wanted to set up in Brazil as a potentially big market for the firm’s services in its own right and an important node in its international network to help it win business elsewhere in the world. But he waited until the boom in Brazil, and in pay and terms for investment bankers there, had waned before doing so.
Last month, Moelis & Co hired four managing directors from Greenhill to establish a private funds advisory business that will provide capital raising, secondary and other independent advisory services to private fund sponsors and limited partners. This expands the firm’s financial sponsors’ capabilities, having advised on more than $300 billion of sponsor-related transactions over the past five years, and enhances its offering to institutional investors.
Moelis sees a growth business opportunity. “If you think back to 2008, a lot of institutions pulled back or stopped new allocations to private investment vehicles. Since then, the value of the S&P and other world stock markets has almost doubled, and so the proportionate allocation to private equity and such has halved. I think we’ll see a big re-allocation back into that space.”
|[When I left UBS in 2006] they were so unconcerned that while I was on gardening leave they let some of my team work up a business plan with me. Those colleagues later had to remind me: ‘Ken, we still haven’t resigned from UBS. You have to actually invite us to be part of this’|
He talks about possible new additions to the firm’s international network of offices, perhaps in continental Europe or southeast Asia, “but really the big thing is to fill in more of the sectors, such as healthcare, energy.” He sees good times ahead and acceleration in revenues. “We could easily double the size of this firm.”
The firm will have its setbacks of course. Always priding itself as a hirer and incubator of young talent, Moelis & Co found itself having to make some bankers redundant last year, just as it hoped that its first cohorts of business school recruits would be stepping up towards the verge of managing director level. “What we found is that you can have very good people that execute everything they are asked to do tremendously well and pass every review with flying colours but then, to your surprise, in this new world of judgment, experience, relationships, they weren’t going to make it to managing director.”
He shrugs. “I wasn’t born with perfect knowledge of the independent investment banking model.” It’s another lesson learned.
One thing he is sure of though, is that it’s the right model to pursue, a certainty that drove him to do an IPO that would help attract more talent leaving the big banks.
“The big banks are in real difficulty,” he says. “Regulators would like deposit-taking institutions to go back to being almost utilities and will continue to push them on capital and leverage ratios, on compensation, on business model, on operational risk. The banking industry is still on a long march to a very different structure in which financing and advice is likely to be further separated.”