Finding Opportunities Amid the Wreckage

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Kenneth D. Moelis discusses his firm's investment strategy

At a time when many bulge bracket investment banks are drowning as a result of the financial crisis, Moelis & Co. is swimming against the tide. Founded in July 2007 by Kenneth D. Moelis, a Wall Street veteran, the Los Angeles-based firm has been busy hiring. In just about 15 months, it has recruited more than 150 people, including some 100 bankers, besides opening offices in Chicago, New York and Boston. How will the continuing financial turmoil affect the fledgling investment bank’s business? What opportunities can investors find amid the wreckage? In an interview with Knowledge@Wharton, Moelis discussed these issues and more.

Below is an edited transcript of the interview.

Knowledge@Wharton: What is your view of the global financial crisis, and do you think it has run its course?

Kenneth Moelis: It has not run its course. We’re seeing a tremendous unwind of leverage that’s been built up for many years. What most people are finding is their inability to catch up with all of the ramifications of leverage. Most people extrapolate from their most recent [experiences], or even a long life. [For those] who have been in business from the mid ’80s, the only possible relevant outcomes were zero growth, or 3%-4% growth. Over time, more credit was made available with slight dips in between. People are having a tough time figuring out what the next year or two might look like, and how severe the credit unwind could be.

Knowledge@Wharton: What do you think would be the impact on investment banks?

Moelis: By definition they were the most levered vehicles in the world – 30:1, 40:1, or 25:1. [They were] even using all sorts of derivative instruments as capital. If you got down to the basic common equity, some of those ratios would be even less. If you are the most levered entity, a gigantic unwind of leverage will a significant problem.

Knowledge@Wharton: What are the biggest risks you see in today’s market conditions?

Moelis: It continues to be the inability to access capital. The most worrisome about it all is the complete inability for even the consumer or the basic industrial company that is not over-levered but just has a standard amount of prudent leverage [to service their debt]. It happens to come due during a time when almost no one will extend credit. That basic transactional environment in the world that we’ve taken for granted is just not functioning right now, and the ramifications are hard to figure out.

Knowledge@Wharton: Where do you think the problems will appear next?

Moelis: You will continue to see problems in areas like the hedge fund community, private equity, or anything that is leveraged to increase its return. But the one that is coming and will affect the general economy more than anything else is credit cards. Even what we call our strong banks today have lent to somebody – that is the basic business of a bank. So I don’t care if you’re one of the strongest banks in the world – you are dependent on somebody paying back a loan — whether it be a prime first mortgage, a credit card, or something else like that. As the economy starts to feel a pinch from what we’re in, you’ll see some things pop up that will surprise again.

“All we have to do is be excellent advisors and trusted at what we’re saying. The clients will make you successful.”

Knowledge@Wharton: The crisis has been quite international in nature. China recently announced a $586 million stimulus package, a lot of it being invested in infrastructure. Is that a good idea?

Moelis: It’s a good idea. The world is going to [face] this problem together. I’ve long been a believer that there was no de-coupling of the [world’s] economies, and that the world was still interconnected in a way that if the U.S. caught a major illness, the world would catch on. The U.K. just lowered interest rates dramatically, and China put a stimulus package, so that you don’t have a situation where a single currency is out of whack because they’re stimulating their economy, or their region faster than others. The fact that this seems to be a coordinated effort to stimulate the world is will be better for the currency market, which will add one piece less of volatility to the capital markets.

Knowledge@Wharton: Given the volatility of the markets, how do you see the prospects for M&A?

Moelis: M&A is very difficult right now. There are two ways to do M&A. One is through a cash acquisition and there’s no way to finance a cash acquisition right now unless you have the cash on your balance sheet, which very few people do. [Even] if you did, you wouldn’t want to use it all in one acquisition.

The other way is to do a stock-for-stock transaction, which you’ll see more of. The trouble with a stock-for-stock type acquisition today is you can literally go in to see a company at 9:30 a.m. at the beginning of the market, and between the time you’re presenting and the end of your presentation the company’s stock could move 20%. I’m talking about major American Fortune 100 companies. In the course of a two- or three-hour presentation, you could have their entire value move 10%-20% on one of these volatile days.

It is very hard for two companies to come up with relative values, which is what a stock-for-stock merger is, and it’s very hard to agree on a relative value merger when you have that kind of volatility. So for the time being, I’m sure there will be exceptions, pretty much all M&A is on standby.

Stirrings of Entrepreneurship

Knowledge@Wharton: I would like to turn now to your own background and starting your own company. You were the president of UBS Investment Bank before you founded Moelis & Company in July 2007. That was when the market was at its peak. What inspired you to take that risk?

Moelis: There’s a moment in time when you’re uncomfortable and I can’t pinpoint it. But I did not feel that the large-scale financial conglomerates were structured to service the client base the way I had for the 27 years of my career prior to that. I happened to be at UBS, and there were others out there. It’s one of those moments when you trust your gut, and you’re right, but it was a very difficult time to get out. It was right after 2006, which was maybe the best year in the history of Wall Street. But something felt wrong about the product, and the way we were delivering it to our clients at that point.

Knowledge@Wharton: Today, with 20/20 hindsight, what do you think about the timing of your decision?

Moelis: In retrospect it was fortunate. It would have been very tough to leave an organization like that six or eight months later when the first signs of problems came about. Even if you were not involved in them I would have found it very difficult to leave in the midst of that situation. It’s somewhat easier to leave when everything seems to be going well, and you’re moving on. So it was very fortunate in that regard. From a business point of view as well, it turns out to be a good time to have left.

“The investment banker who wins is the one who cares the most.”

Knowledge@Wharton: How have you positioned Moelis & Company, vis-a-vis the other bulge bracket banks, and what sets you apart from them?

Moelis: We are trying to go back to what I call old-fashioned relationship investment banking. I think it’s very hard in an organization — some of these organizations are as large as 300,000 people. Even the investment banking subsidiary of some of these large financial conglomerates are 25,000 people. I think maintaining the quality of a relationship, which investment banking was always an industry where you were the CEO’s partner in his or her strategic plan, and what they really wanted to accomplish. [They needed] a confidant. I think it’s hard to organize and maintain that culture in organizations that grow to be the size of 25,000, 50,000, or 100,000. So what we’re trying to do is a very hands-on, very relationship-based, long-term partnership concept with these companies that we’re advising. I actually think, I mean I hate to say it existed 20 years ago, and maybe even 15 years ago, and seems to not exist in the market today.

Client-centric Business Model

Knowledge@Wharton: What would you say is your business model?

Moelis: Our business model I think is a very simple one. People ask me, how do you make money? How do you budget it? Well we don’t budget, and don’t have a business model. I tell our people, you do great work, you become partners, [and in] every meeting you have, put yourself in the shoes of the person across the table. Whether it’s a board of directors or a CEO, don’t think about what Moelis & Company needs. Do not think about any type of issues around us. We’re well capitalized, we are a partnership, we have no bad debts on our books, and we don’t have to feed a distribution machine.

All we have to do is be excellent advisors and trusted at what we’re saying. The clients will make you successful. That’s really my philosophy. If we’re providing that kind of service and it’s unobtainable anywhere else, and they’re really close, and they have invested with their partner at our firm, it’s an irreplaceable relationship, it’s a valuable relationship, and over time they will find ways to make our company successful.

Knowledge@Wharton: That’s very interesting because at a time today when some of the most prestigious names on Wall Street are in shambles, your firm has grown in about 15 months to about 150 professionals including 100 investment bankers. What’s driving your growth?

Moelis: Two things. One is the desire for the clients to have that relationship. When we show up, and we put a 20-year veteran on the field, they have a relationship, and they’re not selling cash management or foreign exchange or commodities or convertible bonds on a Friday, and on Monday they come in with the next product du jour, but are actually trying to think through the problems that are important to the person on the other side of the table at that moment. It’s a new product. I hate to say it, and I wish it was not true, but it’s a new product. So that’s number one.

Number two, on the banking side, on the talent side, people are searching for a place to conduct that business. For them as well it seems that [for what] they have been trained to do, and really want to do — investment bankers — a lot of them get a bad rap. I think they do want to give good advice, and they want to be free to be their client’s partner. It’s just being involved in large companies with budgeting and annual bonus cycles and 360 review processes, and the constant pressure to sell another product to their client, it becomes a very difficult thing, to put up that wall and put yourself in the other person’s seat, and only provide the services that that person needs at that time.

Who Cares the Most Wins

Knowledge@Wharton: You have been recruiting actively. What do you look for in people when you hire them?

Moelis: You know, it’s funny when you make it to this stage, and I say this when I come down here and recruit at Wharton, most people are pretty smart so you don’t have to actually look for that. Look, it pays to be intelligent. But I find that if you have made it to the Wharton School, let’s say, or even to [become] a 15-year veteran in investment banking, often you have some level of intelligence that can get the job done.

What differentiates a great investment banker [from others] is who cares the most. Do you actually care about the outcome? Are you up at two in the morning wondering about the details? You can tell if somebody cares. I think our clients can tell right away, who you care about when you walk into the room. Do you care about them? Do you care about you? Are you worried about your job? Are you worried about your bonus or are you worried about the future of the company you are about to advice? It’s a funny concept but I’ve always said that the investment banker who wins is the one who cares the most.

Knowledge@Wharton: How do you see your growth plans in the U.S. and internationally going forward?

Moelis: In this market it’s very tough. Show me a person with a five-year plan I’ll show you a fool. And right now we have a series of five-day plans. I’m half kidding about that. Look, we want to become, and are fully on our way to becoming a full scale investment bank. I know the word boutique has become the concept but back in my time there were firms that had 1,000 people, possibly 2,000, at their peak. They were called First Boston, Salomon Brothers, Donaldson, Lufkin & Jenrette, and Alex. Brown, or Warburg in London. They were great places, and their clients loved them, and the bankers loved being there.

By the way, loving being there is a very important thing. You get a much higher quality of individual, and you get somebody much more dedicated to their job, which means they care more, which as I said are all of those fundamentals going into making somebody care about the outcome.

“Investment banking is a great career. It’s not just a stepping stone to some other job.”

My goal is to continue to build the firm to that kind of a level. I want to provide the old line investment banking services to a corporation, and probably larger [entities], because the world is more global. We have opened in London about two months ago now, and we will continue to populate offices in places where we think our clients are going to want to have information flow and need our services.

Knowledge@Wharton: Would you also like you to open offices in emerging markets like Shanghai or the Middle East?

Moelis: Yes, very much so. To [cater] to those markets, you have to get London right first. I get asked this question a lot, and I say, “Hey, we’ve been up and running now for less than 18 months, we have 160 people. We’ve accomplished a lot so you can’t be everywhere instantaneously.” You have to do things one step at a time, and in order to get to the Middle East or Shanghai you must have a decent operation in London. Just on time zone, and travel time, and expertise, et cetera, it’s a requirement. [It is] very hard to run Shanghai out of the New York time zone.

Cathartic Beginnings

Knowledge@Wharton: You’ve had a long career in investment banking dating back to the 1970s, and you worked with people like Donald Trump, Steve Wynn, Ron Burkle, John Kluge and so forth. During your career, what do you think has been the biggest leadership challenge or biggest challenge that you have faced? How did you overcome it, and what did you learn from it?

Moelis: I think the most searing event, and maybe because it was when it was happening, was the collapse of Drexel Burnham in my life. I had worked very hard, time seems to truncate now. I got out of Wharton in 1981. And boy, I worked hard at Drexel to get what I thought was on this path toward a great career and a wonderful investment bank.

When I came out of Wharton and went to Drexel, it was an unprofitable firm in 1981, but five years later I think they made $2.5 billion pre-tax [profit], and it was like a rocket ship ride up. And it was like a rocket ship ride down as well. In the period from 1988 to about 1990 when the firm came under investigation, and our leadership — Michael Milken — was forced out there were things nobody could have prepared you for. Whether your office was being bugged, whether things were happening, you were trying to evaluate — very significant issues in a world where there were no lessons on this before, and nobody could teach you what to do.

How do you lead people through that? What do you do with your career? What do you do with your life? It seems like a long time ago but I was seven or eight years in the business, I had devoted a lot of time and energy to making my career at Drexel a success, and all of a sudden was facing a catastrophic outcome. That experience might have been one of the greatest experiences I’ve ever had. Not at the time, by the way. At the time it had to be one of the most difficult I could remember. But it taught you a lot.

You fast forward to this credit crisis, and you learn a lot about the far end of risk and outcomes that you don’t think are possible, and when they become possible how quickly they envelop you. How impossible it is to stop the negative cycle of bad news that seems to surround you once you get into a problem! I do think it has helped me to create and make decisions during my career. You asked me about leaving UBS. Having gone through what I did in the late ’80s at Drexel, it just made it easier to follow your gut instinct and do things before they become apparent to everybody else. So I think it was a good experience.

Advice for Aspiring Investment Bankers

Knowledge@Wharton: If a young person wants to go into investment banking today what advice would you give him or her about how the field has changed, and where it is going to be?

“I hope one day we’re mentioned in the same breath as the Morgans and the Goldmans of today are mentioned 50 years from now.”

Moelis: First of all, I think investment banking is the greatest career there is. You mentioned some of those people I get to work with, and I think I’ve worked with some of the smartest entrepreneurs and businessmen and CEOs in the world. So every day is like going back to school. If you shut up and listen sometimes when you’re in these meetings, you’re going to hear incredible things. [For example,] listening to somebody like Steve Wynn talk about a design and the architecture and the development of casino resorts. Or if you’re listening to somebody that I consider one of the greatest of all time — John Kluge in the media field. So you [have the] ability in our business to continue to learn every day. Every day I go to a meeting with a CEO and learn something fantastic about their business and their insights into what’s going on in the world. You can actually continue to work and get an education, both of which are phenomenal things to put together in one job.

So I would say to everybody, investment banking is a great career. It’s not just a stepping stone to some other job. I know a lot of people start to think of it that way. It’s the best career there is on the street, but make sure you go to an investment bank, and I say that these days [because] in the last 10 years that has gotten confused.

There are investment banks and there are now what I believe commercial banks, or financial conglomerates. I believe you want to understand that an investment bank is a highly specialized place in which you actually sit down and think about your client as a partner, and not somebody that you’ve been sent out to sell a series of products to. And make sure when you’re viewing where you’re going, you keep in mind what the theory and what the culture is at that firm.

Framed Legacy

Knowledge@Wharton: One final question. What is your long term dream for Moelis & Company?

Moelis: My long term dream I think is — I know when you pick up a history book you always look back and you see some crinkly old picture with somebody wearing a funny suit, and a top hat or a cane, and you say, “Hey there’s the first partner meeting of the old Morgan Stanley back in 1908.” Or there’s some old lion firm — they’re always wearing some outdated clothing because it was 100 years old, and they have the roll top desks or something [like that]. But I always loved looking back and saying, “I can’t believe that’s when it all started.” Or when you read the history of Goldman Sachs and [find that] it was a commodities trading firm.

My long term goal is sometime in the future, and I hope I’m still alive for it, somebody is looking back at the old photographs — we actually took them at our founding dinner, and I said “Let’s put them on the wall.” Maybe somebody someday will be looking at our haircuts and our clothes and everything about it and say, “Can you believe that’s when Moelis & Company started?” I hope one day we’re mentioned in the same breath as the Morgans and the Goldmans of today are mentioned 50 years from now.

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