One of the big themes of 2019 has been the move by big banks into the mid-market, with Goldman Sachs building a 50-strong team to target deals worth $500m or more, while HSBC’sUK strategy is focused on the provision of investment banking products to mid-cap commercial banking clients.
Some say this is a typical late-cycle move as big deals dry up; others point to the strategic imperative for firms such as Goldman Sachs to find ways to grow market share. But what of the firms that already operate in this space?
Since 2015, Houlihan Lokey has moved from being a privately held US investment bank with a number one restructuring business to a broad-based, publicly held corporate finance business. It has built a European M&A business focused on mid-market deals with a string of acquisitions. Last month, the firm made its fifth acquisition since 2014 when it bought Fidentiis Capital, a Spanish mid-market M&A business.
“The mid-market accounts for more than 90% of all M&A activity, explaining its attraction to big banks,” says Scott Adelson, co-president and global co-head of corporate finance at Houlihan. “The global M&A market is the mid-market. And in Europe there are just as many deals completed in a year as in the US.”
This explains Houlihan’s appetite for European expansion at a time when Wall Street banks are doubling down on the US. It is operating below the level at which the likes of Goldman are looking to participate. “There are many different definitions of mid-market, but to us it means transactions between $100m and $1bn,” says Shaun Browne, co-head of UK corporate finance.
Houlihan has a 2% market share of this segment, showing how much room it has to grow. It has built a presence in each of Europe’s biggest M&A markets. In 2014 it kicked off its expansion with the acquisition of McQueen, a boutique that specialises in the food and retail sector. This was quickly followed by the purchase of the non-French operations of Banca Leonardo, the firm founded by former Lazard deal-maker Gerardo Braggiotti.
Then last year it purchased Quayle Munro, a UK boutique with a specialist presence in data and analytics, and BearTooth Advisors, an independent firm providing advisory and placement agency services to alternative investment managers.
‘No stars’ culture
This acquisition spree means that over the past five years, headcount in European corporate finance has grown from 15 bankers operating in a single office in London to about 180 across the region. Houlihan derives about 19% of its overall revenue, including restructuring, private capital placement and corporate finance, from outside the US.
The bank continues to eye further acquisition opportunities, but says it does not have a rigid formula for geographic or sector expansion. In an industry known for its destruction of value through mergers, Houlihan will be hoping its integration of multiple businesses can serve as something of a case study. “First and foremost, we look for individuals and teams that we like and believe will fit with our entrepreneurial culture,” says Adelson.
The bank has avoided “big name” hires and is proud of the fact that no single individual accounts for more than 2% of revenues. This is not a place for stars and Houlihan would prefer to acquire a successful boutique that operates below the radar, rather than one bearing the name of its founder. Unlike Moelis & Company, Houlihan is not one to concentrate power in the hands of a small number of owners.
Despite its breakneck expansion, bankers say there is an underlying conservative approach. “It is very long term, very pragmatic — almost a Japanese kind of philosophy,” according to Matteo Manfredi, the bank’s head of corporate finance, continental Europe, and a former Lazard banker who joined the firm through the Leonardo acquisition.
By specialising in mid-market deals, Houlihan has avoided the pitfalls suffered by rivals such as Greenhill & Co, which was over-reliant on big deals and too slow to grow its business outside the US. It believes this approach will insulate it in the event of a downturn in M&A. “While big deals dry up during economic slowdowns, mid-market activity is less cyclical and less volatile,” says Browne.
Even so, revenues in Europe, the Middle East and Africa have dropped in line with a fall in deal activity. In the six months ended September 30, US revenues rose to $446m from $414m, while international revenues fell to $76.7m from $80.7m.
One of the key measures of performance for independent corporate finance firms is revenue generated per managing director and Houlihan’s 152 managing directors generated $6m each across corporate financing and restructuring in its financial year that ended on March 31. By contrast, at market leader Evercore, the firm’s 107 senior managing directors generated $15m apiece in global advisory revenues, according to its 2018 annual report.
Big sponsors coverage team
Senior bankers talk of Houlihan’s “unique culture”, although this is something most firms like to lay claim to. “First and foremost, we are left to get on with running the business and we don’t face any of the bureaucracy or challenges of big banks,” says Browne. “We have a genuine collegiate culture.” That comes from the broad equity ownership, which prevents the regional turf wars seen at other firms.
Aside from giving its bankers relative autonomy, another reason Houlihan may have success in expanding is that the firms it has acquired can point to clear advantages of being owned by a bigger rival.
Speaking of his time at McQueen before Houlihan bought it, Browne says: “We realised that our clients’ needs had become more global and our acquisition by Houlihan has added that dimension.” While he was at McQueen, the firm lost out in a pitch to sell a business, but was later appointed when it became part of Houlihan.
The bank also claims to have the biggest financial sponsor coverage team on the Street, with more than 20 senior bankers globally whose sole job is to call on private equity firms. “Financial sponsors are crucial to our growth,” says Browne. “We cover around 800 sponsor clients and the important thing to remember is that, unlike corporates, sponsors have to do deals.”
Houlihan Lokey entered the syndicated finance market last year through HL Finance LLC, a newly formed, wholly-owned subsidiary, to capitalise on the growth of the leveraged loan and high yield markets. While Houlihan is not a balance sheet firm, it has an agreement with HPS Investment Partners for HPS to participate in the transactions and provide underwriting commitments of up to $1bn, with Houlihan acting only as an arranger.
HL Finance is run by the three co-heads of global capital markets — Gregg Newman, Chris Dunlop and Anthony Martino. Matthew Lyness and Ed Ribaudo, both former managing directors with GE Antares who joined the firm in 2017, are also involved in the initiative. HL Finance’s primary focus is the US, although it could expand into Europe in the future.
Ready for restructuring?
But Houlihan believes the ultimate counter-cyclical play is its restructuring business. Research by EY shows that profit warnings by UK companies have hit their highest level since 2008, while the disruptive force of technology is forcing firms to overhaul their business models to survive. There are many casualties, particularly in the retail sector. By having scale across industry sectors, Houlihan can scout for both M&A and restructuring business.
The firm is a global leader in restructuring and, as befits the late stage of the credit cycle, expects to see an uptick in activity. Joe Swanson, who is co-head of the firm’s restructuring business outside the US, sees several catalysts for activity. As banks look ahead to the prospect of a recession, they seek to pare back positions on marginal borrowers who are struggling to refinance.
Brexit has also depreciated the pound, leaving UK companies with high euro cost bases exposed at a time when consumer demand has weakened. This is particularly true of the UK retail sector. Then there is the end of the commodities super-cycle as it relates to Asia. With China not growing as much as in the past, this is hitting businesses with exposure to the region.
Houlihan Lokey’s global approach to restructuring means it can re-allocate resources to regional hotspots. In recent months it has been shifting staff from London to Dubai, Hong Kong and Singapore.
It’s not just the restructuring practices of firms such as Houlihan that are prepping for an uptick in restructuring activity. Following the longest expansion of the US economy in history, aided by the Federal Reserve, distressed debt funds have raised record levels of dry powder.
According to Swanson, corporate debt has grown by more than 30% since the last crisis, although the next restructuring boom could have a different complexion. “In order to understand where the areas of stress come from, you have to look where the marginal capital is going, and it’s not into leveraged loans. Marginal capital has gone into areas like direct lending and non-performing portfolios. The next wave of restructuring is more likely to come from the corporate sector than the LBO [leveraged buyout] sector.”
Having a big restructuring business gives Houlihan an edge, but its status as market leader means it has less room to grow. The biggest potential upside remains in corporate finance and the mid-market will continue to be the battleground in 2020, despite a recent rebound in big-ticket M&A activity.
European banks’ share of investment banking fees has fallen to an all-time low in 2019, as US rivals have consolidated their lead. “Successful players in M&A can either be very small, with individuals serving a select number of clients, or they must have expertise across countries and industries and be able to provide a global solution to clients,” says Manfredi. “Anything in the middle is looking shaky. Leonardo was a classic case of where it had grown to a certain scale where it was neither big enough nor small enough.”
The rise of Houlihan Lokey demonstrates that for Europe’s investment banks, the threat from US firms may go beyond the bulge bracket.