A conservatively managed investment bank

Independent investment bank Houlihan Lokey survived the recent global financial crisis, argues partner Jim Zukin, in part because it had no leverage and because it didn't try to pick business cycles.
Jim Zukin
Jim Zukin

Jim Zukin is one of the founding partners of Houlihan Lokey, the independent investment bank. Like many of its peers in the middle market, Houlihan Lokey has had a good crisis, benefiting from the boom in restructuring and its distance -- physically and figuratively -- from Wall Street. But it is a company that is changing, not least in its recent corporate deals: firstly, with Orix Corporation of Japan and last month with Knight Capital of the US. These deals allow Houlihan to partner with organisations that have both large balance sheets and access to capital. Will these new moves harm its vaunted independence or has it created a new model for banking that manages to square the circle of clients wanting advice but only paying for capital?

Would you say that you have benefited from the crisis?
It has clearly increased the market for financial restructuring services, but it has diminished the market for M&A services. So we have seen two effects, even though overall we have grown strongly and business is at record levels.

Do you have any metrics you can give on your growth?
This is the problem with being a closely held company. I don't have a handy metric, rather it is a long-term growth story and 2009 certainly was a record year -- for both revenue and profit. There are two parts to our story that are unique. One, we are the only global bank whose fundamental focus is on expert advice delivered in an objective manner. That's been the business plan since day one. The other part is that we decided many years ago that we were no better at picking business cycles than the next guy. Therefore we decided to have a strategy that was independent of the business cycle. That means we spend half our time on services for times of financial distress and recession, and the other half on times of financial growth.

The middle market players such as you, Jefferies and Moelis have all had a good couple of years, turning on its head the orthodoxy that you cannot do restructuring at the same time as M&A.
We initiated this approach in the late 1980s and have been refining it ever since. We have core business units that work well together across all industries and often team up on assignments. It is therefore very important to have a collegial staff. There is only a brief shining moment when all of our businesses are hitting full speed.

The other key element of our business plan is that we do not make our balance sheet available to our clients and so Houlihan Lokey has no indebtedness. We are probably the most conservatively managed investment bank out there. Who else is entirely equity financed and does not put their balance sheet out to their clients?

So why did you go into the Orix and the Knight deals if it wasn't to get balance sheet capacity?
Orix first and foremost offered us true capacity for accessing business in Asia. They also provided a wonderful element of stability. When a firm has been through one or two generations you need to start planning for your people who are living full careers here. So Orix as our corporate partner allows us to more efficiently manage our internal market.

Until recently there seemed to be an endless supply of capital, which in turn pushed up leverage ratios and pricing. What we now see in the middle markets -- where companies are looking for $100 million to $500 million -- they are having issues in accessing capital for many reasons. So we have seen more of a demand for capital on behalf of our clients, mainly relating to the M&A process. In order to close M&A deals these days, you need to come up with significant amounts of cash. So we have been looking for ways that we can put together deals. We act as the strategic investment bankers, but other strategic relations of ours would bring in the capital. So the Knight deal is that other side. Knight is all capital markets, all market making, all the time. It has no investment banking.

So they have the capital, you have the advice and there is a large agency space between you.
Absolutely. But they don't have to do the deals [we bring]. It's a way of delivering proprietary capital markets solutions over and above what our clients can get themselves. It's a unique approach. We sell brain power and not balance sheet.

Has trust left the bulge bracket investment banking model for good?
I don't know that the model was actually based on trust. In the market making function for instance there is an expectation that the broker is on the other side of the trade. So we are not putting together trades. Once you do that you are in a different kind of business. And it extends from there.

You have added new businesses during the past few years, for instance in debt capital markets. How will you avoid the conflicts that bedevil the bulge bracket firms as you maintain this growth? Finding the appropriate way for Houlihan Lokey to participate in the capital markets has been a topic of internal debate for a very long time. As we look at the current capital markets, which are somewhat chaotic (depending on the time of the day and the country you are in), it is safe to say that there is no longer a massive oversupply of capital that anyone can come up with for a good idea.

We have never had a role model and there is still no one like us. We built a platform based on valuation expertise. And in the early 1970s modern valuation techniques had not been introduced. When I was getting my MBA, the calculator was being introduced. But over the years we have learnt that the more complex a financial model, the more likely it is to produce measurement error. The major financial models in vogue today -- with volatility as such a powerful variable -- no one has come up with an accurate way of predicting volatility. In that one variable you get huge measurement issues. So fundamental analysis has never been more important.

You sound more like a value-investing hedge fund manager than an investment banker.
Those hedge funds turn to us for valuation work more than many others, because we do it in this analytical way. Occasionally they turn away from us because we stand behind our opinions. We have pride backed by decades of experience. Our view is not then the basis of a negotiation, which can be confusing to our clients.

This story was initially published in the June 2010 issue of FinanceAsia magazine.

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