Rapid AI Advances And Regulatory Pressures Will Weaken Profitability

Key Takeaways

• Advances in AI, automation, and private capital markets threaten to erode Houlihan Lokey's core revenue streams by commoditizing advisory services and reducing transaction volumes.
  
• Regulatory pressures, demographic shifts, and over-reliance on key personnel introduce higher costs, earnings volatility, and limit the firm's long-term growth opportunities.
  
• Secular industry trends, geographic expansion, and deep sector specialization position Houlihan Lokey for sustained revenue growth, higher margins, and increased brand strength.

Catalysts

An investment banking company, provides merger and acquisition (M&A), capital market, financial restructurings and liability management, and financial and valuation advisory services worldwide.

• Rapid advances in artificial intelligence and automation threaten to commoditize advisory services, undermining Houlihan Lokey's core value proposition and putting long-term pressure on transaction fees, which would compress revenue and weaken net margins as clients increasingly seek lower-cost, tech-driven solutions over premium, relationship-based advisory.
  
• Intensifying global regulatory scrutiny, including anti-trust investigations and expanding ESG compliance requirements, is expected to slow transaction volumes and escalate compliance costs, with rising non-compensation expenses directly hitting operating margins and making revenue streams more volatile and less predictable.
  
• The growing trend toward direct lending and private capital markets enables clients to bypass traditional advisory intermediaries, shrinking Houlihan Lokey's total addressable market and potentially resulting in sustained top-line revenue declines as these alternatives expand.
  
• Demographic shifts in developed economies, such as aging populations and lower rates of entrepreneurial activity, point to a shrinking pool of private businesses exiting or engaging in M&A activity, limiting future growth opportunities and negatively affecting both transaction volumes and long-term earnings potential.
  
• Increased reliance on a handful of senior dealmakers for client relationships raises the risk of talent attrition or key-man losses, making the revenue pipeline vulnerable and introducing greater volatility to quarterly earnings, while escalating compensation wars with competitors could erode net profitability over time.

Houlihan Lokey Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Houlihan Lokey compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Houlihan Lokey's revenue will grow by 9.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 16.5% today to 19.7% in 3 years time.
• The bearish analysts expect earnings to reach $648.9 million (and earnings per share of $9.31) by about August 2028, up from $408.3 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 23.3x on those 2028 earnings, down from 34.5x today. This future PE is lower than the current PE for the US Capital Markets industry at 27.1x.
• Analysts expect the number of shares outstanding to grow by 1.17% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.08%, as per the Simply Wall St company report.

Houlihan Lokey Future Earnings Per Share Growth

Risks

• The robust growth across all three business lines, including an 18 percent increase in revenues and a 75 percent growth in adjusted earnings per share year-over-year, suggests Houlihan Lokey is benefiting from long-term secular trends such as increased globalization of M&A activity and rising corporate complexity, which could sustain or boost revenue and earnings in the coming years.
  
• The resilience of the restructuring segment, which management describes as potentially having established a new trough even in a positive economic cycle, points to a structurally elevated demand for sophisticated liability management and restructuring solutions-a secular shift that may underpin stable or growing revenue streams over time.
  
• The firm's ongoing investment in sector specialization and geographic expansion, as evidenced by the broad-based hiring of senior talent and active acquisition pipeline, aligns with industry trends toward deep expertise and global capabilities, which could drive diversified and secularly growing revenue as Houlihan Lokey grows its market share in new markets and sectors.
  
• Momentum in Corporate Finance and the expectation for further improvement as private equity sponsor activity resumes post-summer indicates that cyclical lows may be behind them, and as activity normalizes, revenue and fee growth could accelerate, sustaining higher net margins and earnings.
  
• Strong client feedback, successful global events such as the Houlihan Lokey ONE Conference, and the attraction of senior dealmakers to the platform support a trend toward increasing brand strength and client stickiness, which typically translates into more repeat business and higher-quality revenue, potentially improving both top-line growth and long-term profitability.

Valuation

• The assumed bearish price target for Houlihan Lokey is $166.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Houlihan Lokey's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $232.0, and the most bearish reporting a price target of just $166.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $3.3 billion, earnings will come to $648.9 million, and it would be trading on a PE ratio of 23.3x, assuming you use a discount rate of 8.1%.
  
• Given the current share price of $200.52, the bearish analyst price target of $166.0 is 20.8% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.