Tighter Regulation And Tech Disruption Will Weaken Advisory Margins

Key Takeaways

• Rapid technological change and rising competition threaten to commoditize advisory services, squeezing Houlihan Lokey's fees, market share, and profit margins.
  
• Regulatory, demographic, and business model headwinds could dampen deal activity and revenue growth, increasing costs and weakening long-term topline performance.
  
• Diversified growth from acquisitions, expanding business lines, and strong deal activity underpin Houlihan Lokey's earnings momentum and resilience across economic cycles.

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.

• Rising adoption of artificial intelligence and automation in financial services threatens to commoditize traditional, human-driven advisory work, significantly reducing Houlihan Lokey's differentiation and putting downward pressure on both revenues and operating margins as deal execution and analytics become less labor-intensive.
  
• Extended regulatory scrutiny and the potential for stricter financial regulations across major markets could substantially increase compliance costs and stifle deal activity, directly weighing on transaction volumes and limiting fee revenue growth for years to come.
  
• Increased competition from both large integrated banks and nimble technology-driven boutiques is likely to compress advisory fees and erode Houlihan Lokey's market share, driving lower revenue growth and putting persistent pressure on net margins.
  
• Demographic headwinds, particularly aging populations in core developed markets, may act as a drag on economic growth and deal activity in the medium to long term, leading to sustained periods of weak M&A demand and directly reducing the firm's topline growth.
  
• Escalation of disintermediation via technology platforms and direct lending is poised to shrink the pool of advisory-driven transactions, undercutting Houlihan Lokey's business model and resulting in lower utilization of advisory talent, ultimately depressing both revenues and earnings.

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 10.6% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 16.7% today to 18.9% in 3 years time.
• The bearish analysts expect earnings to reach $611.6 million (and earnings per share of $8.88) by about July 2028, up from $399.7 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 23.1x on those 2028 earnings, down from 34.3x today. This future PE is lower than the current PE for the US Capital Markets industry at 29.1x.
• Analysts expect the number of shares outstanding to grow by 0.37% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.66%, as per the Simply Wall St company report.

Houlihan Lokey Future Earnings Per Share Growth

Risks

• The company's record revenues in fiscal year 2025, with total revenues up 25% year-over-year and adjusted earnings per share up 54%, demonstrate robust earnings momentum that could enable further long-term profit growth despite cyclical pressures.
  
• Effective execution of a multi-year acquisition strategy has expanded Houlihan Lokey's industry, geographic, and product footprint, which strengthens revenue diversification and reduces dependence on any single market or region, supporting longer-term earnings stability.
  
• Backlogs in Corporate Finance continue to be strong and growing, and average transaction fees and deal sizes are rising, which bodes well for sustained revenue growth and improved net margins if current activity levels persist.
  
• The expansion and sustained strength of the Capital Solutions (capital markets) business, now a strategic, higher-growth and less volatile revenue stream, creates a broader, more stable earnings base and reduces cyclicality across economic cycles.
  
• Substantial increases in the number of managing directors and successful integration of new hires and acquisitions have enhanced capacity across business lines, especially in financial restructuring, positioning the company to capture outsized revenues and higher fees in the event of market dislocations or heightened restructuring cycles.

Valuation

• The assumed bearish price target for Houlihan Lokey is $162.0, 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 $162.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $3.2 billion, earnings will come to $611.6 million, and it would be trading on a PE ratio of 23.1x, assuming you use a discount rate of 7.7%.
• Given the current share price of $196.18, the bearish analyst price target of $162.0 is 21.1% 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.