Lazard Ltd. (NYSE:LAZ)
February 13, 2013 1:00 pm ET
Kenneth M. Jacobs - Chairman and Chief Executive Officer
Ashish Bhutani - Vice Chairman, Managing Director and Chief Executive Officer of LAM
Howard Chen - Crédit Suisse AG, Research Division
It's now my pleasure to welcome back Lazard to this year's Financial Services Forum. While many may immediately think of M&A when you hear the name Lazard, it's certainly an important part of the franchise, but it's not the entire story. In addition to the company's premier global M&A advisory franchise, amongst other things, Lazard has effectuated, built a world-class institutional asset manager tied to some of the important mega-trends of global and international and thematic investing over the last decade. And within its broad Advisory franchise, broadening into businesses such as Restructuring, Sovereign Advisory, as well as Middle Markets Advisory, just to name a few. As Ken mentioned on his earnings call last week, a few businesses that weren't as material contributors to the business a decade ago.
Now just over his third year as Chairman and CEO of Lazard, Ken Jacobs has worked to grow and increase revenue share and market share, while continuing to drive more to the bottom line for shareholders. In his Shareholder Letter last year, Ken just spoke to achieving 25% operating margins by 2014 with no incremental lift in revenues.
Put it all together, and coupled with the strong momentum across the firm, we see exceptional earnings power, potential to franchise, as we continue to emerge from this cycle.
So before we introduce Ken to the stage, we've got a couple audience questions for you all. You have those clickers in front of you, so let's give it a go.
First, what is the most important driver for incremental share price appreciation and outperformance from here for Lazard? You have 5 options.
So the majority of participants believe it's the execution of the 25% operating margin target by 2014. But a good smattering of other answers as well.
Second question. What are my expectations for overall industry M&A announced volume in 2013?
Good difference of opinion. But 40% of you believe that somewhere between a 5% and a 15% increase from 2012 levels.
Third and final question. Lazard led its peers in terms of compensation-related disclosure. What
else would you like to see the company provide more disclosure on?
Great. So looks -- the 2/3 of you believe it's more granularity around profitability and cost allocation by business segment. Excellent. Thanks for participating.
So without further ado, Lazard CEO and Chairman, Ken Jacobs.
Kenneth M. Jacobs
Thank you. That's a pretty clear statement about what we have to do to get the share price up, what we should expect about the M&A markets and what we need to do on disclosures. So we'll take that to heart.
Thank you. Good morning to -- or good afternoon, excuse me. Good afternoon to everyone here and on the webcast.
We've got a bunch of disclosures up here. And let me begin. Lazard is a firm with multiple levers to drive revenue growth and shareholder returns. It's built on Financial Advisory and Asset Management, what we consider to be the 2 most attractive businesses in financial services. Our capital needs are minimal. We generate significant cash flow.
In Financial Advisory, we're the long-standing leaders in M&A, strategic advice for Restructuring and Sovereign Advisory. Our bankers have a deep understanding of capital structure and capital markets. This is a very strong complement to our M&A capabilities.
In Asset Management, we're a world-class firm with strong performance and growth. We have a primarily institutional client base. We provide clients with global, local and regional investment solutions, which we export and import from around the world.
Lazard is the only independent adviser with a fully built-out global network. We've been a public company for 8 years, but the franchise was built over 160 years. We have offices in more than 40 cities, 30 countries, advisory clients in more than 70 countries and half our assets under management come from clients outside of the U.S.
Every year, we meet with literally thousands of corporate CEOs, CFOs, Boards of Directors, government leaders and investing institutions. The power of this global network relationships allows us to deliver better solutions to our clients, and it becomes more powerful as the world economy becomes more integrated.
The blue lines on this slide are a sampling of M&A transactions on which we've recently advised. Half of our M&A transactions in the past year were across borders, often across multiple geographies. For example, 1 transaction last year, we advised a German company on the sale of a stake in a Chilean infrastructure project to consortium of buyers across the globe, involving our offices in Frankfurt, Santiago, Madrid and New York. And again, that's not unusual.
The gold lines are sampling of our Asset Management distribution network. We're not just global but multinational. We manage portfolios in every key region of the world and distribute them locally, globally and across borders. We provide institutional, quality investment solutions to our clients. Over 40% of our Asset Management staff are investment professionals.
Between Lazard Asset Management and Lazard Frères Gestion, we have more than 260 senior investment professionals around the world. We have been in many regions for decades, and we operate as locals in local markets, which is key to advice. We are also well established in emerging markets.
Lazard exists to serve clients. Clients want the best advice and solutions. Lazard has the best ability to provide them. We're independent. Clients can be confident of our interests -- can be confident our interests are aligned with theirs. And we're the only independent advisory firm with a global infrastructure, global industry-wide groups to provide better informed advice and solutions.
Ultimately, the quality of ideas and our ability to execute them is what matters. And our advantage here is people, the performance on behalf -- and their performance on behalf of our clients.
We attract and retain top professionals in our business. Our advisory managing directors and our senior investment professionals have on average more than 20 years of experience and our senior-most people remain actively engaged with clients.
Any 1 of these 3 characteristics is attractive: independent advise, a global network and the quality of our people and their performance. But the combination of all 3 provides Lazard clients with superior advice and pattern of investment returns that they've come to expect from us.
Now let's look at how we're going to drive -- or how we are driving shareholder value. We're focused on growing revenue, enhancing our profitability and increasing shareholder returns through dividends and smart share repurchases. We are making progress in all 3.
First, revenue growth. Our business was impacted, the financial crisis, like everyone. But even in the stop-and-start macro environment since the crisis, our operating revenue today is close to its peak level. In our -- in 2012, our M&A and Other Advisory revenue was up 13% for the year, even as global M&A completions were down 14%. In Europe, our Advisory revenue was flat, while the market was down 32%. In the U.S., our Advisory x Restructuring was up 17%, while the market was up only 2%. And for the rest of the world, our Advisory revenue was close to its all-time high.
The fact that we have maintained this level of operating revenue during a global M&A slowdown in volatile equity markets underscores the strength and stability of our balanced advice-driven model.
Here's a look at our Financial Advisory operating revenue next to competitors. Our scale allows us to compete against the largest firms worldwide and clearly distinguishes us from the smaller boutiques.
Lazard is consistently among the advisers on the largest global M&A transactions. Financial Advisory is a major focus for us, representing over half our revenues compared to 7% or less for most of our competitors. We continue to invest in the business. A significant portion of our Advisory revenue now comes from income streams that either did not exist at Lazard 10 years ago or that we've grown substantially. These include the Lazard Middle Market business, Sovereign Advisory, our work -- and our extensive work on capital structure and capital raising.
We are closing the gap between Lazard and the few remaining firms ahead of us. As you can see, we have markedly increased our share of the advisory fee pool since the peak of the market in 2007.
Asset Management is an equally powerful growth engine for Lazard. Assets under management, a record high of $167 billion as of December 31, have more than doubled since we went public in 2005. Our platform is broad. We have 23 strategies, with over $1.5 billion in AUM. We have a strong pattern of performance and positive net inflows in 5 of the last 6 years, including 2012, despite volatile equity markets.
We're investing in our Asset Management platforms through product extension. For example, we have already a strong global equities platform. In the last couple of years, we've extended it with strategies like Global Multi-Asset and Controlled Volatility.
In emerging market equity, where we have a strong franchise, we're in the process of launching a number of new strategies, including small cap and core.
And in fixed income, we've added to our emerging market debt products and expanded our fixed -- global Fixed Income platform. Both our businesses are well positioned for revenue growth, even if the macro environment remains challenging.
In Financial Advisory, our scale means we don't have to engage in expensive hiring to serve our clients globally. The hiring we do is opportunistic and adding to existing strength. We are in a prime position to benefit from growth in cross-border M&A. We are seeing increasing activity in our Capital Structure Advisory businesses, especially in Europe, and our Sovereign Advisory business in Europe, Africa and Latin America. We are advising clients on holdings of complex instruments, such as derivatives and structured products.
Last year, we strengthened our presence in developing markets, integrating our Brazilian operations, bolstering the Asia Pacific region and forming Lazard Africa team, serving both corporate and sovereign entities in that region of the world. We also have one of the leading U.S. middle market businesses. 2012 was its best year ever.
In Asset Management, we are a market leader in the growth asset classes across equities and fixed income. Our year end record AUM just is a solid foundation entering 2013. We are meeting increasing demand for multi-asset and solution-based strategies, and we have significant capacity for organic growth.
That's a brief overview of Lazard's revenue story. Now let's turn to profitability.
Our business is highly cash generative, and we're making it more so. Early last year, we communicated our near-term financial targets. They include an operating margin of 25% in 2014, at 2012 activity levels. We get to this target by achieving a compensation ratio in the mid to high 50s, while maintaining a consistent rate of deferred compensation each year, with consistent vesting periods. And a non-compensation ratio of between 16% and 20%.
Our discipline in disclosure on deferred compensation make it simple for investors to assess the quality of Lazard's current and future earnings.
In order to meet our targets, we've embarked on global cost saving initiatives. These are focused on increasing profitability, with minimal impact from Lazard's revenue growth. They include ample capacity for new investments, as opportunities unfold. We are streamlining our corporate structure and consolidating support functions, realigning the firm's investment into areas with potential for the greatest long-term return and creating greater flexibility to retain and attract the best people and invest in new growth areas.
We anticipate approximately $125 million in annual savings from our existing cost base. We have completed the bulk of the initiatives, with the remainder expected in the first half of this year. At least 2/3 of the savings should be realized in 2013, with the full impact in 2014.
At 2012 activity levels, we expect these initiatives will result in an operating margin of approximately 21% or 22% in 2013 on both a GAAP
that's worth achieving our target of a 25% operating margin in 2014.
The third leg of our strategy to drive shareholder value is returning capital to shareholders. Since the beginning of 2010, our quarterly dividend has increased 60%, and we've returned more than $1 billion in capital.
As this chart illustrates, 2012 was an especially active year. We returned $540 million or about 16% of our market capitalization through dividends and share buybacks, including a special dividend and an accelerated fourth quarter dividend.
Going forward, we remain committed to offsetting potential share dilution from any equity-related compensation, and we intend to continue deploying excess cash towards dividends, share repurchases and opportunistic debt repurchases.
This slide shows our progress toward our financial goals. Since the beginning of 2009, we've reduced our awarded compensation ratio, what we really pay people in a given year, by 12 percentage points, as operating revenue increased by 22%.
We have exercised discipline on deferrals, maintaining a consistent rate and vesting periods for the 3 years running.
Our non-comp ratio has been flat. We expect to see the impact of our cost-saving initiatives in 2013, and we're confident we can reach our target in 2014. Our current activity levels were on track to reach our operating margin target. We are consistently neutralizing potential dilution from comp-related stock price.
In conclusion, we're creating value for our shareholders. We're enhancing our profitability and increasing our operating leverage. We're well positioned for growth, even if the macro environment remains challenging and more so, as it improves. We continue to generate strong cash flow and we're returning capital to shareholders.
We're confident that with the breadth and depth of our platform, the strength of our global network and our financial discipline, Lazard is better positioned than ever.
Thank you, and I'm happy to questions.
If you have a question, please raise your hand, and we'll get a microphone over to you. Maybe, Ken, I can kick it off. And my first question would be one of the themes of the forum so far has been the optimism that we certainly feel in the markets today. So across your kind of 2 flagship businesses, Financial Advisory, as you and your team go to speak with corporate CEOs and boards, what's the mindset like? And has that changed at all over the last few months? And second, with respect to the Asset Management business, it remains tethered to largely equities in global and emerging market investing. So maybe either for you or Ashish, that we could hear is this the beginning of a re-risking, in your opinion?
Kenneth M. Jacobs
So let me first tackle the first one, which is I think more directed towards the Financial Advisory business, M&A cycle. And then the second, which I'll turn over to Ashish to answer. On the first one, on the M&A cycle or sentiment, really, there appears to be a shift. We traditionally look at 3 factors to judge the health of the M&A environment. The first is financing, second is valuation, third is sentiment. And over the last -- I've been -- we've been kind of consistent on those 3 factors in our business. On the financing side, I think we're all experiencing rates which are at -- in our professional careers, the lowest they've been. And that probably extends for a couple more years, if we're lucky. On the -- and availability of financing for companies large and small in the United States, and probably most of the multinationals in Europe is kind of unparalleled at the moment. Cash balances are also very high. On valuation, things are a little bit more pricey than they were last year. But still -- relative to organic growth opportunities, probably still reasonably priced, and there's opportunity there. And then on sentiment, that's been probably the biggest headwind for the M&A cycle over the last several years. And that seems to be shifting. It's something which you don't really know until it's happened and you kind of have it in the rearview mirror. But there are some events that have taken place globally, which probably make where we are today more favorable than it's been any time in the last kind of 5 or 6 years since the crisis. and those factors are the following: First, in Europe, there's probably less tail risk today than there was 14 months ago. The actions of the ECB, the statements by Draghi over the summer essentially saying "we'll do whatever it takes" has taken down the tail risk. And by tail risk, really, the risk of a discontinuity in markets in the short term in Europe, and that's significant. The second is the leadership change in China and some of the strength we're beginning to see in some of the other emerging markets. My black box is no better than anybody else's with regard to China. I'm always a little skeptical of my own intuition about it. But I think the leadership change is a substantial event, and it seems to be taking hold. And then third is the U.S. recovery. And here, there's some things happening now in the economy, which we haven't seen for several years. The most important of which is probably the housing cycle seems to be healthier. The housing sector seems to be healthier, and we're probably seeing an improvement overall in both valuations, inventories down, increase in starts and remodeling, existing home sales, and all of that translates into jobs. And this is probably one of the most important contributor to jobs in the U.S. economy. And the biggest multiplier effect is probably in this sector as well. And then finally, some of the things which probably had the most negative impact on sentiment over the last sort of 12 months or so has been the election. That's behind us. The first fiscal cliff, which has turned out to be more benign than people thought. I think there's a risk on the second fiscal cliff, but at least we're through 2 of those 3 events. And so all of that together is probably improved sentiment. But the proof is in the pudding. I mean, the proof is do people really start to invest? They really start to spend capital? Do they really start to engage in more aggressive M&A? And I think we'll see that over the next several months, whether that unfolds or not.
Yes. In terms of rotation into equities, we are an institutional job. I mean, typically, retail feels the early brush of it much quicker. RFP activity has certainly picked up. But the time lag in those things is usually 6 months. So we feel more optimistic but it's early is the best way I would put it. On the defined benefit landscape, people should be aware that it is very challenged. Actuarial liability is around 7.5% to 8%, depending on the company you're with. And with rates where they are, it's perversely bullish for any risk asset classes. So as people feel more confident about the macro noise, I think you will see rotation into equities as well as any other risk-based asset classes, as the whole spectrum of them pick up, but it's still early.
Howard Chen - Crédit Suisse AG, Research Division
Ken, in your presentation, you spoke a bit about the growing contribution of businesses that were still in the nascent stages or nonexistent at the firm a decade ago, those included things like Middle Markets, Capital Structure, Advisory, Sovereign Advisory. Are those businesses now hitting on all cylinders, in your opinion? Or is there's still work to do? And second, can you talk about maybe some of the other businesses that you're still incubating? Or where the next level and layer of investment spending would go?
Kenneth M. Jacobs
Yes. Let me first -- firstly, everything that we've done at Lazard has been organic, both on the Advisory side and on the Asset Management side. The exception being a small acquisition in the Middle Market of a firm called Goldsmith Agio in the beginning of 2007, which was really called a large lift-out is really what it turned out to be. And just about everything else has been -- I think everything else has more or less been organic at Lazard. So we're pretty good at doing this, and we've done it for a long time. Clearly, our restructuring business is a scale business. I think we still have some room for growth in Europe as this cycle winds down. And I think we're well positioned again for the next cycle. And my guess is given what's going on in the high-yield markets, there will be another cycle. So we can kind of anticipate that being a good business on a cyclical basis for ourselves. And in the meantime, where we have excess assets there, they get redeployed to the core Advisory business. The Private Fund Advisory Group has been a very good investment for us. This is a group that raises money for private equity funds. We founded the business, we hired the team or recruited the team literally 10 years ago this week. And from a standing start, now it's a real contributor to the business. I think that probably isn't at its peak level. There's some room for growth there as the cycle for private equity funding increases. It was finished a couple years ago, it's improved, but it's not to where it was before. And we've also diversified what we do in that group from being just raising original funds from private equity, but also now doing quite a bit of secondary placements there, which is quite a lucrative market and an interesting market in Europe right now. Because as the banks kind of wind down some of their balance sheets, finally this is one of the first areas that they will focus on. The third area is what I broadly define capital structure advice. And there, it's everything from debt advisory to equity advisory and importantly for us, some of the more esoteric financial products, like derivatives and structured credit where there's literally no one else that's kind of carved out at this niche right now. And here, I think this is just following the trend of people being more skeptical about people who provide capital and being a little bit more cautious about just taking the capital under any circumstances and wanting sort of a second set of eyes and a second set of views. And also recognizing that if handled right, it may actually lower the cost of some of the capitals that's provided. So that's an increasingly interesting area for us. And it also has the benefit of complementing our M&A business because to the extent that we're working on a major M&A transaction and it needs to be financed, which almost everyone does, we get early insight into that process, which really complements and strengthens our position as the adviser or one of the lead advisers to, if not the lead adviser to a company. And that's powerful because it makes your hit rate -- your success rate on all your M&A activities higher. And it also probably gives you some kind of improvement in the overall compensation you get for a particular transaction. So those are sort of the key areas on the Advisory side. Sovereign -- and the last one, which I can't help but mention, the Sovereign Advisory, which has been a business of Lazard for decades. But has really come into its own in the last, I'd say, 5 or 10 years, in part because of the breadth of the opportunity, not only in the emerging markets or some other countries, the trouble countries, with the emerging markets where historically had found its roots. They're increasingly now in some of the developed markets where we're well positioned. On the asset side, everything we've done is organic. I mean, if you think about each and every one of the funds we have right now, they've been incubated as seed portfolios at Lazard. And then when performance gets strong enough and it's launched and then marketed, and then with -- so far a pretty high degree of success, we're able to spawn off other fronts from those core strategies. A great example is the breadth of things we're doing now in the emerging markets, both on the equity side and on the debt side. And some of the global businesses, global equity businesses we have right now come out of some of the core businesses we had 10 years ago. So this is something that we really spent a lot of time on, and I think we do a pretty good job of.
We've seen the largest buyout since the financial crisis, candidates. It's a business that we didn't talk about yet, but one that you all certainly have been building over the last few years. Do you think that's more of a one-off? Or more beginning of a trend from what we see from the financial sponsors?
Kenneth M. Jacobs
And this is -- you're really talking about the Dell transaction? I think that every transaction has -- is unique. In this case, if you look at it, what makes this transaction unique is both its size, the industry it's in and importantly, the fact that a significant portion of the equity comes from an individual or an investment firm associated with that individual, Michael Dell. This is a big deal. It requires a lot of equity to get done. And in the post-crisis world, it's a little bit more difficult to do partnering deals amongst the financial sponsors than it was before. There's been some pushbacks from the institutions on that. So to kind of cobble together this deal without the lead investor in this industry may have been difficult. So I wouldn't look at it as a trend. That said, I think the large private equity firms have adapted. And while they will continue to be partnering deals, I think what you're starting to see is the private equity firms lining up with more institutional sources of capital, some of the large global pension funds, some of their co-investors -- some of their investors themselves, who have co-investment rights. And so I think that will turn out to be the substitute for the club deals of the past, and that will probably enable them to push up the size of the deals that had been taking place over the last couple of years. And that, combined with the fact that financing markets are wide open right now and there's probably more risk capital available on the debt side, I think we'll start to see the size of some of these deals increase.
And since the Dell announcement, we've seen some increasing investor activism and outspoken shareholders. Ken, curious about your point of view. What impact does increased and heightened like investor agitation or activist shareholders have on broader activity levels.
Kenneth M. Jacobs
Well, it's clearly good for M&A. I'm not sure it's always the most pleasant thing for managements. But what's happened over time is the number of activists have increased. The support they get from institutions like ISS and Glass, Lewis and others have increased. And very importantly, institutional shareholders had become increasingly supportive, relatively short time frame, a lot of what the activists ask for. And so consequently, the time between when an activist arrives and the impact they have on boards and companies about decision-making around the proposals has shortened. And therefore, I think it leads to more things going on. I think this is, from an M&A standpoint or financial advisory standpoint, a trend which is going to continue to lead more activity. And I think we can kind of see that unfolding as we speak.
And final question from me, for Ken and the team. Just competitive landscape on both sides of the business. At the heart of your business is people. So what's the competitive landscape like? And what's your hiring outlook for the year?
Kenneth M. Jacobs
So I mean, clearly, the environment for people is competitive. Environment for people is nothing like it was in the period prior to the financial crisis, leading up until 2007. The dynamic is pretty simple to understand. Up until 2007 -- the market for talent, market for compensation traditionally has been set by the large firms. And up until 2007, it was pretty easy to understand why comp got out of control. People increased their balance sheets. I mean, in the late '90s, many of the restrictions towards the size of balance sheets were relaxed by the SEC, and so consequently -- and the other regulatory authorities around the world. And so you saw literally a geometric increase in the size of balance sheets of most in the major financial institutions around the world. Accompanying that was an ability to fund those balance sheets on a short-term basis and invest in higher-yielding, long-term assets and using their, at the time, high credit quality to invest in low credit quality. All of that led to geometric but exponential increase in the size of the revenue line. And with the sort of fixed level of sharing between shareholders and employees, had its sort of this 40-year 50% range depending on the institution, compensation grew at the same rate or quicker than revenues grew. That compensation were shared broadly within firms, and people got paid very well. And the average person got paid especially well for what they were contributing. What we've seen since '07 is the shrinking of balance sheets, much stricter capital requirements and consequently, the inability to do those same trades. First, your revenue is coming down because the size of your balance sheet is declining. You can't borrow short and lend long to the extent that you used to without higher capital. And you can't invest in your -- you take your higher quality rating, which a lot of firms don't have today, and invest in lower quality assets, again, without a lot more capital charge. And so consequently, revenues come down. And as revenues come down, so as your return on equity. And with the return on equity coming down, there's pressure from shareholders appropriately that you ought to be earning at least or in excess of your cost of capital before you pay bonuses as much as you do. So that's where pressure on compensation is coming from. That dynamic is not likely to change for a while. There will be ups and downs in comp and in certain markets every year. But I don't think over the next foreseeable future, we're going to see balance sheets at major financial institutions increase anywhere near where they were precrisis. And I don't think their capital released [ph] will be relaxed so much that people can start earning returns on equity, which they were used to before the crisis. And so consequently, I think it's going to be very difficult to go back to the compensation practices that existed precrisis. All of that is probably a healthy thing for our industry and probably a good thing for us, both in terms of retention of people and also in our ability to recruit other people.
Great. We don't have any questions from the audience. We'll end it there, and head over to the breakout room. Please join me in thanking Ken and the Lazard team for joining us today.
Kenneth M. Jacobs
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