Description

Underindexed / recession priced in / 5.78x EV/EBITDA / safe balance sheet / hidden segment / buybacks

Lazard is doing fine. The financial advisory business continues to perform really well as we still aren't in a recession. Lots of dealmaking advice while the restructuring business isn't completely dead either. Apparently disruptive market forces are still having an effect. Lazard is involved in two of the highest profile chapter 11's of the moment in PG&E and Sears. This part of the business is what needs to bail us out once we enter a recession and M&A activity rolls over. Lazard is currently earning above normalized rates but the firm is growing both top and bottom line. Meaning it can grow into this sort of normalized level of earnings over time. Cyclicality concerns seem to be well reflected in the stock price.In general sell side estimates show modest growth in top and bottom line going forward. I would say the share price reflects a declining top and bottom line.

Levcap56 did a terrific write-up which resulted in a sweet 40% run on Lazard in 16’. We’ve roundtripped back to that level. Please look at Levcap’s write-up to get a good overview of the business. Also he worked in this industry and has a differentiated insiders view on the power of brand/organisation within this business.

Why is this $4.8 billion company overlooked?

• Lazard is Bermuda incorporated
• Lazard is a partnership requiring K-1 filing
• Hard to own for indexes
• Viewed as highly cyclical
• Historically pure play investment bank
• Asset management accelerates earnings growth

Why is this so attractive?

There are very simple stats that accurately paint the picture of how attractively valued Lazard is:

Overview of 10 year financials:

Revenue is essentially generated through two segments; (A)Investment banking (which Lazard focused on for 150 years until 11’) when it added (B)asset management makes up just over 50% of revenue.

But in earnings from operations asset management contributes $530 million.

The earnings from operations for financial advisory are only $440 million.

Already asset management is contributing more to the bottom line because of the superior margins.

Lazard’s asset management business also well positioned:

• It is focused on several specialized niches (command higher fees)

• Lazard has been showing positive net inflows over the past few years

• Its assets are predominantly in equities (which command higher fees and tend to grow faster)

• While doing research into Lazard I looked into its funds and these actually appear well managed and tilted towards value strategies which I feel have a better chance of sustaining performance.

• Currently I generally also feel better about AUM outside of the U.S.

Unfortunately, Lazard’s private equity and alternatives business is still tiny. Private equity is one of the most valuable types of AUM to gather.

Asset management scales much better compared to financial advisory. As AUM grows margins tends to expand. This drives operating earnings from the asset management segment in exponential fashion. Sometimes the market misses these inflection points. With asset management now contributing over 50% its superior economics will become more evident over time.

It deserves passing mention that the company also has $500 million in investments and $200 million real estate on its balance sheet. Because enterprise value is only $4 billion this deserves mention. The investments are mostly into their own funds. In a way this capital is required to run the business but we do have an attractive expected return here that should exceed cash and equivalents.  

RIsk

If we enter a recession Lazard will get slammed. Restructuring won't make up for M&A. The equity focus on the asset management side will hurt. The emerging market and robotics niches will really hurt. However because we are buying at such a low multiple the share price doesn't necessarily dive all the way after earnings.

Catalyst

1. Growth: Growing AUM, expanding margins resulting in exponential EPS growth would do it.
2. Buybacks: The company is actually increasingly prioritizing buybacks over dividends. I think CEO Jacobs got the memo from shareholders this is the preferred way to return capital. In 18’ they bought back 3x as many shares as compared to previous years. It helps CEO Jacobs views the shares as undervalued. He has indicated they want to do more.
3. Segment sale: There is some frustration among management about the company’s undervaluation. Lazard worked on the deal where Oppenheimer Funds, a unit with almost exactly the same amount of AUM as Lazard, was sold to Invesco for about $5.7 billion. This is noteworthy because Lazard’s market cap is only $4.8 billion and its enterprise value $4 billion. Jacobs has said on an earnings call he likes to keep the unit but would be open to a sale. One important difference between the businesses is that Oppenheimer Funds served mostly retail clients while Lazard is focused on the institutional side.

Managing assets of retail clients is attractive because firms are able to charge them somewhat higher fees. Institutional clients have more bargaining power and can put pressure on fees.

On the flipside institutional money is more sticky. If you run an investment organization that actually creates value for its clients (in my view Lazard accomplishes this) the sales process can also be less costly. Although Lazard isn’t able to charge performance fees on the vast majority of its strategies its strategies are specialized (emerging markets, robotics, quant) and mostly run by experienced managers with a value bent.

As Lazard is an investment banking firm its management is acutely aware how it can create value through financial engineering. Jacobs raises the issue of Lazard’s institutional client base but I’m not convinced the Lazard business (especially as it is showing organic growth) is worth much less. A spin-off was discussed on the earnings call but Jacobs didn't like it due to the environment back at the end of 18'. I view either as low probability.

Catalyst

-Growth 

-Buybacks 

-Segment sales