Description
LAZ represents an excellent short opportunity trading at 15 times 2008 estimate of $1.85 and 10 times 2009 EPS estimates based on growth of 50% to $2.75, roughly equaling the record year in 2007. Given the correlation of M&A advisory to global GDP and stock market values, it is highly likely that EPS actually falls in 2009.
Several of the boutique investment banks have seen their stock prices hold up relatively well this year, as bulls think they will pick up cheap talent and market share from Lehman and Bear and Merrill. The other bull point for this group is that “restructuring” revenue associated with bankruptcies will pick up in an economic downturn and pick up the slack for declining M&A business.
The bull thesis is highly unlikely. Bear is part of a stronger JP Morgan, Lehman is part of a larger Barclays and Merrill is now part of a much larger BankAmerica. Much of Lazard’s boutique competitors (Greenhill, Thomas Weisel, Evercore, FBR, Piper Jaffery, Jefferies) are still in business and competing aggressively for a rapidly shrinking pie. Bulls pinning their hopes on growth in restructuring revenue are delusional. LAZ’s restructuring revenue in Q2/08 was $33M, representing only 7% of total revenue—it is far too small to make up for substantial declines in the other 93%.
Lazard’s key business segments
LAZ derives about 40% of its revenue and earnings from “asset management” and 60% from “financial advisory”.
The asset management business, where 80% of its AUM is in equities, is likely to experience substantial declines in AUM and very negative operating leverage. Many pure-play asset management companies have gotten destroyed recently. JNS, which has most of its AUM is down 70% in the last month and trades near 6 times Q2/08 earnings. Franklin Templeton (BEN), which only has about 60% of its AUM in equities, trades at 6 times Q2/08 EPS (ex-cash). LAZ is very expensive.
|
|
($ in millions) |
Q2/08 |
Q2/07 |
H1/08 |
H1/07 |
|
Financial Advisory |
Net Revenue |
289 |
245 |
501 |
468 |
|
|
Operating Expenses |
230 |
192 |
404 |
365 |
|
|
Operating Income |
59 |
53 |
97 |
103 |
|
|
|
|
|
|
|
|
Asset Management |
Net Revenue |
180 |
165 |
345 |
314 |
|
|
Operating Expenses |
142 |
122 |
257 |
233 |
|
|
Operating Income |
38 |
43 |
88 |
81 |
Large charge in Q4
LAZ’s corporate structure is complex and involves a large minority interest held by a bunch of managing directors related to the asset management business. LAZ announced on August 14 that it will be taking a $183M after-tax charge in Q4/08 (about $2.90 of EPS) to exchange pre-IPO goodwill equity interest for cash and stock. It will simplify the corporate structure, but at an obviously high cost. The payment will include $60M in cash upon closing (October 31) and approximately $180M in three years, comprising $90M in cash and 2.2M shares of class A Lazard stock. This deal just stinks of self-dealing. Oh, and insiders also sold another 6.4M shares on September 3rd, at $37 per share—another good reason that investors will/should likely treat Lazard with a lot of skepticism.
Greenhill loss and core miss
Greenhill (GHL), arguably the best-in-class boutique, just reported an outright loss (on its proprietary merchant banking portfolio) and weaker than expected core M&A revenue ($37M vs. $50M in Q2, $117M a year ago, and a Q3/07 estimate of $63M from Credit Suisse). Compensation costs did come down, but that seems insignificant when revenue is missing badly and the stock is trading at 20+ times earnings. The read across for LAZ is not good.
The stock
The stock is up about 17% from its 2005 IPO price of $24. I find it difficult to argue that LAZ’s prospects are better today than they were 3 years ago. It is easier to argue that the future is in fact much worse. Even though LAZ is off sharply in the last week, (I was trying to get this out a few days ago), its relative price is still very high. It might be best to establish an initial position now and add if there is a market bounce in the next week or so.
Catalyst
Q3/07 miss;
Large charge in Q4;
Terrible asset management results