The last tycoons: the secret history of Lazard Frères & Co

by William D. Cohan

  On April 11, the IPO took another important step toward reality when Lazard filed with the SEC an amendment to the registration statement, including for the first time information that would allow investors to assess the price tag the firm had placed on itself. This filing revealed that Lazard and the underwriters were aiming for a price range for the equity of between $25 and $27 per share, valuing 100 percent of Lazard equity at between $2.5 billion and $2.7 billion. When the net debt of around $1.4 billion was added, the enterprise value of the firm was between $3.9 billion and $4.1 billion. Using the midpoint of $4 billion, Lazard would be valued at 11.8 times the 2005 estimated EBITDA (earnings before interest, taxes, depreciation, and amortization) of $339 million and a P/E ratio of 17 times the 2005 estimated earnings.

  Both of these valuation metrics, by design, valued Lazard at a higher multiple than the global investment banks, such as Goldman Sachs, Morgan Stanley, and Merrill Lynch, which Lazard executives had taken to referring to as "hedge funds" and which tended to trade at a P/E multiple of 12. But the proposed Lazard valuation would be at a discount to Greenhill & Co., which in the year since it went public had become the gold standard of boutique investment banking at least as far as its public valuation was concerned. Many wondered who would invest in this offering that would leave Lazard with significant debt, largely dependent on the cyclical M&A business, when only a minimal amount of the capital raised would be retained in the business. Indeed, the money raised would be paid out to the historical shareholders at a materially higher price than the market believed the stock was worth. Also, for the first time, this value range indicated that Bruce's $30 million initial investment in Lazard, plus the shares Michel granted to him, were set to be worth around $290 million.

  In the revised registration statement, Lazard finally admitted that if the compensation of its managing directors were included as an operating expense, "the firm lost money in each of the last three years," just as Michel had been saying. For some existing and former Lazard partners, this admission was confirmation that the financial statements in the S-1 were all but fraudulent because they failed to show the losses and then presented the profitability on a pro forma basis. One Lazard partner said he could not believe the SEC permitted the accounting to be presented in this way. He was even more astounded that this happened given that Steve Golub was a former deputy chief accountant at the SEC. "I am flabbergasted, I have to say," he continued. Ken Wilson, the former Lazard FIG partner now at Goldman Sachs--the lead underwriter of the Lazard IPO--shared the view that some top bankers on Wall Street were buzzing about the Lazard accounting. "There is a clear pattern of greed and deception" at Lazard, he said. "There is something in the culture that permitted it to happen."

  The press was starting to hear these ruminations, too. "All this raises the question of why outside shareholders would want to get involved," the Economist stated. "Mr. Wasserstein has little option but to complete the IPO. But such are the uncertainties around this strange flotation that some observers are already wondering whether it is an opening move rather than an end game." BusinessWeek opined, "Add it all up and investors had better be real comfortable with Wasserstein's stewardship before they get involved in his next excellent adventure as the CEO of a public company. Eventually, the market will sort through the confusing details of the prospectus and value Lazard accordingly. Wasserstein has built a career by defying gravity. But this could be one rocky liftoff."

  Finally, after four months of laborious legal filings and their revisions, the time had come for Bruce and his top executives to see if they could convince the market to buy the shares of what Robert Willens, a top tax and accounting analyst at Lehman Brothers, called "one of the most complicated things I've ever seen." While the S-1 and its amendments are the official documents the SEC requires of a private company seeking to become public, another key document--the prospectus--is used for marketing purposes with potential investors. The prospectus is a slightly jazzed-up version--color pictures are permitted--of the final amended S-1 and is prepared for use on the road show. (The Lazard IPO prospectus was one of the lengthiest ever written.) The culmination of the road show, assuming there is sufficient investor demand, is the pricing of the stock and its purchase by the underwriters.

  Following the SEC's sign-off on the final amendment to the S-1, Lazard could print prospectuses and begin the road show. After a week or so of stops in major cities in western Europe--about halfway through the process--the Lazard IPO road show rolled into New York for lunch at the New York Palace hotel on April 27. The IPO pricing would be negotiated with Goldman Sachs after the market closed on May 4, allowing the new Lazard stock to trade--under the symbol LAZ--beginning at 9:30 a.m. on May 5.

  The Goldman Sachs partner Tom Tuft kicked off the New York lunch, as would be expected, by lauding his client Bruce Wasserstein. "Bruce Wasserstein joined Lazard three years ago to take on the unique challenge of transforming an underdeveloped franchise with a tremendous history," he said. Much to the surprise of many of the approximately 250 listeners in the audience (some of whom were Lazard partners hearing the road show presentation for the first time), Bruce spoke for most of the forty-eight-minute session.

  But as highly anticipated as the meeting was, investment bankers are not actors. Bruce was certainly no Henry V leading his men into the Battle of Agincourt on Saint Crispin's Day. Rather, he covered the saturnine marketing material in an uninspired, droning monotone. His presentation was disjointed and didn't seem to stick to any particular script, which most executives at these types of meetings have the good sense to do. Bruce's message, though, was clear. "The threshold issue when you're thinking about Lazard is, is the M&A market attractive?" he said. "If the M&A business is attractive, Lazard is an attractive investment." He then launched into one of his favorite history lessons about the cycles in the M&A market from 1861 to the present. His presentation was clinical and unemotional. And maybe that is the way Goldman recommended he deliver it. But he conveyed no sense of Lazard's rich and nuanced history on this, the eve of the most momentous event in the firm's 157 years. True, like a neutron bomb, in one fell swoop he intended to eliminate all human traces of the firm's aristocratic ancestry by buying out Michel and his allies. But for a man who seemed so taken with the firm for so many years and who fashioned his own firm after Lazard, his lack of passion was noticeably distressing. Whereas Michel described the firm as "a state of mind vis-a-vis the world" and had a palpable love for it, Bruce merely spouted some investment banking pabulum.

  "Lazard is a very special place," he droned. "We've focused on the added value part of the business. We're particularly prominent in complex deals, international deals, and deals that require a high level of fiduciary responsibility. We feel that's a growing part of the M&A market." Indeed, the closest he came to anything resembling passion for Lazard--at least with this crowd anyway--was when he mentioned offhandedly just how much cash the firm would be able to generate because its two business units, M&A and asset management, required virtually no capital to operate. "In fact, this company spigots cash," he said. "It spigots cash because unlike, say, our friends, say, at Lehman Brothers, who need the capital to support their derivative portfolio or whatever, we don't need that. So we use cash in our minds, cash is for buying back shares, dividends, possible adjacent acquisitions, if we found them, and perhaps paying back debt, although not particularly a priority. So that explains sort of our position."

  He also sought to anticipate some investors' questions about the offering's most unusual aspects. As for the $200 million reduction in compensation needed to achieve the 57.5 percent goal promised in the prospectus, he explained that $100 million of the savings would come from ending the huge payments to Eig and Gullquist. "So that's over, gone, done, nonrecurring," he said. The other $100 million of cuts would have to come, he said, from bankers' compensation, assuming no growth in revenue. But, he pointed out, if overall revenue were to grow at 13 percent in 2005, no compensation cuts wo
uld be required to achieve the 57.5 percent target. "We think this year we're going to make zero cuts, whatever that implies," he said. "We'll be at 57.5 percent." Without addressing the controversial decision to incorporate in Bermuda, he did explain why the firm's tax rate appeared to be 28 percent, lower than that of most U.S. companies. "It's 28 percent because we're a full U.S. taxpayer but we've got half of our businesses overseas," he said. "When you blend the two you are at 28 percent." As for ensuring that talented bankers stayed at the firm long enough to help it achieve the results that Bruce had promised to investors, he had a prepared answer for that, too. "So we have all these valuable employees, how do we keep them?" he asked rhetorically. "What everyone signed up to is a system where if they leave, they can't sell or borrow on their shares for eight years. So a pretty draconian methodology. If they stay, they can sell or convert on an average of four years. By the way, there is also a ninety-day notice and a ninety-day noncompete. And again, everyone signed up for this kind of provision. So we think that that's very powerful."

  As the lunch wound down and Bruce's presentation ended, there were surprisingly few questions from the audience, and none of them delved anywhere near the controversial topic of how the firm found itself in this position after 157 years of privacy.

  BY ANY MEASURE, the Lazard public offering was a historic event. Not only would it spell the end of the firm's enigmatic secrecy, but it would also be the largest IPO--by far--of a Wall Street firm since that of Goldman Sachs in 1999. Yet the Lazard deal was merely anticipated--not much anticipated, not wildly anticipated, just anticipated--by institutional investors. The tepidness of their response could be felt at the New York Palace. Investors' thinking was that at a price, the Lazard deal would begin to look interesting. The problem was that Bruce had made the deal intensely complex by having to solve so many problems at once. Accordingly, he appeared to scare off many retail investors, putting more leverage than usual into the hands of institutions. "The more complicated the structure, the lower the price that can be achieved," one institutional investor told Reuters about the Lazard IPO.

  Compounding the self-imposed problems were the external ones. In April 2005, five of the six IPO pricings were either at or below the low end of the range put on the prospectus cover--investor demand was weakening. Meanwhile, the Lazard IPO also suffered from the roiling debt markets, where the recent downgrading of the debt of bellwether GM had caused yields to rise--just as Lazard needed to price the debt part of its offering. Moody's didn't help Lazard's cause when it rated the debt Lazard would be issuing as Ba1, below investment grade. And then Duff & Phelps, another rating agency, gave the Lazard debt an unsolicited and unexpected below investment grade rating as well, giving the debt offerings the whiff of a junk-bond offering--itself utterly ironic given all of Felix's railings against the junk-bond market. Pricing pressure on the debt put pricing pressure on the equity.

  Two days before the deal was to price, the high-profile professional stock picker and ranter Jim Cramer urged investors to stay away. "How awful is this Lazard IPO deal?" he wondered on his Web site (as opposed to in his financial column in Bruce's New York).

  I mean, has anyone looked at it?...This one's total hubris, especially in light of the downgrades of the real brokerages today. Sometimes I believe that Wall Street thinks we are the biggest bunch of morons. The more I read about this deal, the more I believe it's simply a very expensive buy-off of dissident partners and nothing more than that.... Moreover, its prospectus is the most confusing document that anyone I know has ever seen. Total lack of transparency. Sometimes this business cries out for a ref to throw a flag and say, "Nope, you guys can't do this." But there are no zebras, just guys like me saying, "Please stay away from this." And we have no clout or voice compared with the Street itself, which allows virtually anything to come public. What a crime.

  Such was the backdrop when Lazard's management met with its Goldman Sachs bankers on the night of May 4 to price the IPO. According to Ken Wilson, that night there was the not unexpected wrangling between lead underwriter and issuer. "It was a complicated deal and a very hard deal to get done," he said a few weeks afterward. "There was resistance to Bruce. He has a lot of baggage." Wilson said there was a "weak list of investors" for the Lazard IPO and a "weak book" of demand thanks to "a lot" of selling pressure from "hedge funds that shorted into the syndicate bid." In the end, the demand was at $23 per share, he said, below the low end of the range, which was $25. "But," Wilson said, "Bruce was adamant. He said he had a gun to his head and he had to have $25 per share." According to the New York Times, some Goldman bankers pushed to price the IPO at $22 per share because of "weak demand." In the end, Goldman capitulated to Bruce and priced the IPO at $25 a share.

  Furthermore, Lazard and Goldman increased by 3.7 million shares the amount of stock sold at $25 per share in order to raise another $93 million. Lazard needed to raise this extra money from the equity market because Citigroup was unable to sell the corresponding amount of subordinated debt in the increasingly choppy debt markets. "Given the change in the debt market, we thought it prudent to reduce the debt, which was possible given the demand for the equity," said Lazard's spokesman, Rich Silverman. Added Ken Jacobs: "Goldman priced right through the static. And we got it done. All power to Goldman. To be frank, Goldman did a superb job on this transaction, and you don't usually give competitors a lot of credit." After the pricing had been negotiated on the evening of May 4, Lazard put out a press release announcing the deal. "Lazard is the leading global independent advisor and a premier global asset manager," Bruce said in the release. "For more than 150 years, Lazard has served its clients under changing economic conditions, and we look forward to this exciting new era. We made the decision to become a public company after careful deliberation and with the best interests of our clients, our people and our investors in mind." The equity offering raised $854.6 million in gross proceeds, and $811.9 million after underwriting fees.

  In total, on the evening of May 4, Lazard raised $1.964 billion, with all but $61 million going right back out the door. Of course, the bulk of the money--$1.616 billion--went to Michel, Eurazeo, and the other capitalists. Steve Rattner lauded Bruce's accomplishment. "Bruce had all the cards," he told the New York Times. "He outmaneuvered Michel at every turn." At a Eurazeo shareholders' meeting that day, Michel told the crowd, "I was associated with Lazard for 45 years, and was its head, and very honored to be, for 25 years, so it's a major turning point." The night of the pricing, the deal teams from Goldman and Lazard celebrated with a dinner at Per Se, one of the finest and most expensive restaurants in New York City.

  FOLLOWING A TIME-HONORED tradition, at 9:30 the next morning, Bruce and a group of about seventeen FOBs appeared at the podium, high above the trading floor of the exchange and in front of a large banner with the word "LAZARD" on it. The group had assembled to ring the opening bell at the stock exchange and to watch the first trades of the Lazard stock. After the bell ringing, Bruce and Steve Golub went down to the floor of the exchange, specifically to the trading post of Banc of America Specialist, the specialist firm Lazard had selected, to watch the shares trade for the first time. What they witnessed was not pretty.

  In theory, IPOs are carefully priced so that the demand for the newly traded stock slightly outstrips the supply. When that happens correctly, good things result. The price of the shares trades higher, and investors are happy. Underwriters are happy, too, because they do not have to put their own capital at risk supporting the stock--hence the idea of an underwriting--and they can exercise an option on something called the green shoe, an additional overallotment of 15 percent of the Lazard stock (in this case 5.1 million shares) that allowed them to buy at $25 a share, sell into a robust market at a higher price under the guise of "stabilizing the market," and thus increase their profits. If an IPO trades below its offer price, it is said to be "broken." When an IPO breaks, almost nobody is happy. The original buyers of the stock watch as its value drops, de
spite their best effort to determine the right price before buying. And if the IPO breaks, the underwriters obviously will not exercise the "green shoe" but instead are obligated to actually underwrite the offering by using their own capital to create support for the stock in the market. If someone wants to sell in those early days, the underwriters have to buy, which puts them in a position to lose a lot of money very quickly--something Wall Street firms try very hard to avoid. In the case of a broken IPO the only happy people are investors who sold the stock short--they bet correctly the price would fall--and those people, such as Michel, who sold their stock to Lazard for a price far higher than it turned out to be worth initially in the market.

  The Lazard stock traded flat--at $25 per share--for the first twenty minutes or so, and then actually traded up, to a high of $25.24, just before 10:00 a.m. The stock then returned to $25 a share until around 11:45 a.m., and then it went downhill. LAZ ended the day at $24 a share, off $1, or 4 percent, on volume of just under thirty-five million shares. "When you see it trading near the offer price like that it means the underwriters are supporting the stock," Steve Rattner told Bloomberg that first day. "You normally want to see it go up 10 percent." Added a trader about the $24 closing price: "That's where the demand is." Bloomberg pointed out that Lazard became the first IPO of an investment bank in some time to fall on its first day of trading--both Greenhill (up 17 percent) and Goldman (up 33 percent) rose on their first day of trading--and became one of only a dozen large IPOs since 1987 to do so. Some observers of the IPO market noted that Goldman could not afford to let the Lazard deal fail. "It's too high-profile of a deal," commented a trader at Cantor Fitzgerald. "It is disappointing. I am sure that they didn't anticipate that type of downward price movement." Renaissance Capital, which provides independent research on newly public companies, wrote in a May 5 report about the Lazard IPO that "it seems every last penny was squeezed out of the initial investors" and that "we believe the primary causes of the poor reception [for the IPO] were the company's convoluted corporate structure and the valuation premium on the original deal. We still believe the current valuation is too high, particularly with the mixed trading in investment banking stocks." Red Herring called the Lazard IPO a "belly flop" and added: "The moral of this story boils down to what Wall Street is all about: Look out for No. 1." Financial News, in London, applauded Bruce's tenacity in getting the deal done in the face of the many obstacles Michel laid in his path. "However," it concluded, "a deal that is so transparently designed purely to wrestle control of the firm from chairman Michel David-Weill for the individual enrichment of Wasserstein and his key cohorts at the expense of shareholders has no place in the public equity markets."