Lazard, Inc. (LAZ) Earnings Call Transcript & Summary

Okay. So good morning, everybody. I'm delighted to welcome Ken Jacobs, who is CEO and Chairman of Lazard for a fireside chat. Ken is now in his 13th year, I believe, as CEO. And over his period at Lazard, we've seen a significant growth, both in terms of their product and geographic mix. So Ken, thank you very much for joining us.

I thought what I would do is just start off with a broad question around your view of the macroeconomic environment. Obviously, I know there's a lot of different moving pieces, and you obviously operate in a lot of different geographies around the world. But maybe you could just talk about what you're expecting in terms of economic growth. Maybe talk about what you think will happen to interest rates in some of the different geographies that you operate in, in 2022?

So I think it's important to start with an important caveat around the variant and not being entirely certain how that's going to unfold over the next couple of months or so. So I'm going to put that aside for a moment and then come back to it at the end. Generally speaking, absent the variant going into 2022, the macroeconomic environment, at least for where we operate, which is in the United States and Europe primarily, is quite constructive. We're seeing a lot of -- there's a lot of activity, broadly speaking, in the economy. We're seeing supply chains loosen a little bit. They're getting a little bit better. We're seeing -- yes, we're seeing inflation, but there's more and more signs that this is going to be something that resolves itself in '22. It looks more like what everybody's been wishing for, which is an environment of 2% to 3% inflation may, in fact, be the case, not something that spikes up at 4 or 5. Part of that is driven by the fact that we're also starting to see a little bit of slowing in macroeconomic environment in the U.S. and probably we'll see a little bit in Europe as well, which should take some of the pressure off prices and such. So all of that, as long as you have growth, you have consumer spending, you have confidence, it's pretty constructive overall for our business. The caveat in here is clearly around the variant, which is something which we're going to know a lot more about over the next couple of weeks, but early signs are it's highly transmissible that there is some immune escape, severity is an open question right now, depending on boosters and such. The challenge on that is just the speed at which it transmits is going to perhaps result in some shutdowns and closures. I don't think economic activity will come anywhere near to the halt that we saw in April of 2020, but it's something to keep an eye on.

Okay. So this year has obviously been a great year for the Advisory business. It's been a great year for you as well. Can you talk a little bit about the macro risks in the context of what it means for the Advisory business? So things like supply chain disruptions, I think one of the big issues that came up yesterday is a lot of banks seem to believe that the market is underpricing inflation and interest rates could end up going up much quicker than the market is currently pricing. Even things like the executive order. What do you think about those, do you think that those are an accelerant potentially to activity because they do cause more disruptions to companies? Or do you think they'll have a chilling influence on the level of activity you're seeing?

Well, look, for the M&A business and particularly this cycle where financial sponsors are so important to the contribution to the market, credit is going to -- credit -- watching credit is going to be very important. But with credit, if we see rates going up 100, 200 basis points, I don't think, at least in the environment we're in today, that's going to cause credit to stop. And what M&A more or less reacts to is a stoppage or disruption of the credit markets, not so much a rate increase, especially a rate increase in a relatively healthy economic environment. So I think the thing to watch for is do we see some disruption to the credit markets. See that, then yes, M&A is going to be impacted, particularly the sponsor market, which has been a big driver of M&A. On the other hand, if the credit markets stay intact and they likely will, we will see some increase in rates. We've already seen it. We'll probably see a little bit more if, in fact, we do end up at a 2% to 3% inflation rate, but that shouldn't have much effect on M&A activity. Supply chain, candidly, is probably a plus for M&A. And it's probably also a little bit of a plus for the restructuring business. So I think that's going to -- again, I'm pretty optimistic that we're going to start to see resolution around that over the next 12 to 18 months and also that probably doesn't have much impact overall except for perhaps slight positive on our business.

Okay. You spent a lot of time with corporates, and I appreciate different corporates and different industries have probably got different issues that they're contending with. But how would you characterize the mindset broadly now relative to a year ago when I guess everybody was still very focused on effectiveness of vaccines, rollout of vaccines, speed of economic growth? What would you say is top of mind in corporate boardrooms?

Clearly, how to deal with an inflationary environment? That is -- that is top of mind because it is a new environment for most chief executives and most companies, most boards, most management teams. We haven't had an inflationary environment for a couple of decades now, really since the mid '90s. So that's something I think people are grappling with. I mean, generally speaking, most companies that can put through prices -- are putting through prices and feeling pretty confident about it and have had very little pushback. And so consequently, the impact on bottom line has been minimal if not positive, for many, many companies as we can see. I think the second topic that occupies Chief Executives' minds is really the energy transition. That's gone from being something that comes up in shareholder meetings, occasionally with investors to something that is absolutely top of mind for chief executives in board rooms across industries right now.

So you actually identified, I think, ESG much, much earlier than a lot of your peers as a potential driver of activity. How has your thought process evolved around that? Because I think everyone now agrees with you, it really has become a much more central issue along with stakeholder capitalism. How do you think that impacts the strategic thinking more broadly amongst corporates?

I don't think there's any question that this is going to be with us for the next couple of decades. And I would point to 2 factors. And it really comes down to the fact that at this point, there's no question that climate and energy transition are going to affect the allocation of capital. Climate because for the first time, I think, people have now realized that looking forward, you can't assume climate is fixed. I mean, for our entire lifetimes, perhaps our entire investing careers of anyone and before us, you made the assumption that climate was fixed and it wasn't going to change. I think that presumption is over. And that one, when thinking about a business for 5 or 10 years out now is to think about the fact that climate is uncertain and that there are going to be events that you can't predict based on past patterns. And that changes how you think about resiliency, how you invest capital. That's point one. And then point two, is really around the energy transition. Decarbonization is here. It's going to happen. The pace at which it happens is uncertain, but it is going to happen, and there are going to be enormous investments made by companies around decarbonization. And that's going to get priced by companies, and it's going to impact, again, the allocation of capital. And ultimately, it's going to impact cost of capital and security prices. And I think that's something that is becoming more and more evident.

Okay. So maybe we can just talk a little bit about the geographic skew in the business and how that's been evolving. So this M&A cycle was led by the U.S. It does seem based on more recent data, especially the data restarting in the summer, Europe has seen a significant pickup. As you look across pipelines, when you look across the dialogues that you're having, do you think that the momentum that we're seeing in the rest of the world is going to continue? And what do you think the biggest drivers of that are?

Sure. So U.S. M&A volumes, 2007 was one peak -- I think it was 2016 was the second peak. That was probably the highest until this year. Europe peaked in 2007, and it's still about 30% to 40% below that in announcements. It's probably about where it was in 2008 right now. So it's got significant room not only to get back to where it was -- the peak historically, but in the case of the U.S., we're now running 20%, 25% above where the peak was previously. So there's a lot of room to go. The driver in Europe, again, like the United States has been sponsor activity. But our sense is there's just a lot more room to go on that in Europe. It's developed, but it's not as tall up to this in the U.S., and you're seeing more and more pools of capital moving towards Europe, both in terms of sponsors, but also increasingly in company formation. I mean you're seeing much more company formation in Europe than historically we've ever seen before. And that obviously leads to more M&A activity as time goes on.

I think there's been a view in Europe that there's been a number of structural impediments to activity, politics, regulation, the strength of shareholder unions that have restricted consolidation in Europe and led to Europe becoming less competitive than other parts of the world. As you spend time with those groups in particular, and I appreciate Europe is very -- it's a very fragmented region. Is there a recognition that, that has led to a loss of competitiveness and that consolidation actually does need to take place?

To a degree. And again, if you think about the M&A environment, what I would kind of describe the U.S. M&A environment is one that's being driven by midsize, I mean, $1 billion to $10 billion deals. Yes, strategic in that landscape and also highly active for the sponsors in that landscape. There's not -- we're not seeing the level of very large deal activity that we saw in the period '14 to '18. And the reason for that is, I think, regulatory. I think it's antitrust, it's concerned around antitrust and it's also probably the valuations as well. So that's not that different from Europe right now. I don't think that Europe is going to undertake the kind of consolidation activity amongst the big strategics. That happened in the U.S., '14 to '18. That hasn't happened in Europe yet for all the reasons you outlined. I think that's going to be tough. But on the other hand, the same driver that has really picked up activity in North America, which has been the sponsors, and what I'd describe as these midsized strategic deals, I think you're going to see a lot of that in Europe as well.

Okay. So let's talk about financial responses. Obviously, very important theme for this group and for your company as well this year. So a few questions. I mean the first is, when you think about the sustainability of activity amongst financial sponsors, is there any reason to believe that it's going to slow heading into next year? And then secondly, can you talk a little bit about how you think about approaching the financial sponsor client base relative to corporates? Do you approach them in a different way? Are their needs different? And you have been building out your financial sponsor franchise now over quite a long period of time, where have you got to? And how would you rate yourself relative to your peers in terms of share for that?

So let's just start with the overall macro and then go to Lazard. So from a macro standpoint, the big risk in the sponsor market is credit because these deals will not happen without credit. So that pointed out before, if there's a credit contraction, that's going to be a risk to the market. The allocations to alternatives broadly and to private equity continue to increase. And a question mark is, can private equity effectively put all that money to work and get the kind of returns they're used to. The answer to that is probably not. But on the flip side, the other phenomenon that's taking place is the growth in the secondary market. And so you're seeing just an enormous explosion of activity in the secondary market which is increasingly providing another source of liquidity for private equity firms. So these continuation deals and such, provide another form of liquidity. So if you're a sponsor now, you have an M&A transaction, public markets, the public offering, for a while, SPACs. And now you have continuation deals, which allows you to, in effect, sell a company to series of secondary funds that put up the interest. And so that's a fascinating development because it gives you more liquidity than you had before as a sponsor, which probably means that the required rate of return perhaps goes down a little bit. So that's probably a positive development overall. With regard to Lazard, look, we're -- relative to a number of our competitors, we're under-indexed to the sponsor market. That's something we identified 3 years ago, anticipating some of the things that were happening, and we've moved pretty aggressively to increase that. I think we've doubled the -- I think we're up to about 40% or so of our revenues that are now sponsor-related. That's probably double where we were a couple of years ago. And we're always a little better in Europe than the United States. I mean our franchise has historically been a public company franchise with a -- with some coverage in the sponsor area. Many of our competitors are running at 80%, 85% index to sponsor business. And so they've had just spectacular runs with that. Fundamentally, it's not too different. You have a client, you have expertise. You compete based on your experience, your ability to execute, your knowledge of the sectors. I think the one characteristic of the sponsor universe today that is probably a little bit different from companies is the narrowness of the expertise in each of the areas where you're competing. So you will be a very narrow slice of industry expertise gains you a competitive edge oftentimes. The other aspect of the sponsor business, which is just sort of dawned on us and probably a lot of other people have seen this as well, is that it's a sell side business. It's very rapid. In the virtual environment, it becomes a very efficient business. In a non-virtual environment, you have to travel, you have to be in data rooms, you have to be in places. So one deal team probably is more efficient in a virtual environment than they are in the real environment. And I think actually, that's probably increased productivity for everybody in this particular area this year.

Okay. All right. That's very interesting. So maybe we can talk a little bit about growth and growth expectations from here. So I think the first 9 months, revenues are tracking up roughly 30% relative to last year. How sustainable do you see that pace both of revenue, and when you think about growth overall, is this a base from which you can grow? And what are the avenues that you think will offer the most attractive growth potential heading into next year?

So look, as I think I pointed out in the third quarter call, we expect a record fourth quarter. We're still on track for that. And going into next year, we see an unprecedented level of activity in our business. That's all a good sign. Now how that unfolds over the course of the year is anybody's guess, but that's a very strong way to begin right now. So that's all good. The growth in our business is probably going to come from the following: one is we have to increase our share of the sponsor market. That's something because I think the growth is there, and I think there's a lot of share to be gained on our part. And I think we'll succeed in that, that will be most evident in Europe and I think over time in the U.S. as well. That -- the growth in our business is like everyone else. You get some from productivity and then you get -- and you get some from head count and you get some from new lines of business. I think we've had a good year on hiring in a very competitive market. I think we've hired on the partner, our senior adviser accounts somewhere between 20, 25 by the end of the year, I expect. Our goal is net kind of 15 -- 10 to 15 partners a year, up and down, depending on the cycle. -- which is good. In terms of the opportunity for growth for us, what's very interesting is, again, because of the sponsor market, that opens the aperture for us in terms of hiring. It's very difficult to strategically hire public company bankers on a consistent basis. Those are few and far between and a platform like ours, it's not clear everybody adapts that well. On the other hand, the sponsor business, I think, opens the aperture allows many of our younger partners to be successful earlier and also allows us to -- there's an enormous wealth of talent out there in that space for us to hire. So that's pretty exciting, and we've had a lot of success with that this year.

Okay. And then on the non-M&A Advisory business, which obviously become a more important part of the business not just for you, but also...

Everybody.

For everybody. How do you see the trajectory of growth there and other individual products that you're particularly excited about?

Yes. So the ones that really exciting right now are, clearly, our Shareholder Advisory business is a very important business for us in terms of giving advice to public companies and companies that are entering the public markets. And that business, I think also -- I mean has also expanded into an ESG advisory capability, which is really quite attractive as well. So that's one that's interesting. The fee pool from that is modest, but it's a great feeder into the Advisory business, broadly speaking. The other business is our PCA Fundraising business, which is raising funds for private equity as well as for the secondary transactions I was describing earlier, that business is just an enormously successful business right now and has a lot of room for continued growth, and we're putting a lot of resource in that. The Restructuring business continues to be a gem for the firm. Activity is modest right now, although we're seeing some signs of pickup in companies that have supply chain issues, and we've actually picked up a few assignments, a couple of assignments in Asia, which are kind of interesting for us in that marketplace. And then of the Sovereign business, is a good business. I mean we really have very little competition that this very hard business to enter. It tends to be a very complicated business for other firms to get into.

Things like ECM advisory has grown very rapidly amongst your peers. What's your presence in that market? And is that something that you think?

I think on the equity side, it's an attractive business for us in Europe. It's been less of a an opportunity in the U.S. so that there are some signs that, that will pick up over time. The debt capital markets business, again, is probably more of a European business than it is in the U.S. business right now, although what I call on the sponsor side, there's some opportunity there.

Okay. So let's talk a little bit about the Asset Management business. Risk assets have rebounded pretty convincingly past few days again. And look, the performance really across every asset class this year has been pretty impressive. So when you talk to clients, how are they thinking about asset allocation heading into next year, what do you think is top of mind in terms of asset allocation?

Well, I think the key issue is there's so much money sloshing around. And the real question is, does the Fed start to take some of this off the table and what does that do to risk appetite. I mean, put aside rates for a second, just the sheer volume of money in the system is very high right now. And I think that leads to this kind of risk appetite. And there's an expectation that if the economy stays reasonable, and the Fed starts to pull back -- tries to pull back on inflation a little bit, which I think they will, and they'll succeed at. They're going to pull some of this money off. And then the question is what happens to risk at that point and which classes the securities do better, which do worse. And I think that's the real focus of investors at the moment.

We definitely see the theme whereby clients are willing to sacrifice liquidity for returns. How are you thinking about growth of private credit and core infrastructure funds? I mean, how attractive?

Well, let's kind of look at it as alternatives generally speaking.

Alternatively.

Look, it's a very attractive market, but it's kind of priced to perfection right now. So we're looking for -- I think everybody would say they love more exposure in alts, and we're not alone in that. But you have to find an entry point where you get an adequate return and you get good teams. And right now, the demand is just enormous. And so we're picking our parts carefully. We are going to be launching -- we've been this approach where we've been doing these modified small lift-outs, kind of small acquisitions, essentially one a quarter for the last 6 or 8 quarters. I guess we'll continue that. That's been a mix of long-only, long/short, where there's a long-only strategy because that helps a lot intellectual capital associated with that. And we've done a couple now of small but interesting infrastructure plays, where one team that we brought on, that's a sustainable infrastructure, and we'll see how that goes.

So you brought up the lift-outs, and that's obviously been very successful in terms of driving growth. What about larger acquisitions and asset managers?

There's a lot out there right now. And we, like everyone, are looking very closely at everything that's out there. I would say that it's got -- it just has to have good performance. It has to bring something that we don't have today, and it has to be something that's resilient into the next 5 or 10 years given the changes we expect in the asset management landscape.

And what's -- so the availability of assets you would say is quite high. Maybe you can just touch on the financial criteria that any acquisition would need to be for you to consider in that.

Sure. Let's just make it simple. Strategically, it really has to make sense. We have a great business, we have great teams, we have the ability to create product. Manufacturing product for us has never been a particular issue. It's getting -- selecting the products that we want, which ones are going to work in the market and then distributing it. So strategically, it really has to fit. And then economically, it just has to make sense. It's got to -- in the first instance, on a money-on-money basis payback over time. It's got to have a positive NPV over time, and we'd like it to be accretive. And those are the measures. And at the same time, we have a decent balance sheet, but it's not unlimited.

So let's talk about the recruitment environment. A number of your peers have said that this is the most competitive recruitment environment that they've seen over the course of the year. You've talked about the fact that you have actually managed to attract people and grow. Have you seen a normalization in terms of the competitive environment for talent? And maybe you can talk a little bit about how some of the bulge bracket players are behaving and if they're becoming more competitive in terms of their ability to retain talent?

Short answer is the bulge bracket has benefited from this environment probably just a little -- probably disproportionately. I'd say enormous share was gained by the independents up until last year. And I think this year, the bulge brackets probably grabbed back a little bit of share. And that's not unusual. In a really active market, the firms that literally can be everywhere do a little bit better. And so this doesn't surprise me. But I think when you look at it, it's -- people are probably going to be -- pay is going to be very good this year. It's going to be a very competitive year on Wall Street. But generally, it's a pretty rational industry at the end of the day. And I think that people will be pretty rational. We saw a lot of pressure over the course of the summer because, candidly, I think that people laid off a few more people than they led on during the pandemic. They under-hired in -- for the starting classes in 2020. And then there was some attrition that took place and then the explosion of activity caused a real pressure in people systems. It's not over, but it's probably working its way through the system right now. The greatest pressure on us, I would say, was probably over the course of the summer. It's abated a bit. I think it will pick up again around pay time and then it'll probably abate again into 2022.

Do you feel resource-constrained in any way in terms of your ability to process the activity that...

There are some groups that are a little bit more strained than others for sure. But generally speaking, we are pretty good at moving resource around. So that hasn't been a real -- really hasn't constrained us from the standpoint of top line. Yes.

Yes. Can you also touch on the non-comp side? And maybe talk about that in the context of return to office? And what you're actually seeing from clients in terms of their demand for in-person versus virtual? I think your comment about financial response is very interesting because that suggests that even when they have the opportunity of meeting people, they're probably going to stick with Zoom because they're more productive. But on the corporate side, what's the appetite to go back to the way things were?

I would say different in different places. In Europe, for us, until the last couple of weeks, it was pretty much business as usual, both in terms of being in the office pretty much 100% across the continent until about 3 or 4 weeks ago, it's kind of gone backwards a bit in certain countries. And client visits, not too dissimilar from what it was pre-pandemic. And again, you have to remember, most of what happens in Europe for us is local. So we have a big presence in Paris, Italy, Spain, U.K., Germany, Netherlands and Sweden in each of these countries, the local environment, you're not traveling very much. They're city centers. People are kind of used to seeing people in person, and that's gotten back to normal. The U.S. is very different. There are certain geographies in the U.S. where you're a bit more back in person in, the south and the southwest for sure. But I'd say Silicon Valley and San Francisco are ghost town still. And clients are not back. When you see clients out there, I've been at the West Coast a couple of times, you see them in restaurants. You don't see them in their offices. So it's a very different experience. New York is kind of mixed. It's really come back a lot in the last couple of weeks, but it's something to watch out. But I think overall, I think what we've discovered is a lot of the execution of deals can be done virtually, and I don't think that's going to change candidly. I think that people find it very efficient. Videos begin on time, end on time, and you can get a lot done that way. I think that the initial client visits and the stay in touch with clients are going to be very personal. I actually think a lot of it is going to gravitate to entertainment, that is restaurants, events and may not be as much in-person, in-office kind of situations. And so we're thinking about that in terms of how to do this going forward. I think overall, T&E will be less for a while. It won't be the way it was during the pandemic, but I don't think it's going to completely normalize either.

Broadly, do you think COVID has helped or hurt you in terms of your ability to form relationships with new clients? Because Lazard obviously, has been around for a long period of time. You've got a lot of long-standing relationships. Do you think that's been a plus for you?

I think it's net plus actually, for us, interestingly. I don't think it's hurt us at all.

And that also means that productivity levels for bankers...

Should go up.

Should remain at least high.

It should remain pretty high.

Okay.

I mean the real trick for us, and this has been a big success so far in the U.S. is, for this to work, you still have to have an in-person experience as a firm. And I think we've found a nice medium for that. And that's -- but that's a critical criteria. You cannot do this as a firm that's out of the office. I think it all breaks down very quickly that way.

Okay. So I think we've got a few minutes left. So maybe we can just talk about capital returns, how your thought process there has evolved. Big step-up in buybacks this year. How are you thinking about the attractiveness of buybacks versus dividends versus special dividends? And maybe you can just update us on your thought process around the level of cash you think is appropriate to run with as the world continues to normalize?

Yes. So let's start with the cash. Where we are at the end of each year is about where we want to end up on cash, give or take, $100 million. I think our balance sheet is fine, when maturities on the debt are fine. The cash flow generation in our business is just absolutely enormous on both sides. So that's positive. The dividend is attractive. And so we'll keep it. And my expectation is, as we feel there's continued growth in the business. We can probably grow the dividend alongside that. But what you've seen is when we see value in the stock, we're going to buy it back. We just think that's a great investment. We have a great firm. It's -- lot of time, we feel like it's undervalued, and we're going to be aggressive buyers of the stock in those situations.

Okay. That's great. There's actually one question that came in, which is around the relationship between U.S. and China, right? on this. But the question is, just given the deterioration in the relationship, how does that impact appetite for cross-border activity when you think about the next few years? How meaningful do you think it is?

I think the activity of U.S. inbound to China is going to be extremely limited. I think activity from Europe into China in terms of deal activity, also limited. I think you're going to see quite a bit of divestiture activity on the part of multinationals out of China. I think unless you're really there in a strategic position that is sustainable, you're going to start to think about how you exit candidly. And I think that there's going to continue to be financial sponsor activity into China, but even today, you can see how the Chinese are putting some breaks on that in the technology area. And I think there's going to be some growing restructuring activity over the course of the next month -- several months or so. That's how we see it.

Just as a follow-up, does that mean that there should be more intra-Asia activity? And how are you positioned for that?

The short answer to that is yes. The fee pool is modest right now. And we are reasonably positioned for things involving China-Hong Kong outbound. That's how I describe it.

All right. Well, Ken, thank you very, very much for joining us. Great to have you back in person. I hope to see you next year. So thank you. Thanks a lot.

Thank you.

Thank you.