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

Hi. Good morning. Before we begin, for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. Taking a photography or use of recording devices is not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. So we are pleased to have with us today Peter Orszag, CEO of Financial Advisory at Lazard. Peter has served in a variety of roles in Lazard, including Vice Chairman of Investment Banking and also served on the public side as Director of the Office of Management of Budget and Director of the Congressional Budget Office. Peter, thanks so much for joining.

It's great to be with you. Thank you.

So let's start off with the big news. Lazard recently announced that you will serve as CEO beginning October 1. It's early days. We're still 3.5 months away from that. But can you help us understand how you're approaching the new role and whether we should expect any change in strategy?

Sure. So first, I'm incredibly excited and humbled by assuming this position. As you know, Lazard is celebrating its 175th anniversary this year. So we have a storied history, and we need to marry that with a dynamic future. And the way I think about the next few months is I am spending a lot of time talking to our clients, talking to investors, speaking with our own employees as we fashion a new way forward and taking a fresh look at what we're doing, which I think is appropriate at a moment of leadership transition. But fundamentally, we have truly remarkable people. We've got a wide array of capabilities and content that is world-class. And I think we've got the world's best independent advisory and asset management brand. So we need to couple that with increased ambition and increased intensity. And in some sense, one way to think about it is to leverage the brand even more aggressively than we have been doing in the past.

And how you evaluate your performance as CEO, are there any sort of metrics or targets for growth, capital return, efficiency that you're looking for?

It's a little early for a lot of details, but come October, we'll lay out in more explicit detail how we think we should be judged. But ultimately, that will be an interplay between our own views and the world. But I do think about 3 core attributes that are key to success without getting into the exact details of how you measure them. The first is relevance. Lazard has always been in the boardroom or in the most important asset management discussions, and that is key to what makes us who we are. The second is revenue. It's not enough to just be relevant. We've got to be productive also. And the third is returns. And there will be an increased focus on TSR in particular, and that's obviously an output from what we do. But back to the core points, relevance, revenue and returns are, I think, the 3 ways that at least I'd like to be judged and I'd like our firm to be judged.

Great. Well, that's a good overview, and looking forward to more details in October. Let's shift to advisory. The environment is clearly challenging for the industry. We last heard in the April earnings call that things have deteriorated. Lazard do not expect to rebound in M&A until at least 1Q '24. Has that outlook changed at all? And where do things stand today versus in April?

Well, I think what's happened over the past few months in some sense, the market has caught up or conformed to the view that we had put forward with regard to the M&A cycle. And what I would say at this point, if you think about the drivers and then the headwinds and the balance between the 2, so there are many underlying catalysts and drivers of M&A: technology, ongoing march of technology, the energy transition, the life sciences revolution and the de-risking phenomenon with China and shift in supply chains as 4 key drivers, although there are others. And that is causing a lot of pent-up demand for M&A. But on the other hand, you've got 3 key headwinds: pricing, financing and the regulatory environment. On pricing, you can't raise interest rates by more than 500 basis points over a 14-month period that quickly have the associated impact on the DCF of cash flows for lots of companies and not have some pricing disconnect for some period of time. But I think we're basically getting towards the end of that period where the buyer-seller mismatch has been extreme because this environment has been in place for long enough. On the financing, a lot will depend on when the Fed stops tightening. I have a particular point of view on when they should stop tightening. But obviously, when they do is up to Mr. Powell and colleagues, but that's the second important catalyst. And then the third is the regulatory environment. And there, frankly, I think they're -- maybe we'll talk more -- in more detail about that later. But there are some important cases, lawsuits that are going to play out over the next year or 2 that is going to provide clarity. So if you put those all together, what's interesting is the underlying drivers are durable. And with the exception of maybe the regulatory environment, the headwinds are ephemeral. And so what I would say is I think the M&A market is basically bottoming out as we speak, and I want to be clear about what that means. Bottoming out means there is a period of time between that phenomenon because the pricing disconnect is easing, and the financing conditions are at least becoming clearer as we near the end of the tightening cycle. Bottoming out means there will be some period of time before announcements really pick up. And then there's another lag before -- between announcements and completions. So bottom line for the market, I'm not talking about for Lazard, but for the market, I think it's clear that revenue will be down materially in M&A for the market this year just if you look at what happened with announcements and the lag to completions. But if you look forward, it does seem like activity has bottomed out. There will be a lag to announcement, another lag to completions, and that will play out in the quarters to come.

Let's dig into the regulatory point that you made.

Sure.

Regulatory environment is challenging. And it would seem like that would impact the larger deals more. Is there any trickle down into the more midsized deals in terms of CEO confidence beginning those discussions and maybe just staying on sidelines? Or is it just concentrated in that large segment?

Well, first, a few comments just on the overall environment, and then I'll get to your specific question. Look, what's interesting about the regulatory environment is the biggest [ bad ] perspective effectively is reinterpreting existing law. So the laws haven't changed. The way that they are being implemented has changed. And what that tees up is an interesting phenomenon where a lot of these cases will go to court. And clarity will come partly from what judges then say about this disconnect between existing law and the new interpretation of it because the thought that we're going to have new antitrust legislation, I think, is implausible. So you've got this tension between the new direction and the lack of change in the underlying statutes that will be evaluated in the court system not just by the FTC and the DOJ here in the U.S. That's going to provide some clarity because one of the things that's happening now is no one knows exactly where the boundaries are, but the courts may drive those boundaries even if the FTC and DOJ have been less clear about them. And if that were to happen, then even for the large deals, what you need to do is build in some extra cost for lawyers and some extra time to go through the legal process. But you'd have at least a decent degree of confidence that at the end of the day, the deal would be approved. And we can talk about some of the complexity with the CMA in the U.K. and the EU authorities, too. But with regard to the U.S., I think we will have some more clarity over the next year or 2 as these cases -- some important cases go through the court system. Now with regard to your specific question, it varies a lot by sector and by individual situation. There are situations where actually the lack of the big guy coming in, the big entity coming in and sweeping up mid-cap targets because of the antitrust environment actually opens up opportunities for more midsized-to-midsized deals because you're not competing against the big strategics. So it varies a lot by sector and situation, and there's not one size fits all that rules there.

Got it. That's helpful. And then outside of regulatory thinking through the macro side, last few months, S&P has held up. Fed looks like it's either pausing or maybe we get 1 or 2 more rate hikes. Is that enough to get things starting to increase on a sustainable trend?

Once the Fed clarifies that the tightening cycle is completed, that's going to be a further catalyst that will move from sort of bottoming out to a significant pickup in activity. The market is clearly lots of Boards and C-suites are clearly waiting for that moment because they don't want to be caught out. In fact, I think your CEO said this correctly. You don't want to be caught out between announcement and final financing on a deal between -- on rate changes that might happen in the meanwhile. So once there's clarity, even at a higher rate structure, so even if rates remain higher, but they're stable, and there's no -- the risk of upward pressure on that has been eliminated and there's at least clarity, I think you're going to see a significant deal flow. So in some sense, you tell me when Jay Powell stops tightening, and I'll tell you when you move from bottoming out to pick up in M&A.

If we get that stabilization in rates higher for longer, how do we think through M&A activity in that scenario versus a recessionary scenario with the rate cut?

Oh, I think it's much better to have stability even with higher rates because, again, that does affect the cost of financing, does affect the DCF and the cash flows of the target, et cetera. But if you have enough time for everyone to adjust to that, then you're back to those underlying drivers that I talked about at the beginning. If you're in a scenario where the rates are moving again, there's more uncertainty on that front, and there's a recession, which then brings into question a bunch of other factors, I think that's much worse. In other words, stability and clarity dominates 50 basis points or whatever on the interest rate by a wide margin.

Makes sense. And what's your view on the economic path going forward? As we know in the room, we've had 3 bank failures. We're seeing banks tightening lending standards. On the other hand, equity markets are picking up. What do you think are some of the key drivers and challenges ahead for the economy?

Well, first, just on the regional bank situation, I don't think we're out of the woods yet, and that is causing a form of a credit crunch in certain sectors. And the reason we're not out of the woods is that fundamentally, most of the regional and community banks are still experiencing maybe not a hemorrhaging of deposit flow, but a trickle of deposit flow into money market funds and other alternatives, which will be exacerbated by upward pressure on rates if that were to occur. And then also deposit flow to the G-SIBs to the very large banks. So that's problem 1. And problem 2 is that they -- it's very difficult, I think, to raise equity capital in the current environment because many of these regional and community banks still have a significant asset liability duration mismatch. I mean, if you do the economic value of equity duration for a lot of regional community banks, it is still very high. And that means if you're putting new equity capital in and rates do go up, in other words, if the Fed doesn't provide perfect clarity that, that won't happen, you can have your equity wiped out very, very quickly because of that mismatch. And so you're in the state where it's very hard to raise capital. There's pressure on deposits, maybe not as severe as it was before. And that's causing a lot of caution in terms of new lending, which is what you would do if you were in that situation, you'd also be cautious about new lending. And then that interacts with commercial real estate and so on. So I think this is a -- this will take quarters, if not years, but definitely quarters to play out.

Got it. And then geographically, how do you think about the environment in U.S. versus Europe and some of the other geographies you operate in?

So on the advisory side, to start, we've had -- we've seen a significant amount of strength, both in North America and Europe. And actually, that's worth pausing on. One of the things that we've been doing over the past 2 years is trying to focus our advisory efforts more in the places where there are significant wallets. That is fundamentally North America and Europe. And so for example, the number of MDs that we have on the advisory side outside of North America and Europe, we've reduced in half over the past 4 years because those are where the significant wallets are. And then we've been investing in other high-growth areas like the Middle East as an example. But one of the advantages that Lazard has is that we've got strong footholds and strong positions, both in North America and in Europe. Many of our competitors having -- seeming to saturate one or the other are trying to enter the other continent. And that gives us a fantastic opportunity for growth in the future. I mean, one way of thinking about the white space that Lazard has on the advisory side is we are roughly half of Evercore's footprint in the United States, and we are roughly half of Rothschild's footprint in Europe. And there's no reason that we couldn't be Evercore size here and Rothschild size there as one example. And then in the near term, which is I think what you were asking, we're seeing strength in terms of our backlogs, et cetera, both in North America and Europe. So I don't know that I would call out one or the other in terms of differentiation there. They both seem to be on a similar pattern adjusting to higher rates. The ECB obviously has tightened -- relative to that 500 basis points for the Fed over 14 months, the ECB has been 375 basis points in a little under a year. But it's still a similar phenomenon in terms of that pricing disconnect. The regulatory environment is similar. So a lot of the things are parallel in North America and Europe.

And then on the restructuring business, can you give us some color on what you're seeing on that side? And how do you think about leaning into restructuring as the business picks up?

Well, one of the things that's been interesting is normally when M&A volumes are down by 60% as they are for the market over the past 2 years, you'd see a boom in restructuring. And that has been a bit delayed relative to historical patterns for the market, not -- again, I'm not talking about Lazard's business specifically, although I'll get to that in a second. And I think there are 2 reasons for that. One is normally when M&A falls by 60%, we're in the midst of a recession. That's not currently the case. And the second is the explosion in [ cov-lite ] lending and borrowing over the past 4 or 5 years. Something like 80% or more of the lending that's occurred over the past 4 or 5 years has been [ cov-lite ], which means that as you move into a period of distress, you're not tripping the covenants as quickly, which then delays the process. But we are definitely seeing that inflection point occurring. And our restructuring team is flat out on new discussions and new mandates.

And the follow-up is how soon should we start to expect restructuring revenue pick up to hit your P&L?

Well, the good news on that is restructuring processes tend to not have as long of a lag associated with them between the initial discussion and then the announcement and then the completion. So that lag time is shorter. But this also depends a little bit. I mean, we're seeing a rise in defaults in the market. We're seeing a rise in stress. It depends a little bit on market conditions. I can't give you an exact answer. One thing I would say is we've added 2 MDs in our restructuring practice. And one of the reasons we did that is historically, Lazard was very strong on the debtor side of the restructuring process. We wanted to open the aperture and also invest in the creditor side. And we now have significantly expanded capabilities on the creditor side, too, and are making a lot of progress in the market on winning those mandates also.

Great. Let's shift to Asset Management. How do you view the longer-term trajectory of this business? And where is the biggest opportunity to shift the Asset Management business into more sustainable inflows? Is it net -- new distribution channels, growing in wealth, institutional, more M&A, similar to Truvvo? How do we think through that outlook?

So I think there are a bunch of opportunities for us, and I think of this in sort of 2 categories. There's tuning up what we have, and then there's skating to places that have stronger tailwinds than the places that we've historically been. So on the -- in the first category, and Evan Russo, who runs our Asset Management business is all over this, I think there are 2 key imperatives. The first is improved investment performance, which has been improving with a lag that then affects inflows because, as you know, it takes time for people to appreciate the change in investment performance. But the good news is that investment performance has improved significantly, and we can talk about some of the ways that, that's happened in terms of our internal research and the management processes and what have you. But that's one thing. And the second thing is stronger distribution. So we've made Jen Ryan a key hire in U.S. distribution as an example, very excited about the sales force that we have now. And I view those 2 things as being the kind of keys to the existing structure. And then there's no question that we're exploring adjacencies. So when I talked about leveraging the brand more aggressively, this is a great example. There are lots of adjacencies to our traditional Asset Management business, where the Lazard brand has a lot of power, and we need to explore those areas that have a lot more tailwind associated with them. I'm not going to go into full detail here, but you mentioned some of them. They would clearly involve a whole bunch of the different private markets, the alternatives that are -- where a lot of asset allocation is directed and where we have a lot of white space. So beyond that, as you noted, there are possibilities in wealth management and so on. I would just say this is kind of fixing the core or improving the core, and then building out into adjacencies is a pretty exciting opportunity for us over the coming years.

How should investors think about how the advisory business aligns with the Asset Management business? And do you think that the business mix there is the right mix? You want to lean in on one or the other?

Sure. And again, more to come post October. I'm still in input mode a bit. But a couple of things. I mean, there are clearly benefits to having these 2 businesses together. The first is scale. There's certain fixed costs associated with being a public company. With the larger scale that comes from having 2 businesses rather than one, you're able to spread those costs over a wider base. The second is the brand. I think there is significant benefit to both businesses from the strength of our brand. And the third is culture and the content that we generate that creates benefits on both sides of the business. So there are a lot of benefits associated with having these 2 businesses connected. And I see, as I mentioned before, a lot of upside, well, on the advisory business, but a lot of upside on the Asset Management business. So we are focused on how we can create more value for shareholders by improving and proving both sides of the business.

Great. Let's shift to expenses. We got the 10% reduction force announcement, which should be caveat that there were no other layoffs since COVID. Attrition has been low. Can you give us an update on the cost-cutting initiatives, both on headcount and other puts and takes within the comp line?

Yes. First, just to back up to make sure everyone understands the context. We saw what I think now the market also agrees with a weaker M&A environment for 2023 for the market as a whole. Our share of that market has remained roughly stable. So it's not a Lazard-specific thing. It's a market view that we -- we're concerned that exactly where we started with revenue lagging given the headwinds that we talked about on the advisory side, in particular, that, that would affect 2023. And so we wanted to get ahead of that, which is what we did. So we are -- and then as you noted, we also had, I think for understandable reasons, not acted as aggressively during COVID to call out the lower performers. So we really focused this effort on low productivity geographies, closed several countries and contributed to -- on the advisory side, not on the asset management side, contributed to that reducing half the number of MDs outside of North America and Europe, which is where, again, the bigger wallets are. So really focus the headcount adjustments on low productivity areas and people. And we are on track to hitting that target. The one thing I would note is the cost savings associated with that lags a bit because of the process of separating from people and also what we're trying to do on the noncomp side, too. So this will show up in our cost base as we enter 2024 more so than immediately today.

And we [ here thinks ], recruiting environment is strong. How do you balance leaning in on recruiting with managing expenses?

I agree that there's a lot of attractive talent out there to supplement the talent, the fantastic talent we have. One of the reasons why we wanted to get ahead of the headcount adjustments that I just mentioned was to make sure that we had -- we freed up resources to go hire top talent as appropriate. And that's what we have been doing, and we will continue to do. So we've -- I think I mentioned we just brought on a top team in the Middle East located in Saudi. We upgraded dramatically our team in Germany with 2 top hires. We brought on Ray McGuire as President. We hired a -- 2 bankers to do what we think is a really exciting opportunity for an independent advisory firm, which is help strategics find the sources of private credit that the big private capital providers are really eager to be matched with. And so we have a top-notch team doing that. I already mentioned expanding our restructuring team. So we are in the market actively hiring for top talent in part because we did the culling that we thought we needed to do.

So how soon can the Lazard get back in the mid-50s comp ratio given the current environment and some of the actions that you just outlined?

So the cost savings that we've -- that we're doing will set us up for returning to our normalized margin targets as the revenue environment normalizes. So partly to answer to your question is, you tell me, again, when Jay Powell stops tightening, and the M&A market comes back, and I'll tell you when the revenue environment normalizes and therefore, when we hit the margin targets. But if we were back in a normal revenue environment by early next year, the cost savings will be sufficient to put us in line with our historical target.

Great. And on the noncomp side, how should investors think through the puts and takes there?

Well, there's a bunch of pressure on noncomp that involves ongoing inflationary pressure in a variety of different categories and especially travel and entertainment, but travel increasing as COVID eases. So I don't know that I would go -- the cost savings that we're going to do are going to tilt disproportionately to the compensation side because that is where most of our cost is, and that's where we saw the biggest opportunity for efficiency improvements. And we're on target again to hit the overall margin without breaking down comp, noncomp.

On the capital side, how does the Board think through capital return strategy and the dividend level?

Sure. So just to remind people, I mean, we've got -- we have a very strong dividend. And in fact, the dividend yield now is quite high, mostly because I think our price is too low. So -- but we've got the dividend. We then use -- we do buybacks to offset the dilution from our compensation practices. And then beyond that, it really depends on what is the best and highest use for shareholders? what will create the most value? So going forward, that may be inorganic, it may be buybacks, we'll see. That is the -- those are the questions that once you get through the dividend and the kind of base level of buybacks, it all comes down to what makes most sense from a shareholder return perspective.

On the inorganic side, how does the Board -- what's the Board's approach to evaluating the opportunities there?

Well, one way of thinking about it is if you do the classic analysis of return on invested capital and growth. Lazard is actually a pretty high return on invested capital firm with ROIC in the mid-20s or so. So traditionally, that would suggest that more shareholder value would be created by creating some top line growth, not buying the growth, high-margin top line growth, which is one perspective on the opportunities for us to both organically and inorganically grow. But that's very high level. It has to come down to the granular specifics of is there a match? Is there -- does the value make sense? Does the cultural fit make sense? And so again, there's no one-size-fits-all here, but obviously, inorganic options have to be weighed against the opportunity cost of not doing additional buybacks instead.

Let's pause for a second. Are there any questions from the audience for Peter? The mic is coming up in a second.

There's been a lot of talk of maybe an Asset Management spin-off. Would you say this is likely or not because of interest rates swing on valuation and also net outflows and a switch from active to more passive investing?

So what I would say is we think Asset Management is a very good business. We can make it an even greater business, and we're excited about the opportunities that I talked about before to do that. So we think there's a lot of value creation that can come as part of Lazard from building out our Asset Management business. We're also a public company, so I never want to say never to any creative ideas. But I want to go back again and say, we're pretty excited about the opportunities that we have to buildout the Asset Management business, and that's where we're focused.

Any other questions from the audience? So this year, Lazard is celebrating its 175th year in operation. What are some of the most important elements in Lazard's culture that you really want to maintain as CEO?

So I talk about 4. The first is clients first. That's been part of Lazard's DNA for, well, over 100 years. When you go back to the dry goods store days, the clients were a little different. But that's clearly part of our DNA. The second is collaboration. So I speak about being commercial and collegial. That's what we're looking for. And I'd say, historically, Lazard may have had a reputation of not being as collaborative as other institutions. I will tell you, having seen lots of different institutions that today, Lazard is a remarkably collegial and collaborative place. So to the extent that the reputation is lagging a bit, we need to maintain that very high degree of collegiality, not only because it serves our clients best and because it improves our -- the daily work that we do, but also to help make that reputation fade because it's no longer accurate. The third is a sense of ownership. Lazard and entrepreneurship, Lazard historically invented new businesses and had a sense of initiative, and that's a core part of our DNA and our culture. And then the final part is embracing innovation. And you can't look at what's happening today, whether it's generative AI -- or I mean, there's a whole array of things that are likely to be affecting both sides of our business over the next few years, and we need to be embracing that and trying it out rather than shying away from it.

And one more question just to wrap up. So we just touched on Lazard has had a very long history. As you look forward really long term, what are some of the biggest opportunities that you're most looking forward to? And what are some of the key risks that maybe keep you up at night?

Well, I go back to we have this remarkable opportunity to empower the future while respecting our history. So it's that duality. And the history is what has created this remarkable brand that we are going to be more aggressive about leveraging. So I see a lot of upside opportunity for us as the future unveils to become and reinforce our position as the world's leading independent global source of investment services and advisory to companies, to large investors, to governments across the world. We are the only place where if you want independent advice and deep content that are in all of the major markets, that is Lazard. And we have a reputation for helping clients think around corners and bring [indiscernible] point of view to bear on complicated problems. That's where we're going to continue to excel at.

Great. Peter, thank you so much for...

Thanks for having me.