DLJ Fights Its Way Forward

Its public rooms furnished with handsome antiques and 19th century portraits, Donaldson, Lufkin & Jenrette Inc.'s headquarters on New York's Park Avenue proclaims itself a bastion of the old-guard investment banking establishment.In reality, DLJ is anything but. A scrappy upstart founded 40 years ago, it's not yet big enough to command a position in the top tier, but it's closing in. It boasts an entrepreneurial culture and flat management structure that distinguish it from most of its Wall Street rivals. Of course, every investment bank sees itself that way, but outside observers note its willingness to let bankers build new businesses from scratch and run them with little interference from the corner office. It also was the first bank to have employees participate directly in its venture capital and merchant banking funds, giving them a personal stake in the firm's investing prowess.In some ways, DLJ seems riddled with contradictions. Its bankers are aggressive competitors-"This is a hunter culture," says one-and, at the same time, committed team players with financial incentives to work together. Prima donnas and corporate politicos and need not apply."The people here take pride in applauding each other's successes. Even though we now have 11,000 people worldwide, we've managed to retain our smaller-firm attitude," says Joe L. Roby, president and chief executive officer. A minute later, he adds, "The people here have always taken major pride in smashing other firms in the teeth."The combination seems to be working. In the past few years, DLJ has leapt out of the ranks of the investment business's also-rans to nip at the heels of the top tier. Last year, DLJ ranked fifth in investment banking revenue, with $2.5 billion, close behind Citigroup's Salomon Smith Barney unit. But it's still far smaller than the industry's leaders, such as Morgan Stanley Dean Witter & Co., which reported $4.5 billion in banking revenue last year. In the past three years, the firm's total revenues have doubled to $5.6 billion, and its profits have grown accordingly. Within the next four or five years, it expects to double in size again and is increasingly looking overseas to do so.In many ways, DLJ is the kind of investment banking operation many commercial banks want to build or buy. Some of its practices, such as letting bankers invest personally in ventures along with the firm, have already provided a model for its industry. But whether anyone else-particularly coming from the hierarchical and control-focused world of commercial banking-could replicate its formula is open to debate.Could DLJ be bought? More than 70% of its outstanding common stock is owned by AXA Financial Inc. (formerly The Equitable Companies)-itself majority owned by the French insurance holding company AXA S.A.-and it has been a significant and growing contributor to AXA's earnings. So a sale at this point doesn't look likely.If Roby and his colleagues have one frustration right now, it's DLJ's stock price, whose performance substantially lags its rivals. Based on its closing price of $41.13 on May 12th, the stock is trading at eight times its trailing 12-month earnings. That compares with 14-times earnings for Merrill Lynch & Co. and a p/e of 15 for Morgan Stanley. Since employees own about 20% of the company (counting both issued stock and options), they have a concrete reason for concern. And because such a small proportion of DLJ's stock actually trades, it tends to be volatile, too.Asked why the stock isn't catching on among investors, Roby replies, "It's difficult to put a finger on it, especially after we reported such great earnings in the first quarter." In the first three months of this year, the company returned 26.4% on equity, and its record $1.72 earnings per diluted share handily beat analysts' expectations of $1.29. "We've traditionally outperformed analysts' estimates by a wide margin," the CEO says.To be sure, one reason DLJ's stock trades at a discount to its rivals is the meagerness of its public ownership. But there are other reasons, too. Some analysts, such as Morgan Stanley's Henry McVey, caution that the cost of DLJ's ambitious international expansion-particularly its heavy investment in Europe, where it has 200 investment bankers, up from just 20 three years ago-may drag down future earnings. That business isn't profitable yet, although "it's moving quickly toward break-even," Roby says. This year's slowdown in such fields as stock and high-yield bond issuance-both crucial businesses for DLJ-may also be scaring investors.The firm's top brass feel that the market doesn't understand the full breadth of DLJ's business, and they may be right. After all, as their own office décor demonstrates, perceptions often fail to keep pace with a changing reality. Having built its reputation as a middle-market corporate investment bank and specialist in high-yield, DLJ has made strong inroads into the Fortune 100, and its business is increasingly diverse. It encompasses not just traditional investment banking functions such as mergers and acquisitions advisory, securities underwriting and brokerage, but merchant banking, private asset management and a highly regarded and Internet brokerage, DLJdirect. The firm has 50 profit centers, Roby says. What unifies them is a common culture and management style. "DLJ has always been a very entrepreneurial place," says Raphael Soifer, the former financial institutions analyst at Brown Brothers Harriman & Co. and now an independent consultant in Ridgewood, NJ. "People grow their own businesses, they're given the latitude to do that, and they're given strong incentives to succeed." Says Hamilton (Tony) James, chairman of the firm's banking group, "There's a natural tension between having aggressive, talented people, who want to achieve things individually, and our desire to provide seamless teamwork for our clients. Managing that is one of the hardest tricks in our businesses." He says that balancing those opposing forces is the biggest worry for him and his partner in the banking business, Garrett M. Moran. DLJ doesn't just pay lip service to teamwork; it bases its compensation scheme on encouraging it, through bonuses, investment opportunities and surveys in which team members evaluate each other's team performance. (Those surveys, based on objective measures, lead to bonuses like extra vacations for the best performers and punishments like deductions from pay for the worst.) The firm also does a lot of socializing-everything from taking 125 people on an Outward Bound wilderness trip to sending employees and their families to resorts.More important, DLJ tends to build its business from the inside out, capitalizing on its strengths. According to James, the firm looks for opportunities where it can reap high margins and create barriers to entry for others. It tends to build its businesses step-by-step, adding resources after it's scored some initial success, rather than swooping in with a lot of firepower all at once.But there are some exceptions to the firm's build-it-internally rule. About two years ago, DLJ hired a team of 25 investment bankers, led by managing director Richard J. Barrett, from UBS Securities, reconfiguring DLJ's financial institutions practice. Until then, the firm had been mainly focused on insurance-not surprising, given its AXA connection. As a result, DLJ topped U.S. Banker's list of the top M&A advisors on bank and thrift deals in 1999 and performed similarly in advising other financial institutions. It worked on four of last year's five biggest financial industry deals, including advising Fleet Financial Group in its $16.2 billion merger with BankBoston Corp., and Aegon N.V. on its $10.8 billion purchase of Transmerica Corp. According to Roby, the financial institutions group took in about $300 million last year.Barrett credits not just his original team but the way DLJ integrated it into its existing business. "You've seen the power of that combination," he says. "There's a synergistic effect-our approach is broader than simply putting the two together would have been." At the same time, Barrett has a fair amount of autonomy in running his business. Technically he answers to Joel J. Cohen and Herald (Hal) L. Ritch, co-heads of M&A. But they let the group do its own thing, stepping in to help when needed, mainly on complex or hostile deals. In all, the firm raked in $880 million in M&A revenues last year, up from $50 million in 1993.To meet Cohen and Ritch simultaneously is to see DLJ's paradoxical culture, with its mixture of aggression and team spirit, personified. They complete each other's sentences, although not necessarily in the same words the other might use.The league tables-the investment industry's term for the standard rankings of different businesses, such as M&A advisory and equity underwriting-doesn't mean much to them. "Hal and I try to run this business for the revenues," Cohen says. "The league table is a reference point, that's all."Says Ritch, "It's a funny thing-we can gun those rankings at any time. All we'd have to do is cut prices.""And we'd make less money," Cohen adds. "The hell with-"Ritch interrupts: "Why would we do that? The answer is we wouldn't."Once primarily an advisor to middle-market companies, among which it still has the dominant market share, DLJ has been moving steadily into big corporate deals. According to Cohen, five years ago the firm didn't work on any mergers or acquisitions worth more than $1 billion; in 1999, it did about 50 of them. For instance, it advised Quest Communications International Inc. on its $48 billion merger with US WEST Inc. Internationally, nearly all of its work is with huge companies, such as helping Italy's Olivetti S.p.A. acquire 52% of Telecom Italia for $34.8 billion. Indeed, pushing up-market into the Fortune 500 and overseas into Europe and Asia are two of what Tony James calls DLJ's three big themes in banking. The third: participating in the so-called New Economy, including Internet, broadband and wireless telecommunications, genomics, biotechnology and the like. "We started chasing it before it was hot," James says. Interviewed before April's steep slide in the stocks of such companies, he sounded chagrined that their popularity had enticed so many other investment banks into the field. "We like to enter businesses when they're out of favor or overlooked."James' 25-year career with DLJ illustrates how one business begets another. In the early 1980s, he ran M&A. Merchant banking grew out of that as the firm leveraged its balance sheet to help clients by taking stakes or buying them out altogether, acting as a principal in acquisitions rather than simply an advisor. Its high-yield debt finance business, in turn, grew out of that. "We use our balance sheet fairly aggressively," James says. "And we willingly take on a lot of credit risk on behalf of our clients."That experience also aided his professional development, he says. "You make an investment in a company and work with it to grow its franchise value-that's helped me as a manager. You're with a company for years, through the highs and lows."In merchant banking, DLJ is second only to Kohlberg Kravis Roberts & Co. in direct investments, with 39 portfolios and $12.2 billion in assets at the end of 1999, including both merchant banking and its Sprout venture capital funds. According to a recent presentation to investors and securities analysts, DLJ expects those funds to reach $18.2 billion by the end of this year, growing at a compound annual rate of 38% since 1995. Better yet are the fees they produce. The firm projects recurring fees to hit $127 million this year, a compound annual growth rate of 43% in the past five years. DLJ created funds for employees that mirror those investments, giving its bankers a chance to "participate in a lot of the wealth created for shareholders," CEO Roby says. The firm both encourages employees to invest and invests on their behalf as a form of incentive pay. Allowing investment bankers to share the rewards of the firm's investing both gives them a stake in the investments they recommend-presumably leading them to choose carefully-and ties them to DLJ, since they have to drop out of the funds if they leave. That kind of financial incentive used to be unique to DLJ, but more and more Wall Street firms have begun to imitate it.With all that going on, it's easy to overlook the firm's biggest fee-generating machine, what it refers to generically as its financial services group. That includes its Pershing division, which provides correspondent brokerage and related services to 600 institutional customers with 3.2 million active client accounts holding nearly $400 billion in assets. That business is driven more by technology and size, getting proportionately more profitable as it grows.DLJ offers investment and portfolio services to high-net-worth individuals, using a staff of 450 brokers, and its asset management group manages $28 billion (about $16 billion for institutions and $12 billion for individuals).Its online discount brokerage, DLJdirect, makes a profit. But the 11-year-old online brokerage hasn't had the stunning growth in the number of customers or average daily trading volume that Web rivals such as E*Trade and Charles Schwab & Co. have. It reports just 389,000 active accounts, about one-tenth of Schwab's base.Analyst Alan Weichselbaum of Gerard Klauer Mattison & Co. thinks such comparisons are unfair. That's because DLJdirect follows a different strategy from the mass-market approach of its competitors. Instead, it focuses on affluent investors with at least $100,000 in liquid assets. They carry higher balances, so the firm earns more interest on the cash. And, the analyst says, although the number of accounts hasn't grown as fast as E*Trade's, growth in customer assets far outpaces it. "The gross profit from a DLJdirect customer is higher."Observers say that DLJ's relationship with its majority owner, AXA Financial, provides a model for how banks ought to manage the investment banks they buy. That is: helpful and supportive, but largely hands-off. "AXA has left them alone," consultant Ray Soifer says. He thinks that's because AXA sees it as an investment, not an operating unit, the way a bank probably would. "A strategic partner would be less likely to leave it alone." DLJ's Joe Roby meets with AXA CEO Edward D. Miller and chief operating officer Michael Hegarty (both former commercial bankers) about once a month-more often if something big is going on. "We have an increasing amount of interaction, especially in technology, where we can aggregate our purchasing," Roby says. "The tone is one of collaboration where it makes sense to collaborate, and our personal relationship is quite good."That's not surprising, since DLJ has been such a big contributor to AXA's bottom line lately. But if the capital markets continue their tumult, stifling investment banking, will DLJ's owners be able to stomach Wall Street's cycle? Roby thinks so, and so do many others.DLJ has lived through plenty of market swings before, including 1998's collapse in the fixed-income market. Whatever the short-term conditions, the firm itself is in the game for the long run and aiming for the big score."DLJ has been a success story for 40 years," Soifer says, "and some of these guys have been there nearly that long."