Lazard Ltd (NYSE:LAZ) Q3 2023 Earnings Call Transcript

Lazard Ltd (NYSE:LAZ) Q3 2023 Earnings Call Transcript October 26, 2023

Lazard Ltd misses on earnings expectations. Reported EPS is $0.1 EPS, expectations were $0.16.

Operator: Good morning, and welcome to Lazard’s Third Quarter and First 9 Months of 2023 Earnings Conference Call. This call is being recorded. Currently all participants are in a listen-only mode. Following their remarks we will conduct the question and answer session, instruction will be provided at that time. [Operator Instructions] At this time, I’ll turn the call over to Alexandra Deignan, Lazard’s Head of Investor Relations, Treasury and Corporate Sustainability. Please go ahead.

Alexandra Deignan: Thank you, David. Good morning, and welcome to Lazard’s earnings call for the third quarter and first 9 months of 2023. I’m Alexandra Deignan, Head of Investor Relations, Treasury and Corporate Sustainability. In addition to today’s audio comments, we have posted our earnings release on our website. A replay of this call will also be available on our website later today. Before we begin, let me remind you that we may make forward-looking statements about our business and performance. There are important factors that could cause our actual results, level of activity, performance, achievements or other events to differ materially from those expressed or implied by the forward-looking statements, including, but not limited to, those factors discussed in the company’s SEC filings, which you can access on our website.

Lazard assumes no responsibility for the accuracy or completeness of these forward-looking statements and assumes no duty to update these forward-looking statements. Today’s discussion also includes certain non-GAAP financial measures that we believe are meaningful when evaluating the company’s performance. A reconciliation of these non-GAAP financial measures to the comparable GAAP measures is provided in our earnings release and investor presentation. Hosting our call today are Peter Orszag, Lazard’s Chief Executive Officer; and Mary Ann Betsch, Lazard’s Chief Financial Officer. Peter will begin with some brief remarks before turning the call over to Mary Ann, who will provide an overview of our financial results. Peter will then provide his perspective on current market conditions and the outlook for our business.

After our prepared remarks, Peter and Mary Ann will be joined by Evan Russo, Chief Executive Officer of Asset Management, as they open the call for questions. I’ll now turn the call over to Peter.

Peter Orszag: Thanks, Ale, and good morning, everyone. I’d like to begin my first earnings call as CEO of Lazard by expressing my thanks to my predecessor, Ken Jacobs. We are thrilled that Ken, 1 of the world’s premier bankers is now our Executive Chairman and has shifted his focus to advising clients. I also want to thank our Board of Directors for entrusting me with this role. It is a privilege to work with such exceptionally talented colleagues across the firm, and I look forward to serving and supporting them, our clients and our shareholders. Lazard is one of the world’s preeminent financial advisory and asset management firms with one of the most powerful brands in the financial services industry, and I am excited about our prospects to further elevate our relevance, revenue and returns. I’ll provide more on our outlook and plans for Lazard later, but now let’s turn the call over to Mary Ann to discuss our third quarter and 9-month results.

Mary Ann: Thanks, Peter, and good morning, everyone. Today, we reported operating revenue of $532 million for the third quarter of 2023, a 27% decrease from the third quarter of 2022. Operating revenue for the first 9 months was $1.7 billion compared to $2.1 billion in the first 9 months of the prior year. In Financial Advisory, we reported third quarter revenue of $261 million and $879 million for the first 9 months of the year. Advisory operating revenue continues to be impacted by the ongoing slowdown in M&A and this quarter’s results reflect the lagged state of M&A announcements from several quarters ago. Looking ahead, we believe the M&A cycle is turning, and we are well positioned as the market recovers to advise on a variety of transactions, including those associated with private capital as well as large cross-border and complex transactions.

Outside of M&A, we see continued momentum in several areas of the advisory business. Private Capital Advisory, our primary and secondary capital raising group, continues to see significant demand for its services, especially in the secondaries business, building on its strong second quarter and year-to-date results. Lazard’s Global Restructuring and Liability Management Group also had a strong quarter, with operating revenue increasing both sequentially and year-over-year. The pickup in restructuring activity is accelerating, and the team is currently advising on a number of significant transactions for a wide range of debtor and creditor clients. Our Software and Advisory business also continues to perform well and advised a number of governments during the quarter, including prominent assignments for Srilanka and Greece.

Lastly, 1 year after its launch, client demand continues to increase for our geopolitical advisory services amid the growing demand from corporate leaders for advice concerning global risks. In Asset Management, third quarter operating revenue was $262 million, flat compared to the third quarter last year, and down 2% sequentially. The management fees and other revenue for the third quarter were up 8% compared to the third quarter of 2022 and flat compared to the second quarter of 2023. For the first 9 months of the year, management fees and other revenue declined 1% compared to the same period in 2022. Asset Management revenue was $794 million in the first 9 months of 2023, 5% lower than the prior year period, reflecting lower incentive fees.

As of September 30, we reported AUM of $228 billion, 5% lower than June 30, 2023, and 15% higher than September 30, 2022. The sequential decrease was driven by market depreciation of $5.8 billion, foreign exchange depreciation of $3.3 billion and net outflows of $2 billion. Average AUM for the third quarter was $236 billion, increasing 11% from a year earlier, and flat on a sequential basis. Average AUM for the first 9 months of 2023 was $233 billion, level with the first 9 months of the prior year. Now turning to expenses. For the third quarter, adjusted compensation expense was $364 million. This equates to a 68.4% adjusted ratio during the third quarter, which reflects our current best estimate for the remainder of the year. Our non-compensation expense was $137 million in the third quarter, 7% higher than the third quarter last year related to increased occupancy costs as well as higher technology and professional services expenses.

We are progressing on our cost saving initiatives announced in April to reduce our count rate by 10% by the first quarter of 2024. Our goal to reduce overall costs includes a reduction in reprioritization of long-term projects. These changes reflect our commitment to return to our target expense ratios as revenues normalize. Our effective tax rate for the third quarter as adjusted was 8.4%, which compares to 25.1% in the prior year quarter. Our current estimate for the full year tax rate is projected to be in the low to mid-teens. Our estimate, as always, is dependent on the level and location of earnings as well as the impact of discrete items in the fourth quarter. Turning to capital allocation. In the third quarter of 2023, we returned $52 million to shareholders, primarily reflecting our quarterly dividend.

During the first 9 months of the year, we returned $285 million to shareholders, including $129 million in dividends, $102 million in share repurchases and $54 million in satisfaction of employee tax obligations. Additionally, yesterday, we declared a quarterly dividend of $0.50 per share. I will now turn it back over to Peter for comments on the outlook.

Peter Orszag: Thank you, Mary Ann. Today’s results underscore the lagged effect of the slowdown in M&A announcements from several quarters ago. However, our Asset Management business and part of our Advisory business, including restructuring and private capital secondaries fundraising, are offsetting some of the overall market weakness in M&A. Looking forward, and as we have previously stated, we believe that the worst of the M&A slowdown is behind us. We continue to see signs that the market is bottoming out and stabilizing with the quarters ahead poised for a rebound in deal activity. We are already seeing significant M&A activity in financial institutions, health care and energy transition among other sectors. We are also seeing early signs of an increase in cross-border M&A activity, which, with our global presence and expertise, we are well positioned to capture.

This bottoming out reflects the interplay between the catalyst of activity, including ongoing technological innovation, shifts in global supply chains, the life sciences revolution and the energy transition and the headwinds, which include a divergence in expectations between buyers and sellers because of the impact on valuations from the sharp increase in interest rates, the uncertainty in financing markets and regulatory concerns. As higher interest rates remain in place for a longer period, as monetary policy tightening likely nears its end, and as some companies have won court victories on regulatory matters, the headwinds have generally been easing in recent months. One of the strong indications of this changing balance between catalyst and headwinds comes from the tenor of our client discussions, which are growing more constructive.

There are 2 important lags between such a constructive shift in client discussions and revenue though. First, there is a lag between active discussions and an increase in announcements, which, for the market as a whole, have now stabilized, but are not yet increasing meaningfully. After a pickup in announcements, another lag then occurs to completions, at which time the revenue impact of the rebound in activity begins to be felt. In addition, as the M&A market begins to rebound, we are also seeing non-M&A revenue opportunities within our capital solutions and restructuring businesses both of which are seeing client activity accelerate. In Asset Management, despite volatility in the market, the challenging interest rate environment and another surge in growth, mainly attributable to a select group of technology companies, we saw strong performance across many of our investment strategies and groups, including emerging markets, thematic and local strategies.

While new money is being put to work, the appeal of short-term investments, T-bills and money market funds remain significant. As such, investor appetite to allocate cash to equities and risk assets remain subdued. Nonetheless, institutional investors are showing interest in our global quant and thematic strategies. Let’s now turn to our future outlook for Lazard. In addition to our world-class brand, Lazard today has the potential to combine high-return future growth with a significant underlying degree of stability. Our growth will be built on a foundation of a resilient model that spans across businesses, products and regions and a structure that is more secure than one focused solely on M&A in a specific geography. Last month, I outlined our objectives between now and 2030.

Our growth will come from proactively leveraging our brand into new and expanded areas through talent development, lateral hires and inorganic additions, while concurrently managing our existing business even more efficiently. One important step on this path involves elevating our relevance through more involvement in top deals in Advisory, winning important mandates in Asset Management and leveraging our global insights with increased thought leadership and content-rich convening. Our Lazard 2030 vision also includes 2 specific and concrete goals for the firm to accomplish by the end of this decade. The first is to double revenue firm-wide by 2030, with the increases split roughly evenly between Asset Management and Financial Advisory, implying double-digit revenue growth annually on average.

The second goal is for Lazard’s total shareholder return to average 10% to 15% per year through 2030. Let me share a few more details on some of the specific actions we will take to reach these goals. Looking first at the Asset Management business, we have opportunities in both the core business and in adjacencies, and we intend to pursue these opportunities aggressively through both organic and targeted inorganic growth. Private asset managers with some degree of established track record, but that are still relatively early in their AUM progression are of particular interest in any programmatic M&A for us over the coming years. We believe opportunities of this kind will combine the strength of our brand and distribution with the benefits from a fund manager’s established investment performance, while optimizing shareholder value relative to the acquisition costs.

We also see potential for Asset Management growth by investing in and expanding our distribution capabilities. Evan has been implementing a strategic plan to maximize the value of our global distribution platform, which includes increasing our client reach worldwide with a particular focus on financial intermediaries in the U.S. and Europe and regional expansion in Asia as well as engaging more effectively with our clients. Additionally, we have continued to develop a group of recently launched strategies with strong investment track records that are poised for growth, and we will continue to launch new ancillary products and vehicles to build upon our current investment capabilities and offerings. Turning to Financial Advisory. Multiple pathways will contribute to doubling our revenue over the next 7 years, including an expanded private capital efforts spanning our capital raising business, our new Lazard Capital Solutions practice, and more expensive M&A fees from private equity.

Among our M&A clients, we see potential for growth in both the United States and Europe. One key differentiator is that Lazard has long been known for its exceptional insight into geopolitical events, and our ability to combine our business advice with an awareness of the geopolitical forces that could affect outcomes. That’s all the more valuable to clients today, and our capabilities in this area have been reinforced by our outstanding geopolitical advisory team. Turning to specific sectors. Opportunities for us exist across many areas in North America, with particular growth potential in technology, industrials, power and energy and health care, while we continue to build on our historically strong positions in sectors such as financial institutions and real estate.

We also see significant additional revenue opportunities in Europe, which would be accentuated by an expansion of U.S., Europe M&A trade given our uniquely strong position in both continents. We are seeing increased interest among European companies seeking to acquire U.S. assets, and Lazard is well positioned to advise these clients. All of this will require Lazard to expand its ranks of managing directors. Some will come from internal promotions. We are unique among the independent advisory firms in having an established track record of being able to develop our own productive bankers. Part of the expansion will also come from more aggressive lateral hiring than Lazard has historically done in the past. One question may naturally be whether we can maintain our historical margin target as the market normalizes, which we expect to do, if we are also going to undertake a significant increase in our number of managing directors?

The answer lies partially in our potential to raise productivity per MD. More specifically, if each of our Advisory MDs generates an additional $1 million in revenue, the effect is to free up more than $50 million in total each year to invest in new lateral hires without any adverse impact on our compensation margin. We are confident that with increased intensity, targeting of market opportunities, being paid appropriately for the exceptional work we do, expanded use of cutting-edge technology and more significant annual trimming of less productive MDs, we can substantially raise productivity over time. We also expect to benefit from the embedded growth in the disproportionately high share of our current MDs who are newly hired or newly promoted.

Such a high productivity growth path is the best way to combine our traditional emphasis on excellence with our expanded revenue opportunities and ambitions. None of this will occur overnight, but with consistent effort, we are confident that we can achieve our 2030 goals. As we expand our business across asset management and financial advisory in the years ahead, I look forward to updating you on our progress over time. We will also find the right moment to provide you with more detailed plans and targets for between now and 2030 to help you measure how we are doing along the way. Over recent months, I’ve been traveling extensively to meet with Lazard investors and hear their thoughts about the firm. One of the clearest messages that has come through during this listening exercise is a widespread desire to see our corporate structure simplify.

For that reason, we are announcing today that Lazard intends to convert its current structure to a new status as a U.S. corporation or C-Corp. We believe conversion to a C-Corp will simplify tax reporting, may act as a catalyst for enhanced shareholder ownership, and therefore, provide liquidity benefits for our stock. One significant change relative to our previous evaluations of such a conversion is that the tax benefit of our current structure is declining materially due to changes in global tax laws. Given the smaller tax impact than in the past, we believe that the benefits of conversion now outweigh those costs. We expect the conversion to take place on January 1, 2024, subject to compliance with global regulatory requirements. Lastly, as our 175th anniversary enters its final months, we are proud of our history and confident in our future.

For the better part of 2 centuries, we have served as trusted advisers for our clients, providing an unparalleled level of expertise, insight and global reach. We have attracted and developed extraordinary talent, and we have evolved and adapted into a stronger and more resilient institution. It is our heritage, resilience and commitment to excellence that make the Lazard brand so extraordinary, and we now have an opportunity to combine that resilience in excellence with significant growth going forward. In the years ahead, we will leverage our brand, our global business model, the investments we are making and expect to make and the extraordinary calibre and commitment of our people to expand our business and take Lazard to new heights. Now let’s open the call to questions.

Operator: [Operator Instructions] We’ll take our first question from Brennan Hawken with UBS. Please go ahead. Your line is open.

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Q&A Session

Brennan Hawken: I’d like to — Peter, you laid out a lot there, and I’d love to drill down on some of it. I’d say since you’ve sort of announced your ambition to double revenue by 2030, which is roughly 7 years, I’d say the part where there’s the most pushback is on the Asset Management side. In covering the industry, there’s a lot of pressure, right? And the big example that people point to when thinking about your plans, which seem to combine both organic and inorganic opportunities as you referenced in your comments, would be Invesco. Over the past 7 years, Invesco has nearly doubled AUM. AUM is up 90%. So just about in line with your doubling ambition. But the problem is, is the revenue translation hasn’t been there. Revenue is only up 30% over that time frame. So how are you thinking about the ways in which you can double the revenue over that timeframe despite the persistent fee rate pressure on this business?

Peter Orszag: Sure. Well, the way I would put it is we’re not interested in growth for growth’s sake, and we’re not interested in AUM accumulation for the sake of accumulating AUM. Our goals here are to grow in a high-return way and in a way that enhances shareholder value. So the objectives are exactly the ones that you put forward. That having been said, we see significant opportunity within the existing business to continue to upgrade our performance in distribution, which will be helpful in maintaining our revenue and earnings streams. A good example is we’re doing this call from the U.K., where we just held our Board meeting, both on the investment teams located here and on the distribution within the U.K., we’ve seen changes that have been occurring under Evan’s leadership that’s going to improve performance in both distribution and performance.

So there’s a lot that can be done there. And then on the inorganic side, we are interested in adjacencies where we see promise for revenue growth and for earnings growth over time. And so areas such as private credit, real estate and infrastructure are areas that we think will continue to attract capital allocation and — because they are less liquid, continue to have a healthy degree of fee associated with them.

Brennan Hawken: The valuation delta, though, is a bit challenging here. So if you’re going to be particularly looking to acquire and add teams and capabilities within some of those private credit and more alternative structures, how are you planning to finance that? Is the idea going to be, you said in your comments, lift-outs and smaller teams that don’t have — that have the good capabilities on the investment side, but don’t have the other capabilities that you can add like distribution and scale and whatnot. So that seems clear, but is that going to be largely just cash deals that have earn-outs and so you’re going to change maybe a capital return structure to be more embedded to allocating capital to growing some of these businesses? Or are you going to be adding leverage? Like what’s your plan as far as financing these lift-outs?

Peter Orszag: Sure. Well, first, I think in terms of the sweet spot of the kind of target zone, you have it basically right, which is we’re looking for a salvage track records, but earlier in the AUM progression so that we can optimize shareholder value even post the acquisition cost because we think that’s the right part of the growth trajectory to get maximum benefit from our brand and our distribution while also benefiting from the historical track record that target will have accumulated. With regard to the financing options, obviously, that’s going to depend deal by deal. What I would say is we have 2 — in normalized conditions, we have 2 very cash-generative businesses. One indicator of that is if you look at the buybacks that we’ve done beyond what’s required, take the dividend out beyond that and then take out what’s required to offset the dilution from our deferred compensation packages, we have bought back $1 billion of stock in additional buybacks over the past 4 years.