Second Tier No More: $11.5 Billion Deal Catapults DLJ, CS First Boston

Updated from 8/29/00

Credit Suisse First Boston's decision to buy Donaldson Lufkin and Jenrette (DLJ) has a timeless rationale -- size. DLJ needs to get big and CS First Boston needs to get bigger.

The investment banking business is largely dominated by the top tier, Goldman Sachs (GS), Morgan Stanley Dean Witter (MWD), Citigroup's (C) Salomon Smith Barney and Merrill Lynch (MER). So firms in the second-tier need to break into the top tier to avoid losing business to the Big Four.

That fact wasn't lost on the market, which bid up DLJ's shares 28% to $84 Tuesday on reports of a deal. Credit Suisse agreed Wednesday morning to pay $90 a share, or $11.5 billion, putting it on par with the 18 times estimated 2000 earnings that UBS (UBS) agreed to pay for PaineWebber (PWJ) in July.

DLJ's Run The firm's stock soared Tuesday on speculation of a deal.

The Standings

CS First Boston ranks fourth in underwriting, or selling shares in companies to the public, through April, the most recent data available, according to CommScan. But among other things, it lacks a surefire way to distribute the offerings it underwrites. Merrill, Morgan and Solly have big broker forces to do the job. (Better distribution is a need for Goldman, as well.)

And while DLJ -- in ninth place in those rankings -- has been nimble enough to build businesses like underwriting bonds for less creditworthy companies, online brokerage and clearing and execution of trades, it simply isn't big enough to compete over the long haul and effectively penetrate Europe's growing capital markets.

"Together, we would be ranked one, two or three in every league table," says an executive at one of the firms. "Right now, the big firms are pulling away from the pack and the feeling is that soon there will be no second tier."

Of 303 equity underwriting deals done by the top 10 investment banks between Jan. 1 and April 30, Goldman, Morgan, Merrill and Solly brought 169 of them to market. CS First Boston and DLJ combined to bring 68, a total that would have been larger than any of the top 10 banks. Their combined underwriting market share would be 15%, behind only Goldman's 18% and Morgan Stanley's 16%.

Actually, any two of the second-tier firms could join up to battle the giants. For instance, J.P. Morgan (JPM) could acquire Bear Stearns (BSC), or Lehman Brothers (LEH) could have won the battle for DLJ.

CS First Boston is taking home DLJ because it has the cash to spend, while Lehman would've had to use stock. That stock -- up about 60% since May 1 -- has been inflated by the sector's takeover frenzy.

DLJ Diversity

Perhaps what made DLJ so desirable is that its business is so broad. Along with its underwriting and M&A advisory, it owns Pershing, one of the largest trade-execution and clearing firms, and it has the seventh-largest online brokerage in DLJdirect (DIR). It also has about 500 brokers servicing wealthy individual investors competing against firms such as Goldman Sachs.

"Typically, you see stronger firms buying somewhat weaker ones, but in the case of DLJ, it's a strong firm that's getting acquired," says one Wall Street veteran.

"DLJ has chosen its business spots extremely well, and then executed its plans well," adds money manager Michael Holland, who doesn't hold shares of DLJ in his (HOLBX)Holland Balanced Fund. "You tend to think that when DLJ decides to partner up with someone -- knowing its history -- the firm will do something smart."

With the brokers and DLJdirect, a combined CS First Boston-DLJ could distribute stock underwritten by the firm's investment bankers. Having large distribution networks has helped Merrill, Solly and Morgan Stanley lure potential issuers, which want broad distribution of their shares. That could only help CS First Boston's big-time tech bankers, a group that under the guidance of Frank Quattrone has become a force in Silicon Valley finance.

More Deals to Come

Meanwhile, the acquisition of DLJ is likely to add even more fuel to the sector's M&A bonfire. Lehman and Bear Stearns have been among the most talked about. Both firms are similar in makeup to DLJ, although with a market cap of $17 billion Lehman is considerably larger. DLJ's market cap is about $12 billion while Bear's is just under $7 billion.

The stocks have run up considerably. Lehman shares have risen about 60% since May 1, while Bear's stock has popped about 40% since then. With Tuesday's performance, DLJ shares have almost doubled in that period.

And beyond the pure investment banks, firms that cater to individual investors are also seen as prime targets. Citigroup's Salomon unit is informally studying acquiring a retail firm to add troops to its 12,000-broker sales force. (TSC reported recently on Solly's plans.)

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