Wall Street Whispers: Lazard's Lagging Performance

Given second-quarter strength and fewer hurdles to mount than bigger Wall Street peers, why is Lazard's stock faring worse than competitors?
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NEW YORK (TheStreet) -- Lazard (LAZ) - Get Report made it clear on Wednesday it's been busy scooping up business from larger competitors who continue to fight fires in Washington.

The boutique investment bank delivered earnings growth of 58% in the second quarter and managed to grow the top line, despite an uncertain and volatile operating environment. Its profit of 39 cents a share beat Wall Street's average estimate by a penny.

The New York-based firm also managed to snatch top talent away from its peers during the quarter. And unlike any of its giant, "too big to fail" competitors, Lazard isn't being pressured to shrink, nor has it been forced into the harsh spotlight of public scrutiny. It's just doing the same things it's been doing for over a century, with the same core operating principles, applied to new circumstances.

So, the real question is -- why has Lazard's stock underperformed larger peers so badly?

Lazard shares are down 20% so far this year and 23% since the financial stocks began to sell off in mid-April. That's a wide margin below big leaguers like

Goldman Sachs

(GS) - Get Report


Morgan Stanley

(MS) - Get Report

, which have fallen three-to-11 percentage points less over the same periods. The story is similar with other large financial-services firms that have top-tier investment banking divisions.

On Wednesday, Lazard shares were again essentially flat as they have been for the past few sessions. Wall Street shrugged off the second-quarter numbers and sent the stock incrementally lower.

One reason for the slump is clear: Lazard is more expensive than its white-shoe competitors.

Its shares are trading at 5.3 times 2010 book value and 15.8 times the average analyst's forecast for full-year 2010 earnings, according to

Thomson Reuters

. Meanwhile, Goldman is trading at 1.1 times book value and 9.7 times forward-looking earnings; Morgan Stanley is trading under book value and at 8.2 times 2010 EPS estimates. (The company points out that other boutique firms like


(GHL) - Get Report



(EVR) - Get Report

are more expensive than Lazard using the same metrics.)

But Lazard's recent performance is also a reflection of the short-term story, which, in turn, is part and parcel of the firm's long-term growth plans. It's putting more emphasis on certain business lines and stepping out from the shadow of longtime CEO Bruce Wasserstein, who died unexpectedly in October. Just as the broader market will take time to improve, so may the fortunes of Lazard's stock investors.

In asset management, Lazard delivered accomplishments of epic proportions last quarter for a few reasons.

First, because it's a sweet spot for the investment banking industry right now. Second, because its net inflows of more than $2 billion are in stark comparison to most other firms that were battling massive outflows -- little surprise during a quarter that included a "flash crash," a European debt crisis, the near-passage of a sweeping financial reform measure and general uncertainty about global economic strength. Lastly, Lazard has a history of plunging into equities and "alternative investments," which haven't been performing so well.

So how did Lazard manage to get more client dollars' in-house?

"The remarkable thing about the Lazard franchise is that, if you look at the breadth of the business both on the financial advisory side and on the asset management side, a significant portion of our activity really is following the flows of money from the developed markets into the developing markets," Chairman and CEO Kenneth Jacobs explained on a conference call.

Indeed, Lazard showcased a list of nearly three dozen significant deals closed last quarter, with roughly 70 more in the pipeline. Quite a few completed during the second quarter related to emerging markets where value exists, but hasn't been fully serviced by the financial industry. Among them: Qatar, Egypt, Morocco, Mauritania and Côte d'Ivoire, where commodities and natural resources have left a select few companies and families flush with cash.

Additionally, Lazard provided financial advice to the U.S. government as it figures out what to do with General Motors and Greek government as it goes through a giant debt-restructuring process. Since the two countries represent matches that lit the flames of the broader financial crisis and the more recent European debt contagion, it's telling that Lazard has a place on those governments' small advisory roster. Building such relationships also bodes well for future business, since the recovery process isn't going to be over any time soon.

"We were involved in some of the most important government and sovereign assignments," Jacobs pointed out. He then offered a not-so-subtle dig to competitors: "Our growing profile in this business emphasizes the importance to our clients of getting unconflicted advice when raising capital rather than relying on advice from those firms providing the capital."

Still, Lazard's M&A business -- which makes up a large chunk of operating revenue -- is being hindered by the broader economy. Companies are still hesitant to spend money on devouring others until a clearer timeline of future growth emerges. And while Lazard's M&A revenue grew last quarter, the top-line still missed some analysts' targets.

Meanwhile, the restructuring and capital markets businesses both saw double-digit declines. That was partly because of ongoing stress in the debt markets at home and abroad.

"The shutdown of the junk bond markets in Europe is creating a demand for more financial restructuring aid. The real estate business in the United States continues to require assistance," Rochdale Securities analyst Dick Bove pointed out ahead of Lazard's results. "However, in neither case are the markets expanding."

Another problem is that compensation has gotten more expensive as Lazard continues to poach talent away from competing firms. Some key hires since the start of the summer include a top infrastructure banker from Citigroup and both an investment banker and a private-equity star from Bank of America-Merrill Lynch.

The other oft-cited compensation "overhang" on Lazard's stock relates to two items that are more technical than fundamental. A lock-up period for insider stock sales expired in May, and Wasserstein's well-compensated estate is in the process of selling 7.9 million shares. Some on Wall Street suspect that the internal selling has added pressure to Lazard's share price.

The bottom line for Lazard can be seen in comparison to bigger competitors: Like


(C) - Get Report

, Lazard capitalized on its proven capabilities overseas; like Morgan Stanley, it also became tactical during the quarter, growing asset management revenue as others fell behind; like

JPMorgan Chase

(JPM) - Get Report

, it has an outstanding reputation on The Street; like Goldman Sachs, it has a strong reputation for advisory services; like

Wells Fargo

(WFC) - Get Report


Bank of America

(BAC) - Get Report

, it is trying hard to gain market share as an underdog in the league tables.

But because Lazard is less diversified than its bigger competitors, quarterly results can be "lumpy," as one analyst put it. Since its main business lines are being held back by problems beyond Wall Street, it may take some time for the market to get bullish on the stock.

The buy-side collectively recommends adding to Lazard positions, with a $39 price target. But Credit Suisse analysts maintained a neutral rating on Wednesday. Although they "like the Lazard franchise over the longer-term," they're still waiting for "a broader pick-up in M&A activity, payoff from the company's investments in human capital and the removal of share overhang."

-- Written by Lauren Tara LaCapra in New York


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