Lazard made a hire in domestic restructuring, the first one in over 7 years putting up a press release of the hiring of a Managing Director (MD) in its reorg business overnight. With only 141 MDs in total at the firm, the hire is not inconsequential in our view and signals that growth in M&A is waning. While the firm hired a new restructuring head in Germany in 2013, the announcement of a U.S. restructuring MD is the first since December 2008.
The firm's Vice Chairman also made an address from Davos this morning, referencing volatility shaking out industry M&A activity and striking a positive tone broadly on restructuring and reorgs. Our research echoes that sentiment and we think that corporate credit spreads having increased over 100 basis points since mid-2015 will impact merger announcements in 2016 and that higher volatility (VIX) is shaking out deal activity which will create the first negative comp for M&A activity in 4 years.
A bull market in restructuring is not good for Lazard and its shareholders as the stock declines when M&A percentages of advisory drop:
The restructuring cycle of 2009 boosted restructuring revenues by $100 million year-over-year but M&A revenues dropped by $150 million and LAZ stock fell:
Our main contention is that the rise of corporate credit spreads will take activity out of the M&A market as funding costs rise. Moody's BAA spreads have risen 100 basis points since 2015:
A negative inflection in credit has always portended a reversal in M&A and we expect higher funding costs to impact merger activity as we get into 2016:
In 14 years of data, a +100 basis point rise in corporate credit has impacted M&A activity by -20%:
A spiking VIX or the volatility index has historically halved M&A activity when crossing over the 20 threshold:
We are also concerned that investors underestimate the firm's exposure to emerging markets (EM) and that the stated 30% of assets-under-management in EM is actually over 50% when adding strategies in Global and Multi-Regional:
The firm has never historically escaped an EM melt-down in the past and we don't expect it to this time. The EM downcycle of 2002-2005 created negative organic growth and market losses for Lazard Asset Management.
Street estimates are completely unrealistic assuming a best case scenario for the out years of 2017 and 2018:
Even near term assumptions are way too high and we don't have Lazard earning $3.00 this year which is -20% below the Street:
We think the deceleration of the firm's earnings will continue to compress the stock's multiple. In addition, we expect some reactionary downgrades of the stock with no Sell recommendations on the Street and estimates too high. Our base case valuation is $30 per share or 10x our '16 estimate with a Bear case at $22 per share on $2.20 in EPS. The stock remains on our Best Ideas list as a Short:
Please let us know of questions,
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA