Last year, New York-based investment bank Donaldson Lufkin Jenrette (DLJ) moved decidedly up-town. Leaving behind its old, slightly run-down, headquarters on Broadway after 30 years, it moved into swish new premises at 277 Park Avenue, next door to Bear Stearns and across the street from the newly merged Chase Manhattan Bank. Employees moved over several weekends in early spring. Each Friday night was the same. The snow would descend on New York in one of the worst periods of bad weather the city could remember. But, so far at least, last year’s storms have not been a bad omen for DLJ.
As well as accommodating a lot of new people the firm employs 5,900, up from 4,900 at the end of 1995 and 1,500 in 1987 the move was symbolic of a firm that had suddenly grown up. Started as a pure equity research firm in 1959, DLJ is now the youngest and newest member of Wall Street’s investment banking bulge bracket.
“We have claimed our birthright,” says Joe Roby, its president and chief operating officer. “There is a tendency to describe DLJ as a niche firm. But I don’t see the niches. We compete with the leading firms in our industry, daily.”
DLJ’s growth during the 1990s makes it the envy of every investment banker who has broken his heart trying to fight his way into the US investment banking business. In 1990, it ranked 23rd as a lead manager of US common stock offerings with 0.5% market share. Last year, it ranked fourth, behind only Merrill Lynch, Goldman Sachs and Morgan Stanley, with a 7% market share. That puts it ahead of more famous Wall Street names, including Salomon Brothers, Lehman Brothers, Credit Suisse First Boston and Smith Barney.
It has come from nowhere in high-yield debt in 1990, to be the top-ranked lead manager with 20.1% of new issues in 1996. That puts it way ahead of second-placed Merrill Lynch with 14.5% and third-placed Goldman Sachs with 9.3%.
Its achievement is all the more remarkable considering that those two sectors, equity and high-yield debt, are the most lucrative in the new-issue business and the most appealing to new entrants. Countless foreign and American firms have struggled to break into their top ranks, especially into equity underwriting. It was the ruinously expensive effort to establish itself in US equities which ultimately cost leading UK merchant bank SG Warburg its independence.
A top executive at one of the three American firms above DLJ in the league tables says: “DLJ is a great example of focus, of deciding what to do and concentrating on that without worrying about being all things to all men.”
DLJ is certainly not that. True, it has more revenues to fall back on than just underwriting. It has, for example, a large and successful merchant banking business, with funds available for investment that are exceeded only by those of KKR. Over the past two years, sales of equity stakes held in its merchant-banking portfolio have provided some spectacular investment gains, and boosted the firm’s earnings. It also has an under-appreciated, steady-earning correspondent clearing and trade processing division, Pershing, which accounts for 10% of daily reported volume on the New York Stock Exchange.
But DLJ is far from being anybody’s idea of a global investment banking powerhouse. It has only recently begun to build its business outside the US. It is not known as a lead adviser or arranger of finance for the largest American companies. In lower-margin underwriting sectors, DLJ has not been so visible. It is still outside the top 10 in investment-grade bond underwriting. It is an also-ran in US treasury and agency bonds, and a non-starter in Eurobonds. Despite such shortcomings, it has become a force for every other capital markets firm to reckon with, completing highlight transactions in Europe as well as the US.
In the overall US rankings for all public new issues carrying disclosed fees, it is up from 13th place in 1990 with 0.7% market share to fourth in 1996 with 7%, behind Morgan Stanley with 9.6%, Goldman Sachs with 13.1% and Merrill Lynch with 14.5%. Roby does add the caution that “for a while we had the advantage that one or more of our leading competitors was wounded. Now they are all competing well. Firms like Lehman Brothers and Salomon Brothers still have the potential to cause us some pain. But our primary business competitors are Morgan Stanley, Merrill Lynch and Goldman Sachs and I preach to our people that those firms will still be our main competitors five years from now.”
How has DLJ managed what has eluded so many other larger and better capitalized firms? It’s well worth remembering that it did not start the 1990s with nothing. Unlike any foreign investment bank trying to build its US operations from scratch, DLJ has, ever since it was founded in 1959, been known for high-quality research. “This truly is the firm that research built,” says Michael Lipper, analyst at Lipper Analytical, echoing a favourite DLJ catechism. “A lot of credit for that goes to its founders and to [present chairman and chief executive] John Chalsty who remember has been a president of the New York Society of Security Analysts. They have used research to build their corporate finance activity.”
Analyst-driven
Other Wall Street firms are run by investment bankers or traders: DLJ is still largely run by analysts. Chalsty arrived at DLJ in 1969 as an oil analyst. Two of the firm’s three main divisions are run by men who also joined as analysts. Theodore Shen, who heads the capital markets group covering fixed income and equities, joined in 1968, covering the airline industry. Richard Pechter, who heads the financial services group including Pershing, and the firm’s high-net-worth brokerage and investment management businesses, joined as an analyst in 1969. The firm’s other top executives include Joe Roby, the clearly designated number two and successor to Chalsty, who joined as an investment banker in 1972, and Hamilton James, another investment banker who joined in 1975 and now heads the banking group, responsible for underwriting and merchant banking.
The firm used its research strength to build in areas carefully chosen for their attractive profitability: equity and high-yield debt underwriting, principal investing and merchant banking. “The essential difference between DLJ and other major investment banks lies in the strategic position of research at the centre of the firm,” says Shen, “rather than in any specific aspects of product differentiation. Almost everything we have built has research at its core.” He admits that “today, there is no question that underwriting is the highest-margin product in equities, but research contributed importantly to that success, so we would never consider diluting our research capability to further the firm’s underwriting mandates.”
Perhaps the firm’s commitment to research, perhaps an innate conservatism, has preserved a good record in the risky business of merchant banking and bridge lending. It has had mishaps. The prospectus for DLJ’s flotation in 1995 required it to disclose a $25 million hit against a soured bridge loan, widely believed to be to troubled Denver-based home healthcare services company Coram Healthcare Corp. But that pales beside the losses other firms have suffered in the same business and is heavily outweighed by the firm’s more numerous merchant banking successes.
Ten years ago, the firm made several important decisions from which it is still benefiting today. First it decided to stay principally a domestic US firm. While it has long had the biggest market share of any firm selling US stock to UK and European investors, DLJ ignored London’s Big Bang. “We reasoned that there would be so much competition, from UK merchant banks, continental banks, US commercial and investment banks and the Japanese, that we would be trampled,” recalls Chalsty. “And DLJ was not well known.”
By saving its scarce capital and resources, DLJ survived relatively well the 1987 crash and later bridge loan problems that destroyed several American firms EF Hutton, LF Rothschild, Drexel Burnham Lambert and required others such as Shearson Lehman and First Boston to be rescued by large shareholders. With 50,000 Wall Streeters suddenly unemployed, DLJ the survivor was able to recruit and build.
Embracing high yield
In equities, the task was to bolt investment banking onto a mature research business. In high-yield debt, the firm chose to pick up large numbers of sales, trading and investment banking refugees from Drexel Burnham Lambert. Those moves show a strong characteristic of the firm’s management: having the courage and commitment to make controversial choices and stick to them. “We embraced high yield, when everybody else was saying ‘junk is dead,'” recalls Chalsty. “We thought it was a legitimate form of financing that had been around for a long time.” But for two or three years, the market was lifeless. It was only from 1993 onwards that that bold decision started to pay off.
The decisions taken in the mid-1980s gave DLJ 10 years of momentum. But what happens next? Other firms would like to copy its trick of picking high-margin businesses and building strong positions in them. And the businesses DLJ targeted years ago are no longer unfashionable. Many firms are now eager to establish themselves in high-yield bonds. Oddly, the firm is not unduly worried. Last year, it increased its market share of high-yield underwriting to 20.1% from the 16% it had enjoyed as top underwriter in 1995. That increase came in a year “when everybody and his brother wanted to be in high yield”, says Chalsty. “Dislodging us won’t be easy. High-yield issuers, don’t want their deals to fail.” They really need the money. And so, it appears, they go to the firms with strong track records.
More challenging, Chalsty fears, will be “funding and building new high-margin businesses. That won’t be easy”.
Just over two years ago, the firm decided it was finally time to build a stronger business overseas. It reasoned that it could now present itself to foreign issuers as a real leader in selling stocks and bonds to US buyers. Having made that broad decision, DLJ was characteristically opportunistic in carrying it out. It took advantage of a pull-back from emerging markets on Wall Street following the peso crisis and hired Neil Allen, a managing director from Bankers Trust, and a team of bankers to build an emerging markets business. That group now numbers over 50. But it is a competitive area. The leading US commercial and investment banks did not cut and run from emerging markets in early 1995, as they did from junk in 1990. DLJ has underwritten some emerging market issues, but it is far from being a market leader yet.
It has had some significant international successes. Last year, it jointly led the first-ever listing of a Russian stock on the New York Stock Exchange, a $127 million initial public offering for Moscow-based mobile-phone company VimpelCom. The mandate was won partly because DLJ has top-ranked analysts and investment bankers in mobile phones and has a strong record leading equity issues in that sector. Also last year, the firm led a $184 million IPO for Hong Kong-based APT Satellite Co, a provider of satellite services in China. “That was a complex dual listing and a tough deal to get done. In fact, if either of those deals had not worked it would have been a big set-back for us,” says Chalsty. “We could not afford to fail. Hopefully now foreign companies will see the beginnings of a track record.”
The firm also did a nifty $360 million high-yield deal for German Fresnius Medical Care. The preferred trust securities allow the issuer to account the proceeds as equity but still enjoy tax deductibility on interest payments in the US. The firm has a high-yield investment banking group in London drumming up business among European growth companies that have no high-yield market of their own in which to raise finance. It has done several deals for UK cable operators.
Now in an effort to leap ahead in its build-up of investment banking in Europe, the firm has acquired Phoenix Securities, the UK-based M&A advisory boutique famed as a specialist in the financial services industry and as match-maker in many of those Big Bang marriages DLJ so carefully avoided in the 1980s. The original plan for London had been to put maybe 10 investment bankers on the ground, focused on high-yield origination, and then spend on aeroplane tickets to complete deals they brought in. The Phoenix acquisition was opportunistic and is now intended to form the core of a more ambitious expansion and to send a signal of intent.
But was it a wise acquisition? Phoenix, though successful in its sectors, has remained stubbornly narrow in focus. It has expanded into insurance and media and into principal investing, and it has grown from 15 people to 60 in five years. But Phoenix has always struggled to break away from the tag of financial services industry specialist. And its founding partners were all pleased to have broken away from the larger firms where they began their careers Merrill Lynch, White Weld, Bankers Trust. They relished and played on their independence.
Partly what appealed to DLJ was that the four or five Phoenix partners had built a decent business, something that the firm likes to think many new hires still have the chance to do within DLJ. “Clearly our strategy will be different with Phoenix than without,” Hamilton James, chairman of DLJ’s banking group, says. “Phoenix brings seasoned managerial talent to oversee building of that business. We get a chassis to build on and a group that can drive the car when it’s built.”
A business plan on the fly
If the plans of the assembly line aren’t exactly mapped out yet, that doesn’t seem to worry either side. “The textbook approach would have been to sort out a three-year business plan before we got into bed,” says Philip Seers, a partner at Phoenix. “But their attitude and ours was: ‘Don’t let’s spend huge amounts of time working out who will sit exactly where. Let’s seize the opportunity.'”
So what kind of firm are the Phoenix partners joining? Most striking to an outsider is just how long most of the senior management has served at the firm. Chalsty, Shen and Pechter have been there since 1969, Roby since 1972, James since 1975 and his deputy in the banking group, Garret Moran, since 1982. Such stability is unusual on Wall Street and counts for a lot. Because the top five or so people know one another so well and can remember all the bad times the firm was the first US securities firm to float publicly in 1970 but during the painfully slow markets of the early 1970s its stock languished at under $2 they can anticipate one another’s likely attitudes to problems and opportunities and act quickly.
Seers says: “It is the least managed firm of its size, I have ever come across. Most major investment banks have two linked management problems: fiefdoms from which people fight each other and don’t cooperate; and a proliferation of committees, which senior people come to believe it is more important to sit on than to do business. DLJ is very decentralized. It is light on committees.” The top managers admit they do not actually see each other that often. Lower down the ranks, staff turnover is low by Wall Street standards, at about 5% annually, and it is rare for people to leave for competitors. Roby acknowledges that the “firm is under more aggressive siege than ever, mostly from the newcomers, the foreign banks and other Wall Street wannabes”. But he warns them: “Historically, this has been a difficult place for competitors to shop.”
When Chalsty joined there were 150 partners and staff, most of whom have since retired or left the industry. He has been there for the hiring of just about every one of the firm’s 6,000 employees. He is a paternal figure.
Chalsty was born in South Africa in 1933 and became a naturalized US citizen in 1964. Tall and white-haired, he is a rather gentlemanly figure. DLJ pays well and Chalsty has been CEO for 10 years. He is not poor. But he rides the subway to work and often to meetings between mid-town and down-town. One employee remembers accompanying him on such a trip when a particularly deranged and dangerous-looking New York whacko wove intimidatingly towards them through the near-empty carriage. The immaculate-looking Chalsty didn’t bat an eyelid. The moment passed. The employee reflected that it would have been an unusual way for a Wall Street CEO to meet his end.
Those little things send a message. The firm fights arrogance. It has no corporate limousines or jets. Pechter recently flew back from a meeting in London with Michael Campbell, head of the high-net-worth broking business, in economy class. They were flying during daylight hours. A night-time trip, with meetings the following morning, might have bumped them up to business class. No-one flies Concorde. “Their people have strength of personality but are not personality driven. The traders don’t feel they have to do the monument trade,” suggests Lipper. Sallie Krawcheck, analyst at Sanford C Bernstein suggests: “It’s a fun place to work. DLJ is a lot of people who have got together to make money and have some fun, while taking on the big guys.”
But now DLJ is one of the big guys. Can it remain a special, fun place to work or, in growing, does it risk becoming a bureaucracy or, worse, a typically faction-ridden investment bank? Chalsty admits: “That is the biggest philosophical and in a way strategic question that we face.” In partial answer he points out: “You don’t grow as quickly and as profitably as this firm has without winning a lot. We’ve won many competitions for pieces of business against bigger firms. And people are turned on by winning. I don’t know whether it will last forever but, so far, the special nature of this firm has survived its growth.”
Culture is a phrase applied too often to investment banks. At the heart of what makes most firms tick is the same issue: pay. DLJ pays well. Total pay comprises various pieces, including the now-conventional-on-Wall-Street low basic salaries and individual and departmental bonuses. When DLJ went public in late-1995, it revealed that compensation ate up some 60% of revenues, compared with an industry average closer to 55%. Since then, DLJ has worked to reduce that figure by increasing the equity component of employees’ remuneration. Through three-year plans, a large part of individuals’ pay is linked to the profitability of the whole firm, bringing an incentive to cooperate.
Conflicts inevitably arise, for example, between investment banking and research. “It’s never a question of analysts being pressured to say something nice about an investment banking client,” says James. “But we do spend a lot of time trying to find the balance of how much time analysts should spend covering the companies investing clients want covered and how much they should spend working with investment bankers on new issues.”
The manner in which, rather than the amount, DLJ pays its people is intriguing. The firm’s strong position in merchant banking provides more than just a stream of investment gains and a ready source of in-house business for its IPO and high-yield bond groups. It provides an attractive series of opportunities for employees to co-invest alongside the firm itself. DLJ raised $1 billion for its first merchant banking limited partners’ fund in 1992. It rewarded investors with a net annual return of over 75%. Not surprisingly, when it raised a second fund last year, investors were biting salesmen’s hands off for a piece. DLJ closed DLJ Merchant Banking Partners II at $3 billion against an initial target of $1.75 billion. Its own employees committed up to $750 million of their personal wealth.
This is how the process works. Say the firm makes a merchant banking principal investment of $30 million, the merchant banking limited partners funds will take 75%-80% of the investment and DLJ itself exposure of another 10%-15% of the total. Employees put up the remaining 10%-15% of the investment, largely through their participation in funds which the firm manages. Employees might also put up between 3% and 3.5% of the deal directly using money borrowed from DLJ. The team working directly on the deal might have roughly a quarter of this last portion of the investment, with the rest broadly distributed to other bankers, salesmen and analysts. It’s an activity which, says James, “pulls the firm together”.
That’s not surprising. Some of the firm’s recent merchant banking realizations have been eye-popping. For example, from an initial investment made in 1994 of $10.5 million in healthcare company Total Renal Care, the firm has already realized proceeds of more than $100 million.
All in one bonus pool
It’s an aspect of DLJ which intrigues its competitors and which they are keen to know more about. “When they come over the barricades onto the battlefield with us, they are strong competitors in their markets,” says a senior executive at a leading US firm. “But I wonder how much time back at barracks they spend arguing among themselves. There seem to be a lot of individual deals cut.”
Absolutely incorrect, replies James. “True, people are put in charge of their own businesses and can build them, but there are no individual P&Ls in investment banking nor does, for example, mergers and acquisitions have a separate bonus pool. There is one bonus pool for the whole of investment banking and all the managing directors are partners in that pool. We precisely avoid having people cut their own deals.”
Clearly DLJ has done a lot of things right and ridden some luck. Challenges await. It has not done much business with Fortune 500 companies. As the companies its investment bankers follow grow larger, the firm might have to do more conventional business for them to retain those customers. It cannot keep on making such spectacular merchant banking gains year after year. “As they become larger they might have to chase more diminishing-return business,” says Krawcheck. “You can already see that a little in investment-grade bonds. And that will be a little return-depressing for them.”
DLJ remains an oddity: a bulge-bracket investment bank with scarcely any international business. It does not have a lot of capital. And it remains to be seen how DLJ’s expense structure will fare, following its recent move up-town and its rapid growth especially when the market turns down. But, up to now, it has survived and thrived while others have fallen by the wayside. Chalsty says: “This firm is the overnight success story it took 25 years to build.”
