Tears in the boardroom

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Fiercely independent managers grew their research-oriented boutique from little Donaldson, Lufkin & Jenrette into one of the most successful Wall Street firms in the best businesses: equities, high-yield debt, private equity and online broking. For years, DLJ clung to its distinctive culture while owner Axa happily pocketed dividends. Now the French insurer has tossed it to CSFB and no-one knows if the two can work together.

It was hardly a resounding vote of confidence in his decision, but then Joe Roby probably had not expected it to be. There were no cheers, no congratulations, in fact there was very little response at all as Donaldson, Lufkin&Jenrette's chief executive officially informed his staff on August 30 of the sale of the bank to a rival, Credit Suisse First Boston. Some, of course, already knew. Senior managers had been told of the probability of the deal two weeks beforehand. Of the rest, most were stunned, and many are still scratching their heads to work out why DLJ is disappearing into the Swiss-owned investment bank. Many say that they thought there was much DLJ still could have achieved as an independent investment bank. "He said that he simply didn't want DLJ to be the last one left on the street," says one DLJer. The venue Roby chose to address his staff was the canteen, a small irony itself. It is a part of the office on Park Avenue that the CEO, his fellow senior executives, and their predecessors are perhaps more acquainted with than their counterparts at other Wall Street investment banks. DLJ's most senior executives would all regularly eat there, mixing with the traders and deal-doers. It was not the only example of how senior executives at DLJ would avoid the excess often seen at rival firms. Roby's predecessor as CEO, John Chalsty, who is now chairman, would travel to meetings in Manhattan on the subway, rather than by corporate limo. Senior executives would fly economy class even across the Atlantic during daylight hours. It fostered a unique spirit among employees, a sense that all from the lowliest associate (now equipped, as are their peers at other investment banks, with laptop, laundry and concierge services, and big bonuses, to stop them jumping ship to start-ups) to the most senior executive were playing their part in an operation that was friendly and fun, but also aggressively entrepreneurial, seriously professional and a big money spinner. Chalsty, and then Roby, often boasted that DLJ had one of the best employee retention records on Wall Street, with very few leaving for jobs with rivals, and many of those who did often coming back. Many throughout the firm had never worked anywhere else, having joined after graduation, and envisaged staying there for life. But now Roby was in the canteen, to announce the end of the firm as an independent entity and its sale to a rival whose history and culture could not be further away from DLJ's. Rumour has it that Chalsty was so upset at seeing the firm he had spent years nurturing lose its independence - and its name - that he had been in tears in his office. Of course there was always a chance that DLJ would end up on the block. It had already been bought twice: first, by the Equitable in 1985, which took a 71% stake, and then effectively by Axa, which took a 70% stake in Equitable in the early 1990s. Senior business managers at DLJ would occasionally roll out these figures to convince people that DLJ was still a majority-US-owned institution: 70% of 71% is 49.7%. DLJ always maintained an arms-length relationship with its parents. John Chalsty, CEO from 1972 until 1997, and one of the co-founders, Richard Jenrette, worked hard to keep first Equitable and then Axa silent partners. It helped that Jenrette became chairman of Equitable in the late 1980s. For his part, Claude Bébéar, Axa's CEO until last year, would often describe DLJ as a non-core business for the group, but also take care to add that he was happy with DLJ's progress and contribution to the bottom line. Combining such a benign patron with the independent bent of Jenrette and Chalsty was enough to make any attempts to buy or merge with DLJ difficult. "One of DLJ's defining characteristics was that Axa left them alone, and that Jenrette and Chalsty would make a point of keeping it that way," says Ray Soifer, who runs his own firm, Soifer Consulting. In the end this led to a false sense of security. Rumours of DLJ's sale have circulated on and oV for four years or more. In 1996 it was apparently just two weeks away from jumping into bed with NatWest Markets. It was a lucky escape. At the time seemingly one of the more successful European houses, NatWest Markets disappeared less than a year later, after a relatively small derivatives loss exposed the inherent weaknesses of its management, business strategy and earnings capabilities. Another rumour was that the whole of Axa, not just DLJ, would jump in with Deutsche Bank, with DLJ forming the vanguard of its investment-banking operations. And in the past 18 months there has been occasional speculation that it would fit relatively well into Chase Manhattan. Thus in all instances, observers and employees alike assumed that the combination of committed and successful management with its ownership structure, one of the most convoluted on the street, would guarantee that DLJ would only ever merge with or be acquired by an institution where it could plug an obvious gap, and where its leaders would retain the upper hand in the business. Yet exactly the opposite has been achieved by selling to CSFB. The reason for selling is pretty obvious. Roby may not have wanted DLJ to be the last smaller firm left on the street, but the ultimate decision rested with a man sitting 3,500 miles away in Paris. Axa's new CEO, Henri de Castries, shared the same opinion about DLJ's role within the group as his predecessor - that it was non-core. Unlike Bébéar he wanted to do something about it. Earlier this year, in the spring, he stated publicly that all non-core businesses would more than likely be sold off and indicated that he would consolidate the group's holdings in its core insurance operations. So it was that on May 2 Axa bought the remaining 44% stake that it did not own of UK insurer Royal&Sun Alliance. This roused the attention of some DLJ Europe staff, who took note of who advised Axa on the deal - Goldman Sachs. "Some of us started wondering whether there was a hidden message in there that Axa didn't use us for that deal," says one banker. "That was home turf for our financial institutions team." In 1997 DLJ had bought M&A specialist Phoenix, which had advised on many of the UK financial services deals from the mid-1980s onwards. Perhaps, says the banker with the benefit of hindsight, "it was the beginning of Axa trying to distance itself from us before moving to sell". Goldman, which has been a key banker to Axa for years, and has one of the strongest FIG teams in Europe, was to advise Axa on the sale of DLJ to CSFB. Market gossip had it that DLJ was on the block but its name was linked with a number of other Wrms that had an obvious gap, whether in leadership, product, geographic reach, or all three. UBS Warburg and ABN Amro were two of the most obvious European houses lacking a deep domestic presence in US investment banking; JP Morgan had built a solid equities and M&A platform, but it had limited client coverage and bankers who, although good, were not regarded as the best on the street; and Chase Manhattan had been searching for an equities house for three years or more. And these were just the names that kept cropping up. Any of the above combinations would have been difficult, but none so difficult as CSFB, a firm with ostensibly similar operations, but with gaps here and there that prevented it from being considered a bulge-bracket firm. It also has a chequered history that could not be more different to that of its target. First Boston had its heyday in the 1980s, when men such as Hans-Joerg Rudloff, Bruce Wasserstein and Joe Perella held sway - Rudloff over the development of the Eurobond market, the latter two over US M&A. At that stage Credit Suisse had been a minority investor since 1978. The firm's downfall began at the end of the decade, and is partly chronicled in Barbarians at the Gate, the story of the fight to buy out RJR Nabisco. Wasserstein and Perella left to set up an M&A boutique on their own (Perella soon left for Morgan Stanley, and last month Wasserstein sold most of the firm to Dresdner Kleinwort Benson). By 1990 the bank was carrying $1.1 billion in unrefinanceable loans, called in Credit Suisse for a $300 million capital infusion, and so started several years of restructuring and political infighting as Credit Suisse became the majority owner. Everything from business strategy to bonus payment structures were a cause for controversy. Bust-ups over bonuses became an annual event as the investment bankers in the US battled against what they saw as tight-fistedness on the part of their bosses in Zurich. They in turn deplored the Americans' greed and struggled to comprehend the need to pay so extravagantly to compete in the business.
      
Chalsty: saddened by DLJ's sell-off
Only in the past three years under CEO Allen Wheat has the ship been turned around. He took over at the start of 1997, and in November that year CSFB bought the European equities and M&A franchise of BZW for a song (£125 million). In 1998 Wheat pulled off two more coups, first in beating Goldman Sachs in the fight to buy premier Brazilian investment bank Garantia, and then in persuading Frank Quattrone, Deutsche Bank's infamous tech banking supremo, to jump ship and bring his entire team with him. At that stage it was only the credit markets and foreign exchange products that regularly made money for the firm. Equities, says one former employee, would usually break even, while M&A, in the US at least, would lose the firm as much as $140 million a year because mandates were never enough to pay the salaries of the bankers. CSFB maintains that investment banking has never been unprofitable. That situation has now changed, and if anything it is the credit markets that appear to be the weaker link. The change is largely due to Quattrone. He is an acknowledged leader in the sector which accounts for over 50% of the volume of all deals in the US - internet and technology investment banking and equity capital markets. The proliferation of deals he and his team have brought in have catapulted CSFB into third place behind Morgan Stanley Dean Witter and Goldman Sachs for tech-related business. But Quattrone is also a potential weak link for CSFB. The franchise is tightly linked to him, not the firm. And few will forget the circumstances in which he joined: quitting Deutsche Bank just months after making a very public commitment to stay, leaving Deutsche with absolutely no presence in US tech banking. Competitors believe that CSFB is using Quattrone to pull in as many equity and M&A deals as possible - tech and non-tech - in an attempt to establish a franchise that can survive without him. Rumours have persisted all summer that he might be about to jump ship again, in all likelihood to set up an LBO firm. If that were the case, he might leave many of his team behind, though probably not George Boutros, who most regard as the key rainmaker for Quattrone. Even though Quattrone apparently signed a new three-year contract with CSFB in the summer, the rumours that he is leaving continued up to and beyond the acquisition of DLJ. Nonetheless, CSFB has stormed up the equity and M&A rankings in the US, and has been enjoying similar, if not such stellar, success in Europe after absorbing BZW's equities and M&A franchises surprisingly well. It is by no means a powerhouse such as Goldman, Morgan Stanley or Merrill Lynch, but it is arguably the best serious overall contender they have faced for some time. And according to John Leonard, European banking analyst at Salomon Smith Barney in London, CSFB has something no other investment bank has. "We have long viewed Credit Suisse First Boston as having perhaps the best balance of any major investment bank between the US and Europe, but perhaps slightly short of top-tier status in either market." Whether the takeover of another institution can rectify that is debatable. Simple addition of two banks' league-table positions would certainly give the impression that it can happen, but such addition is rarely reliable. Take the example of the SBC-UBS merger in 1997-98. Combining the league table shares would have made the new UBS the largest M&A house in Europe, a full 33% ahead of the nearest competitor, Goldman Sachs. That clearly has not happened. UBS Warburg is fourth in European M&A this year, way behind the leaders.
      
O'Hara: helped CSFB ahead in high yield
Of the four major investment banking businesses - high-grade debt, high-yield debt, equities and M&A - there are theoretically two areas where DLJ's franchise could be of immediate benefit: M&A and high-yield debt. DLJ has one of the most successful and profitable M&A operations on the Street, last year ranking fourth by volume, and first by number of deals in the US. There is just 5% client overlap between the two. DLJ has a formidable middle-tier franchise, while CSFB has concentrated on bigger companies and, more recently, on new-economy companies. As for high-yield debt, DLJ has been the industry leader for nearly 10 years, mostly under the auspices of Bennett Goodman, while CSFB stuttered along for much of the 1990s and only began to make an impact under Tim O'Hara in the last couple of years. DLJ's high-grade debt business is small, having been built from scratch over the last three years by Chris Lynch, who was recruited from Smith Barney after the messy merger with Salomon Brothers. But it is also very profitable. Lynch wanted no part in the 60% of US deals that he describes as loss-leads or break-evens. The business is built around Global Edge, a web-based tool using data on 35,000 bonds stretching back to 1961 and designed to allow CFOs to manage portfolios of bond, equity and convertible issues more effectively. This frees up the bank's staff from research for the companies and allows them to concentrate on that elusive idea of adding value. It's not had a huge impact on the firm's league-table standing. DLJ usually ranks tenth or eleventh in the US. But it brings in the money and insiders say that Roby quickly developed a great deal of respect for Lynch and his team. Two-and-a-half years ago, DLJ's equities franchise would have been a key part of the deal. At that point CSFB was lucky to break even in US equities, Quattrone was not yet on board, and DLJ was vying with Salomon (before and after the merger with Smith Barney) for fourth place in the league tables for US domestic IPOs. Now it has slipped a couple of places, coming sixth last year. This was largely because DLJ had a smaller share of the tech sector. It has a good team in California, and its deals have one of the better records for aftermarket performance, but is not as large as some of its competitors. Thus far, four weeks after the announcement, it is M&A and high-grade debt that appear to be coming together reasonably well: M&A because there is so little overlap, and in part because CSFB has named DLJer Hamilton James, co-head of investment banking; high-grade debt because the two respective heads, Chris Lynch at DLJ and John Walsh at CSFB, have been friends for several years. Lynch actually spent five years at CSFB in the early 1990s. That relationship, say insiders, has made the process less confrontational. But equities and high-yield debt are the sticking points. These are DLJ's core businesses, and the heart of its culture. DLJ was started as an equity research firm in 1959. All its CEOs started as research analysts, as did many of the senior executives over the years. Off that base the firm built its equity underwriting and trading operations and its M&A franchise. It is still perceived as having some of the best analysts on the street, and as being a more cohesive force than CSFB. CSFB has been hiring analysts off the back of its Quattrone coup, and not just in tech. It was rapidly increasing its company coverage throughout last year. But DLJ has the dominant franchise, at least outside of tech. If DLJ does not run research at the combined entity, or have many senior positions on the underwriting and trading side, too many DLJers will regard it as a betrayal, and the potential for large-scale defections from an already embittered staff will be high. Senior positions in equities were announced at the start of October, and there were very few places for DLJers. Global head Tom Fox is co-head of equity capital markets Americas, but shares the role with Jeff Bunzel and Alan Sheriff of CSFB. Fox has also been given responsibility for developing the tech franchise, joining CSFB's Andy Fisher. Three co-CEOs and crossed lines of responsibility do not bode well for an efficient, effective integration. High-yield debt is DLJ's more recent success story. Chalsty took a big risk in 1990 when he snapped up the core of his high-yield team following the demise of Drexel Burnham Lambert and the subsequent collapse of the market as a whole. For two years the market was near-silent, but the gamble paid off. DLJ has been at the top of the US league tables for nearly a decade, enjoying a franchise broader and deeper than any of its competitors. Many of the bankers from the early days are still there, loyal to the firm that showed faith in them at a time when most were cutting jobs and wary of a product that had become synonymous with the greed and amorality of the 1980s corporate raider culture. Ostensibly, this franchise is one of the main attractions for CSFB, filling a gap that will benefit Quattrone's division in particular as many of the tech companies carry junk status. But after two years of improving its own franchise, CSFB is keen to keep as much control as possible. "Brady Dougan is fighting real hard for his boys," says one DLJ insider of CSFB's global head of equities and member of the integration team. "The discussions over who does what are going painfully slowly, and aren't particularly pretty. Tension is high and nerves are frayed." Integration is not a hopeless cause, though. CSFB has already absorbed one group of disgruntled bankers - the BZW group of just under 1,000 staff. And it executed that very well. Several members of the old BZW group now hold senior positions in CSFB. Charles Stonehill is deputy head of investment banking at CSFB in New York. He is keenly aware of how depressing a sale can be, having joined BZW from Morgan Stanley just six months before it was sold, only after receiving personal assurances from Barclays' then CEO Martin Taylor that he was committed to the business. Richard Gillingwater and Charles Kirwan-Taylor are two more ex-BZW managers still at CSFB. Gillingwater is head of European M&A; Kirwan-Taylor is head of European equity capital markets. CSFB needed their franchise, so perhaps it was not that difficult to make them feel wanted after parent Barclays had effectively thrown them out with the trash. Placating 10,000 DLJ staff will be much more tricky, though one DLJer describes CSFB's approach as "thorough, professional, and very considerate of our position. I've been through a messy merger before, and this one is being handled in completely the opposite manner. I'm surprised, and impressed." Although many have been at DLJ since starting in their careers, there is a significant minority of people who joined the firm who were casualties of earlier mergers. The high-yield group was built around former Drexel people. Chris Lynch and Paul Galant joined from Smith Barney to set up high-grade debt capital markets (Galant was made head of e-commerce in February this year). Dick Barrett and his financial institutions group moved from the old UBS, one block up Park Avenue, as did some of the foreign exchange team run by Kenneth Gettinger. Their experience might help temper the feelings of a core group of long-serving DLJers who are angry at the loss of the name and at the identity of the partner that has been forced upon them. The high-yield group especially appears to be involved in a protracted battle with its CSFB counterparts. And in London, head of international equity capital markets Hector Sants is faced with a Swiss bank breaking up his business for the second time in three years. He was previously head of equities at the old UBS, the losing side in the merger with SBC Warburg. He earned a great deal of respect for sticking it out and battling to get jobs for as many of his people as he could. He then left to set up DLJ's European operations, which were launched in the first half of last year. Despite DLJ's strong presence in telecoms, it is likely that Sants will again be forced to fight on behalf of his staff.

Makeweights or heavyweights?DLJ has three business lines that have received relatively little attention since the merger was announced. One is its private equity unit. As of the end of 1999, the firm had $12 billion in funds, either invested or ready to invest, one of the largest funds on the street, and one of the most successful. Competitors quip that the unit is so profitable that it can afford to pay the salaries and bonuses of all DLJ executives of managing director level and above. This is a business that CSFB does not have, or at least not in any size (it owns, for example, 20% of asset management and private equity firm Warburg Pincus). And it is a business that major banks have been lending more weight to. Chase, Citigroup, Morgan Stanley Dean Witter, Goldman Sachs, each have, or are building, significant private equity arms. Goldman, for example, recently closed a $5 billion fund, one of the largest single funds ever. The second business is the quiet money spinner: Pershing. This is the second-largest clearing operation on the New York Stock Exchange (Bear Stearns is larger), accounting for 10% of volume, and acts as the perfect earnings foil to DLJ's more volatile businesses. It is an operation CSFB does not have, but an earnings stream it could benefit from. As yet there are no plans to incorporate the unit under the CSFB banner. The same cannot be said of the third business line, DLJdirect. This is DLJ's retail distribution arm, a 12-year-old business that has been among the leaders of the retail brokers' rush to go on-line. Last year DLJ listed 20% of its subsidiary on Nasdaq, although its shares have not been trading all that well. DLJdirect is nowhere near as large as Schwab or E*Trade, but that was intentional, as DLJdirect is aimed at the mass affluent - $10,000 gets you a trading account, but to get the full benefit of the service, such as DLJ's equity research, clients have to have $100,000 or more of investable assets. CSFB developed its own access to retail investors three years ago when it, along with JP Morgan, struck up an agreement with Schwab to distribute IPOs to its customers. At the time it was a stop-gap measure to help CSFB to compete at least in part with the retail platforms investment banking powerhouses Merrill Lynch and Morgan Stanley (which bought Dean Witter in 1997) could bring to the table. As retail trades have increased, so the need for a dedicated retail platform to complement institutional sales coverage has increased. For their part, retail houses recognize the need to have access to institutional investors, which is why Schwab has set up Epoch Partners. The agreement with Schwab is due to lapse within the next few months, and neither side was particularly keen to extend it, even before CSFB got its hands on DLJdirect. CSFB had been working on its own retail platform, called Apollo, for the past 18 months. CSFB set aside $250 million for it, and put Kevin English in charge. He hired about 120 people, who sat on their own floor in the bank's Madison Avenue headquarters, out of bounds to the rest of the firm. The team had spent about $100 million thus far, but once the DLJ acquisition is finalized the group is to be disbanded.

In its place CSFB gets a ready-built platform with a recognized brand and a solid customer base, saving it hundreds of millions. It appears to be recognizing the full benefits of this, as initial plans to change the name to CSFBdirect have been shelved, at least for now. Retail customers, it appears, are more loyal and discerning than institutions.