Lazard (NYSE: LAZ) is an action that we have covered in 2020 along with the rest of the financial advisory companies in the market. The company is quite easy to understand, and we can see in which direction With rates rising and the general spike even before the hammer had officially fallen, the M&A boom was bound to turn. Now, with markets down sharply, we can expect major financial outflows, and with nowhere to really hide in asset markets, and with crypto possibly hurting consumer savings, these outings may become more sustainable than they were with COVID-19, where opportunities were still ample. Nonetheless, a restructuring franchise and other counter-cyclical elements of LAZ make it a story to watch, especially with the price falling so sharply.
A reminder of the Lazard model
Let’s quickly recap what LAZ actually does. It provides financial advisory services, which encompass mergers and acquisitions and typical capital markets fundraising work, as well as asset management, which primarily includes actively managed funds in mainstream asset classes. .
Traditionally, we call the split between these companies roughly 50:50, but due to the extraordinary boom in mergers and acquisitions, financial consulting has come a long way. The asset management business is generally where we expect less cyclicality, and LAZ focuses on this in its investor materials.
LTM figures show that on the FA side, revenue growth has slowed, which is expected given the liquidity pipe offered by monetary authorities during the pandemic, while in AM, which is a less leveraged business for all liquidity , has declined somewhat, but is well ahead even of 2019 levels.
What could happen next?
The problem is that there is nowhere to hide in the markets as we move from inflation to higher rates. Cash and fixed income are always a waste, even when rolling in MM funds, because of rising rates or at least because of inflation. Stocks are also pretty trash due to TINA conditioning breaking, consumer risk from leverage and rising rates, and of course corporate leverage which will also impact profits. Where do you put funds to work? It’s hard to say, and with crypto taking out a lot of retail money, maybe those funds aren’t being put to use and they’re going into household or cash savings in due to consumer uncertainty.
The FA segment will of course be affected by current conditions, but where AM is generally more stable, it will also be significantly affected. Comparatively, we believe more in the FA business thanks to the restructuring of LAZ, which is a well-respected franchise, as well as the various capital markets functions that are somewhat less cyclical than M&A. Moreover, with structural issues in the market due to geopolitics, defensive M&As may take on greater significance than, say, in 2008 and 2009, when the issue was a total credit crunch. The problems here are more related to the productive frontier, which means that mergers and acquisitions might still be needed to improve the position.
With AM having fallen in terms of AUM by around 10% in 2020, we believe that repeat performance is due, except that the recovery in 2021 will not occur. We expect a 15%-20% decline in current AM revenue with lost management and performance fees due to outflows of assets under management and weak overall market performance. With FA, we expect a little more downside, around 25%, where M&A could slump 50-60% with restructuring, now at historic lows, taking over with mixed declines capital market activities. Operating leverage isn’t too bad with a business like this, so we think net income could drop 33% on a current basis, which would normalize the 6.2x LTM PE to around 9x. The 6.2x comes from the aggressive declines in the LAZ price lately.
A multiple of 9x on a normalized basis means that even after a decline, the current earnings yield is greater than 10%. From a valuation perspective, this would mean a risk premium of around 6% over expected risk-free rates. The company profile probably doesn’t quite justify it, as the cash flow is attractive for both AM and FA business. However, with the direction clearly to the downside for sentiment in the markets, certainly the ones LAZ is connected to, we think we will stay on the sidelines here for now.