Lazard Ltd

NYSE:LAZ

Earnings Call Transcript 2022-Q3

[Operator]

Good morning, and welcome to Lazard's Third Quarter and First 9 Months of 2022 Earnings Conference Call. This call is being recorded. [Operator Instructions].

At this time, I will turn the call over to Alexandra Deignan, Lazard's Head of Investor Relations and Corporate Sustainability. Please go ahead.

[Alexandra Deignan, Head, IR]

Thank you, and good morning. Welcome to Lazard's earnings call for the third quarter and first 9 months of 2022. I'm Alexandra Deignan, Head of Investor Relations and Corporate Sustainability. In addition to today's audio comments, we have posted our earnings release and an investor presentation on our website. A replay of this call will also be available on our website later today.

Before we begin, let me remind you that we may make forward-looking statements about our business and performance. There are important factors that could cause our actual results, level of activity, performance or achievements to differ materially from those expressed or implied by the forward-looking statements including, but not limited to, those factors discussed in the company's SEC filings, which you can access on our website. Lazard assumes no responsibility for the accuracy or completeness of these forward-looking statements and assumes no duty to update these forward-looking statements. Today's audio -- today's discussion also includes certain non-GAAP financial measures that we believe are meaningful when evaluating the company's performance. A reconciliation of these non-GAAP financial measures to the comparable GAAP measure is provided in our earnings release and investor presentation.

Hosting our call today are Kenneth Jacobs, Lazard's Chairman and Chief Executive Officer; and Mary Betsch, Lazard's new Chief Financial Officer. Mary Ann will start the discussion with an overview of our financial results, then Ken will provide his perspective on the outlook for our business. After that, Ken and Mary Ann will be joined by Peter Orszag, Chief Financial Officer of Financial Advisory; and Evan Russo, Chief Executive Officer of Asset Management as they will open the call to questions. I'll now turn the call over to Mary Ann.

[Mary Betsch, CFO]

Thank you, Ale. Good morning. Let me begin by saying how happy I am to be here at Lazard. I'm looking forward to meeting many of you on the call today as I settle into my new role. Let's get started with a review of our financials. Today, we reported record third quarter operating revenue of $724 million, a 3% increase from revenue of $702 million in the third quarter of 2021. Operating revenue for the first 9 months of 2022 was $2.1 billion, 3% lower than in the first 9 months of 2021. In Financial Advisory, we recorded third quarter revenue of $454 million, up 19% from last year's third quarter. For the first 9 months of the year, operating revenue was also at a record level of $1.2 billion, 7% higher than the same period in 2021. As demonstrated by the record quarter, M&A has been active, particularly in Europe, where we advised on several high-profile transactions.

In restructuring, although activity is still relatively low, our discussions with clients are increasing as a result of current market conditions and demand for liability management. In addition, our restructuring practice is ranked #1 globally on announced transactions year-to-date. Our sovereign advisory team is also working on a number of complex assignments. In Asset Management, third quarter operating revenue was $263 million, 15% lower than third quarter 2021 revenue of $311 million. Management fees of $241 million decreased 20% year-over-year. Incentive fees in the third quarter were $22 million compared to $7 million for the third quarter of 2021. For the first 9 months of 2022, Asset Management revenue was $840 million, a decline of 14% compared to the first 9 months of 2021, reflecting lower average assets under Management. As of September 30, we reported AUM of $198 billion, a decrease of 27% compared to September 30, 2021, and 9% lower on a sequential basis from June 30, 2022. The sequential decrease was driven by market depreciation of $10.3 billion, foreign currency depreciation of $6.6 billion and net outflows of $2 billion. Average AUM for the third quarter was $212 billion, decreasing 24% from a year ago and 8% on a sequential basis. This reflected global markets continuing to weaken in both equities and fixed income during the third quarter. In addition, the strengthening U.S. dollar has been a headwind thus far in 2022.

As of October 21, our AUM was approximately $200 billion, driven by market appreciation of $3.4 billion, negative foreign currency impact of $0.6 billion and net outflows of approximately $0.7 billion. Now turning to expenses. We accrued compensation expense at a 60% adjusted compensation ratio in the third quarter compared to 58.5% in the second quarter of 2022. For the first 9 months of 2022, we accrued at a 59% ratio. This is our best estimate for the full year but is subject to performance during the remainder of 2022. Compensation levels reflect our significant investment for growth in both businesses and our focus on investing in and preserving intellectual capital through the cycle. Our adjusted noncompensation expense for the third quarter was $128 million, 10% higher than the prior year, primarily reflecting the impact of increased travel and investments in technology. Our effective tax rate for the third quarter as adjusted was 25.1%, which is unchanged from the prior year quarter.

For the first 9 months of the year, our adjusted tax rate was 25.6% versus 26.2% in 2021. We expect this year's annual effective tax rate to be in the mid-20% range. We have generated strong cash flow year-to-date. In the third quarter, we returned $286 million to shareholders, including $46 million in dividends and $237 million in share repurchases. Additionally, yesterday, we declared a quarterly dividend of $0.50 per share. During the third quarter, we bought back 6.7 million shares of stock at an average price of $35.63 per share. During the first 9 months of 2022, we repurchased a record 17.2 million shares at an average price of $35.49 per share. Our weighted average share count at quarter end was 102 million shares, a decrease of 11% from 114 million shares in the prior year quarter. Our unweighted share count as of September 30 was less than 100 million shares. Our total outstanding share repurchase authorization as of September 30 was $382 million.

Ken will now share his perspective on our performance and outlook.

[Kenneth Jacobs, Chairman & CEO]

Thank you, Mary Ann. Let me take this opportunity to again welcome you to Lazard. The global macroeconomic environment continues to reflect significant levels of uncertainty. Global inflation remains at multi-decade highs to fight these central banks have engineered sharp interest rate increases around the world and further rate hikes are likely. Until there is more clarity on interest rates, inflation in the economy, we can expect ongoing turbulence in the capital markets. Amid these challenging conditions, Lazard continues to perform well, and our record third quarter results underscore the strength, stability and discipline of our model across both our businesses. In Financial Advisory, we delivered record operating revenue for the quarter, year-to-date and over the last 12 months. These results were driven by record performance in Europe, despite a slowdown in M&A activity around the world.

While the market is softening, we are seeing an increase in client conversations pertaining to restructuring and liability management. The energy transition continues to drive deal activity in the sectors that are less influenced by the business cycle, such as health care and reshoring and infrastructure investment are propelling a range of substantial transactions globally. We are making investments to further diversify our offering for clients in financial advisory, including expanding our efforts in infrastructure, broadening our coverage in private credit and launching a new geopolitical advisory group.

In Asset Management, the strength of the U.S. dollar resulted in continued foreign currency headwinds in the quarter as approximately 2/3 of our AUM are invested in non-U.S. dollar assets. As markets remain under pressure, we are focused on working with our clients as they navigate today's complex global investing environment.

Our research-driven fundamental investment style continues to perform well, especially in our value -- relative value and quality portfolios. Additionally, we continue to innovate around thematic strategies, such as our recent launch of a Lazard Thematic Inflation Opportunities strategy as well as building upon recent successes in sustainable agriculture and digital health. For Lazard as a whole, we are making investments in people and technology to position us for success through the economic cycle while being disciplined on cost and managing our business for the long term. We remain focused on serving clients while maintaining profitable growth and shareholder value. Now let's open the call to questions. Thank you.

[Operator]

[Operator Instructions]. We'll take our first question from Richard Ramsden from Goldman Sachs.

[Richard Ramsden, Goldman Sachs Group]

So Ken, maybe I can start off with a bigger picture question, which is where do you think we've got to in terms of both private equity firms and strategic adjusting to much higher borrowing costs and less leverage. I mean, I guess, look, the specific question is, it looks as if both short rates and long rates are going to be structurally much higher than what we've seen over the last couple of decades. So what do you think that means for the longer-term growth trajectory of the advisory business?

[Kenneth Jacobs, Chairman & CEO]

Look, I think you have to separate out financial sponsors from strategic. So let's talk about the strategics first. I think, generally, when you're talking about strategics, you're looking at investment-grade credits that drive the market. Generally speaking, they have strong balance sheets, and they tend to be opportunistic during periods of uncertainty. And I think we'll see that. It takes some time for that to happen because you need an adjustment between buyer and seller expectations. But I think we're starting to see that, and I think we'll see opportunistic activity across a range of sectors by strategics. It's not going to be at the levels of a boom cycle, but I think we'll see more of that. And then as people become more comfortable with their ability to predict the future, that has more confidence in their predictions than I think you'll see activity pick up again on a more sustained basis, but we're not quite there yet. There will be industry -- strategic industries where I think there'll be activity through the cycle. These will be industries which are less affected by the business cycle itself. Good examples of this are ones that have catalysts that will push activity. The best is in the energy transition. I think to continue to see a lot of activity there. I think you're going to see activity in sectors, again, that not too influenced by the business cycle like health care, perhaps some of the telecom area and such.

Moving to sponsors for a minute. There, you're much more subject to the noninvestment-grade credit environment. And you've seen, obviously, the high-yield markets -- the public high-yield markets have been closed for quite some time. the private credit markets pulled back in the summer. And I think until, again, we have more certainty about the future, those markets are going to be tough, and traditional type of high leverage sponsor transactions are not going to be that plentiful. That said, the sponsor universe is an incredibly creative group of participants and you're starting to see people adapting to the environment. One area is equity -- heavy equity investments that is investments where you're finding a financial asset that can be moved and then taking a minority investment in that asset. That's one area where we've seen some activity. You're seeing it in continuation funds. That's an area that's been pretty active for us. And I think in areas where infrastructure is the primary investor not relying a lot -- on a lot of debt financing, you continue to see activity that's in the telecom infrastructure space, we're seeing that clearly in the renewables space, and I think you'll see it in some of the moves around onshoring. So that's kind of a pick on the landscape.

But I think candidly, until you see more certainty about the environment that is people being more comfortable with their predictions about the future with regard to interest rates, inflation, importantly, the depth of the recession in Europe and if there will be a recession in the U.S. and the depth of that recession, I think the financing markets are going to be pretty volatile.

[Operator]

Our next question comes from Brennan Hawken from UBS.

[Brennan Hawken, UBS]

Mary Ann welcome, and congrats on the new role. Would love to start off actually by dovetailing on that last question from Richard. We've seen over the past decade, what's been described as a secular shift in the share of M&A activity to sponsors or that sponsors are involved with. And certainly, some of that is secular, but maybe with the remarkably low rates and buoyant period that we've seen here in the last couple of years, maybe some of that was also a bit cyclical. Do you have a view on how much of the shift was secular versus cyclical? And how are you thinking about the shift that you've been making towards sponsors given the potential for some of that to reverse?

[Kenneth Jacobs, Chairman & CEO]

Yes. So there's clearly been a mix of both. Secular in the sense that the -- just the sheer magnitude of money that is being managed now by the sponsor universe compared to where it was even 5, certainly 10 years ago is vastly different, and that's going to continue. There's just been a tremendous demand for alternative investments. And we'll see some pullback on funding because of the pull in assets under Management by the end owners, but I think the allocation still will remain pretty high. And therefore, this funding the secular move towards alternative investments, particularly private equity, is going to continue for a while, and that money has to be put to work. So that's the secular part of it. Clearly, there have been some cyclical elements to it that is the turnover portfolio perhaps is being pushed to a degree by the ability of very low-cost financing that is sponsor-to-sponsor deals, are probably more manageable on a very low financing environment, but there's alternatives for a lot of these companies, which at the right pricing in the public markets and alternatively to strategic. So I think it's going to be a strong environment from a secular standpoint, some pullback in cycle. And actually, that mix, that kind of environment is almost tailor-made for the kind of positioning we have with regard to our mix between strategics and sponsors. We were way underweighted a few years ago. We're more balanced today, but we never have gone nearly as far as some of some of our competitors with regard to commitment to sponsor activity.

[Brennan Hawken, UBS]

Fair. Sure. Okay. So it sounds like you think it's was more of a supporting role than the starting one.

[Kenneth Jacobs, Chairman & CEO]

Yes.

[Brennan Hawken, UBS]

Okay. That's helpful. And then shifting gears to the comp ratio. So we saw an increase by about 100 -- 50 basis points this quarter versus where you had been running year-to-date. What drove that increase? And how should we be thinking about the comp ratio for the full year?

[Kenneth Jacobs, Chairman & CEO]

Well, as you know, comp ratio is at this point in time is always our best estimate of what it will be for year-end. But of course, this is a business where what happens in the fourth quarter. That's when we pay people, that's when we get to see what's going on in the outside environment and so on and so forth. So you don't really know your final decisions until you get through year-end. That said, you have to remember, we're a little bit different from some of our peers in that we have 2 businesses, the advisory business and the asset management business. As you know, the Asset Management business operates on a different set of characteristics in the advisory business, particularly with regard to comp ratio. And you can see what's happened in terms of the contribution of revenues from the asset Management business to the overall revenues of Lazard. And if you do the math, you can see what the impact could be on compensation.

[Operator]

Next question comes from Ryan, Devin from JMP Securities.

[Devin Ryan, JMP Securities]

This is Devin Ryan. And welcome, Mary Ann as well. I guess, first question, just on the environment. So Ken, you talked about the M&A activity, I think industry-wide has been slowing, but Lazard is a very diverse business and businesses like restructuring and debt advisory [indiscernible] defense are accelerating in this backdrop. And so love to just maybe put it all together and think about what client engagement overall when you think about all those pieces of your business that looks like today, relative to maybe a year ago when M&A was hotter, but some of these other businesses were less active.

[Kenneth Jacobs, Chairman & CEO]

Yes. So in our business, you always prefer an active M&A environment in any other environment because it obviously is what provides the best outcomes, I think with regard to fees and revenues and everything else. It's just -- that is a buoyant atmosphere. That said, as you pointed out, we're constructed to be able to take advantage of a lot of different environments. And I think the breadth of our business, both geographically and across a range of industries and capabilities helps offset or buffer some of the drop in the M&A activity. It never fully offsets it, as we all know. What we're seeing is, in fact, what happens in these environments is dialogue tends to go up as things get worse. But that doesn't mean there's as many transactions. But at the same time, we're seeing a lot more dialogue around liability management than we did a few months ago. As you'd expect, when you have the drop in earnings combined with increase in interest rates, companies that need to go to the market are going to be constrained and they have to start thinking about alternatives.

We're seeing a real uptake in everything around the energy transition that just is an area of a lot of activity both in the U.S. and in Europe. And I think some of the areas that I pointed out before that are less subject to the business cycle are going to continue to do well here. But this is an environment where you're spending a lot of time with clients and you're trying to solve problems. So oftentimes, that aren't necessarily built around M&A, and that's something which we do from cycle to cycle.

[Devin Ryan, JMP Securities]

Okay. Great color. Shifting gears, just want to talk about capital return and the buyback. Clearly, there's been, I think, a shift internally at Lazard around just the appetite for buybacks and 17 million shares year-to-date and almost $7 million in the third quarter, just the pace is continuing here. I'd love to just think about how you guys are internally thinking about capacity for buybacks and maybe appetite from here? I know you have $1 billion of the cash, but you have to earmark some of that for compensation. And so just how we should think about capacity and also ability to continue at maybe a similar pace, just given that it is starting to move the needle on, I think, shareholder value, in my opinion.

[Kenneth Jacobs, Chairman & CEO]

Yes. We agree with you on that, hopefully. Obviously, at the levels that the stock is out, it's been attractive to buy back shares. And we will, with the resources we have, continue to take advantage of that. Again, this is a very cash-generative business through the cycle. And as you know, we allocate a certain amount of that cash to dividend and the remainder to buyback. And that's how I think you can expect it to unfold over the course of the next period of time. We have a very large share authorization outstanding. And at these levels, we think there's value in our -- in buying back shares. And I think our goal is to continue to do that.

[Operator]

And our next question comes from Manan Gosalia from Morgan Stanley.

[Manan Gosalia, Morgan Stanley]

Welcome Mary Ann. I had a question on the asset management fee rate, that's been steadily climbing. And I know part of the reason is that the outflows earlier this year were from some of the lower fee mandates. Is the same thing happening this quarter as well? And I guess the question is, how much more room does that have to run where you might see a few more outflows here or a little bit more mix shift, but you should see the fee rate climb.

[Evan Russo, CEO, Asset Management]

Manan, it's Evan and I'll take that one. Yes, look, as you mentioned, the last couple of quarters, we've seen the sort of stabilization actually increase in the average basis points, average fee rate the bulk of our business. And as you correctly pointed out and we talked about this last quarter as well, some of the outflows that we've seen in the past 2 quarters were from lower fee platforms, lower fee products, a couple of larger mandates. So that had an impact. But generally, as you point out, look, at the end of the day, the average fee rate is driven by the mix of assets that we have and a little bit on the vehicle mix as well, and that sort of shifted a little bit more into our favor. We've also had some strong flows and performance this year in many of our equity part of our business, the equity products that we've had, some of our listed infrastructure, global equity, global franchise and other areas. And we've also seen some less pressure from some of the outflows that we've seen in the past from EM. So that's all sort of contributed to the sort of creating a more stabilized average fee rate over time. Look, I expect it to still be lumpy, and it's going to be dependent upon the business mix and the mix of assets going forward.

[Manan Gosalia, Morgan Stanley]

Got it. And then just a quick question on the FX side. I was wondering, has there been any material impact from the stronger dollar on your pretax margins? I mean I know there is a headwind to revenues on the translation and the benefit of expenses. But are there any -- is there any mix between regions that we should be thinking about between expenses and revenues that might have already had an impact on your pretax margins year-to-date?

[Evan Russo, CEO, Asset Management]

Yes. So look, I think on the FX component, as you mentioned, the biggest part of the FX impact is that you're going to see it in the AUM that we see because obviously, as we point out, we have about 2/3 of our AUM is a non-U.S. dollar assets. So you're going to see it in the translation to that component. But as you correctly point out, Manan, look, at the end of the day, as we get closer towards year-end, you're also going to see some impact on the expense side because many of our non-U.S. dollar assets can also be the expense part of those assets that we manage sometimes are in different areas around the world, which could have different currency impacts, and that could have an impact margin, specifically in the asset management business. But overall, I'd say if you want to comment about the general business, I'd say, look, FX plays a role. We're a large company that has a significant portion of our overall business in foreign currency and non-U.S. dollar denominated. That does have an impact on the expense line as well.

[Operator]

Our next question comes from Steven Chubak from Wolfe Research.

[Brendan O'Brien, Wolfe Research]

This is Brendan filling in for Steven. So to start, I wanted to follow up on Devin's question on capital return. I appreciate that you will continue to use the excess cash to repurchase shares. But I wanted to get a sense as to how we should be thinking about the cadence of the buyback from here in light of the elevated levels of macro uncertainty and your ongoing commitment to invest in the business.

[Kenneth Jacobs, Chairman & CEO]

Look, the issue on investing in the business is usually -- so far, the investments we've made in the business are organic in nature, and they run through the comp line. That's the kind of the beauty and the curse of being in a people business. And to the extent that we continue to do that, it doesn't really have much of an impact on the capital return policy other than the fact that if you overdo it, you end up driving down earnings, obviously. But to the extent that we're producing earnings, our goal is to return as much of that cash as possible to shareholders and the balance is between dividend and share buyback, and there's a lot of room between the amount that's left over from dividend and share buyback the levels we're operating at today. So to the extent that we have that cash and we see value in our stock, and I say, see value in our stock, we'll continue to buy it back.

[Brendan O'Brien, Wolfe Research]

Great. And then I guess I wanted to dig a bit more on Europe. You obviously had record results in the region. But we've seen in the public data that new business activity has steadily slowed as the years progress. Wanted to get a sense as to how the velocity of new deals has changed over the past 3 months? And what your outlook for activity in the region is going forward relative to the U.S. as it feels like headwinds there are a bit more acute given the reliance on Russian natural gas exports, the volatility in Britain that we've seen recently and the like.

[Kenneth Jacobs, Chairman & CEO]

Yes. So look, I would say our performance for the first 9 months of this year were against the terrible backdrop and completed transactions in the market. There was a big drop in Europe for the first part of the year in announced deals. I mean, in completed deals for the first 9 months and we way outperformed. I think that everybody is being impacted across the globe by this downturn in activity, it is both in Europe and in the U.S. What it stood out for us in Europe, I think, is a combination of things for the first 9 months, which was a really excellent franchise that's been focused on the areas that have been activity. But to the extent that activity levels fall across the board, that's going to impact us as well. And my guess is the real challenge for everyone right now is building backlog into the first part of next year and later into the year. And that doesn't only apply to Europe. It applies to the United States. And I think that's the challenge at the moment that we're all facing.

[Operator]

That was our last question. This now concludes the Lazard conference call.

[Kenneth Jacobs, Chairman & CEO]

Thank you.