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Lazard Ltd
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Good morning, and welcome to Lazard's Fourth Quarter and Full Year 2017 Earnings Conference Call. This call is being recorded. At this time all participants are in a listen-only-mode. Following the remarks, we will conduct a question-and-answer session. Instructions will be provided at that time. [Operator Instructions]
At this time, I would turn the call over to Judi Frost Mackey, Lazard's Head of Global Communications. Please go ahead.
Good morning, and thank you for joining our conference call to review Lazard's results for the full year and fourth quarter of 2017.
Hosting the call today are Kenneth Jacobs, Lazard's Chairman and Chief Executive Officer; and Evan Russo, Chief Financial Officer. A replay of this call will be available on the Lazard website beginning today by 10 a.m. Eastern Time.
Today's call may contain forward-looking statements. These statements are based on our current expectations about future events and are subject to known and unknown risks, uncertainties and assumptions. 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. These factors include, but are not limited to, those discussed in Lazard's filings with the SEC, including our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
Lazard assumes no responsibility for the accuracy or completeness of any of these forward-looking statements. Investors should not rely upon forward-looking statements as predictions of future events. Lazard is under no duty to update any of these forward-looking statements after the date on which they are made.
Today's discussion may also include certain non-GAAP financial measures. A description of these non-GAAP financial measures and their reconciliation to the comparable GAAP measures are contained in our earnings release, which has been issued this morning.
For today's call, we will focus on highlights of our performance. The details of our earnings can be found in our press release issued this morning and in our investor presentation, both of which are posted on our website. Following their remarks, Ken and Evan will be happy to answer your questions.
I will now turn the call over to our Chairman and Chief Executive Officer, Ken Jacobs.
Good morning. Today we reported record results for 2017. We achieved record annual operating revenue with strong performance across all our businesses. And we generated record earnings from operations even as we increased our investments for growth.
These results underscore the strength of our business model, the power of our franchise and the results we are achieving for both clients and shareholders. Our Financial Advisory business generated record operating revenue for the third year in a row even as the global markets for M&A completions declined. We gained market share in global M&A announcements, our volume increased 3% while the market decreased 4%.
Our M&A activity was stronger in Europe, where economic growth is driving increased confidence among decision-makers. We are a market leader in the world’s largest and most complex M&A transactions. In 2017, we advised on four of the 10 largest M&A transactions completed globally, and three of the 10 largest announced transactions. And in 2018, our M&A announcements are off to a strong start.
In Financial Advisory, we are serving clients with a broad range of integrated capabilities including M&A, Restructuring, Shareholder Advisory, Capital Advisory, Capital Raising, and Sovereign Advisory. Our asset management business achieved record operating revenue in 2017 gaining momentum throughout the year with record quarterly revenue for each of the last three quarters.
Assets under management increased 26% in 2017 ending the year at a record level of $249 billion, an increase of $51 billion from the end of 2016. We achieved annual net inflows for the fourth year in a row in an industry where most active equity managers continued to experience substantial net outflows. We continue to invest in the development and scaling up of new and existing platforms. In 2017, we expanded our quantitative and multiasset platform, as well as our distribution capabilities globally.
We see opportunities for growth in both our asset management and Financial Advisory and we have been stepping up our investments in people, technology and new initiatives accordingly. We are investing in the development and promotion of our outstanding performers, strategic hiring, enhanced services for clients, thought leadership initiatives and the ongoing evolution of our work processes and environments.
We are successfully achieving significant organic growth and we continue to consider inorganic growth opportunities, including [list outs] and acquisitions.
Evan will now provide color on our financial results and capital management. Then I will comment on our outlook.
Thank you Ken. Lazard's full year and fourth quarter results reflect the stability and continued high-performance of our businesses. Full-year operating revenue in 2017 was a record $2.7 billion, 13% higher than the prior year. Diluted net income on an adjusted basis increased 22% to $3.78 per share for the year, a record level.
In Financial Advisory, we completed the year with a record $1.4 billion in operating revenue, up 1.7% from 2016. This was driven by strong performance in M&A despite a relatively soft second half for closings, reflecting upon the announcements after the US presidential election.
Restructuring had another strong year as we continued to advice on high-profile global assignments. In the fourth quarter restructuring revenue tapered from the high levels of the prior two quarters, reflecting a more normalized level of activity for current market conditions. Financial Advisory fourth quarter revenue was down from last year's record quarter, but our advisory business had momentum entering 2018 with a strong pace of M&A announcements in January and a high level of activity in both Europe and the United States.
In asset management, annual operating revenue reached a record $1.24 billion, up 20% from 2016. In the fourth quarter, asset management achieved its highest quarterly operating revenue ever, $339 million, up 23% from a year ago. Management fees increased 18% year-over-year reaching a record level. In the fourth quarter, they increased 3% sequentially from the third quarter of 2017.
Incentive fees for the year were $46 million compared to $16 million in the prior year, reflecting our strong performance. During the fourth quarter, average AUM reached a record level of $244 billion. This was a sequential increase of $10 billion or 4% from the third quarter of 2017.
The increase was driven primarily by market appreciation, foreign exchange movements and net inflows of $137 million. For full year 2017, we achieved net inflows of $3.1 billion. Gross inflows remained strong across our investment platform.
Our asset management business continues to be resilient amid deep pressure in the asset management industry. In 2017, our average management fee was 51 basis points, consistent with the average of recent years. Asset management is off to a strong start in 2018. As of January 26th, AUM was approximately $265 billion, 17% higher than its average for 2017. The increase from year-end was driven by market appreciation of about $10 billion, positive foreign exchange movement of about $5 billion and net inflows of over $1 billion.
Turning to expenses, in 2017, we maintained our cost discipline with an adjusted compensation ratio for the year of 55.8%, down from 56.5% in 2016. The corresponding awarded comp ratio was 55.6% down from 56.2% in 2016. Awarded compensation includes significant investment in our business during 2017 through hiring and acquisitions.
Adjusted non-compensation expense for the year rose 6%, reflecting our increased investments in the business and marketing expenses related to higher levels of activity. Our non-comp ratio declined year-over-year from 18.5% to 17.4%. Our adjusted non-comp expense excludes certain charges primarily reflecting the implementation of a new global enterprise resource planning system.
We realized $25 billion of these costs in 2017 and expect up to another $15 million in additional costs in 2018. With our continued focus on revenue growth and cost discipline, we achieved strong operating margin expansion. On an adjusted basis, our operating margin was 26.8% for the full year, up from 25% in the prior year.
Our 2017 effective tax rate was 24.1%, up slightly from the prior year's rate. Looking ahead in 2018, we expect the significant benefit from recent accounting changes to the tax treatment of stock-based compensation. Assuming current stock price levels, we estimate the benefit of our annual effective tax rate for 2018 will be approximately 500 basis points.
Now let us walk through the effect of US tax reform on our business. The immediate impact was on our US GAAP fourth quarter 2017 earnings. Like many other financial institutions, we incurred a non-cash charge relating to reduced value of our deferred tax assets. The net impact after an offsetting benefit from the reduction in our tax receivable agreement obligation was $217 million or $1.81 per share for the quarter.
Going forward, the new tax laws provide a significant benefit to our tax rate under our current business structure. We estimate that with no change to our structure, our steady-state annual tax rate will decline by approximately 200 basis points to 300 basis points, result in a future effective tax rate in the mid-20s with cash taxes expected to be in the mid-to-high teens before discrete items.
As we have discussed in the past, we would prefer a C corp structure for Lazard for a number of reasons, and we had hoped that tax reform would provide a relatively simple route to conversion. However, specific provisions within the new tax laws mean that a straightforward conversion to US C corp would result in a significantly higher tax rate for Lazard. The primary reasons are these; first, our NOL balances would limit our ability to use foreign tax credit, as well as a new special deduction, the so-called new territorial system.
This would make most of our non-US earnings subject to double taxation. Second, the categories of foreign income taxed in the United States would be expanded and certainly incomes not currently taxed in the United States would become subject to US tax. We estimate that these and other factors would increase our effective tax rate by approximately 10 percentage points, although we are actively exploring potential structuring alternatives that could mitigate some of these economic costs.
It is also important to remember that many items in tax reform await further guidance from treasury or the IRS. Net-net, the impact of US tax reform is a significant benefit to our tax rate under our current structure and a significant detriment to our tax rate were we would convert to a C corp.
Turning now to capital allocation, we continue to generate strong cash flow to support share repurchases and dividends. In 2017, we returned $760 million to shareholders through a combination of share purchases and dividends. Consistent with the past several years, we are also returning capital to shareholders in the form of an extra cash dividend.
Yesterday, we declared dividends totaling $1.71 per share comprised of a quarterly dividend of $0.41 per share plus an extra cash dividend of $1.30 per share.
Ken will now conclude our remarks.
Thank you, Evan. The year is off to a great start. The current global macroeconomic environment continues to strengthen with synchronized growth across the world's major economies. The US economy remains healthy and tax reform has boosted earnings expectation. Priority on tax policies [removed] the drag on large-cap M&A. In every sector, the new tax laws are spurring discussions on capital structure and strategic planning.
In Europe, an improving economy is raising growth forecasts driving increased confidence in M&A activity. Shareholder activism is expanding in this market fueling demand for our Financial Advisory business. Improving corporate earnings combined with the impact of US tax law changes are starting to re-enforce market valuations in both developed and emerging markets. Both of our businesses are exceptionally well positioned in this environment.
In Financial Advisory, we have an unrivaled global platform serving clients on large strategically driven transactions with broad [indiscernible] across industries, practices and geographies. In asset management, we are serving a global, primarily institutional client base, with a diversified set of investment strategies and a strong pattern of long-term performance.
Our quantitative strategies are competing effectively against passive products and we continue to expand our platform through the seeding of new strategies, lift-outs and fund launches. A few key takeaways; we achieved record operating performance in 2017 and we have momentum entering 2018 in both our businesses. Asset management’s AUM is now 17% above its average level in 2017 with net inflows and resilient management fees.
Financial Advisory’s activity is accelerating in a vibrant M&A environment. We are investing in our businesses for continued growth. We are maintaining our cost discipline. Tax reform is a 200 basis points to 300 basis point benefit for our tax rate, and we are returning substantial cash to our shareholders.
We remain focused on serving all our clients well while we manage the firm for profitable growth and shareholder value over the long term.
Now let us open the call to questions.
[Operator Instructions] We'll now take our first question from Brennan Hawken from UBS. Please go ahead.
Good morning. Thanks for taking the question. I just wanted to maybe start on the incremental color on the C corp conversion. I know that you indicated that you are still looking through it, and we are still waiting for guidance from the treasury and the IRS here. But I guess how definitive is this view and is this the sort of thing that I would think, personally given Lazard’s background, you guys are very well positioned to come up with a creative solution for it. So how should we think about – how should we think how we go from here and what some of the different avenues are for coming up with a new structure?
Okay. So let me give you a big picture on that and then Evan give you a little bit more color. I think we have been pretty straightforward in all of our conversations with you and with shareholders over the course of the last year or so as tax reform has unfolded that our strong preference would be to convert to a C corp for all the reasons that we have explained in the past.
Tax reform, as it unfolded, moved quite a bit from where we expected it to land. And I think that was the case for many people. It was not a terribly transparent process until the very end. And we were – I think I would describe it as pleasantly surprised at how it turned out – how it turned out for the resilience of our current structure not only in terms of stability of that structure, but also with regard to the benefits in terms of rate on that structure.
And we are also somewhat surprised by the difficulty that it created in terms of converting to a C corp and the costs involved in doing that. The impact of the use of NOLs and OFLs turns out to be quite punitive to us certainly over the foreseeable future under, what I would describe it, simple conversion, which is what we had anticipated. And then there are other features which I have been described around foreign income taxed in that US that is also quite punitive.
I think we have carefully left open the possibility still of a conversion, but it would require a lot more study. And also it is much more complex to achieve. So it is next to impossible for us today to give any guidance on the likelihood that that is going to happen.
But I can say with real certainty that if we had our druthers, we would be at C corp, but today that looks uneconomic to us.
Evan, do you want to add anything or is that…?
Hi, Brennan. I think Ken summarized it well. I think there is a difference between where this started, where it ended and really a lot of it had to do with the benefits we have received under tax reform. We had 200 basis points to 300 basis points of ongoing benefit leading to a mid-20s type rate, which is where we are heading. And that created a significant benefit, and as Ken mentioned, made our structure more durable going forward.
There are a lot of variables. We tried to highlight a few during the prepared remarks. But the double taxation of foreign earnings is certainly very critical. And the NOLs and OFL present a complicated situation that are going to increase the cost pretty significantly.
We're not going to do anything that's going to destroy shareholder value. And so, we analyze this very comprehensively certainly over the last few weeks but really the month leading up to as we went through tax reform and we are going to continue to analyze different structures as you said.
We are always looking and trying to find ways to benefit the shareholders and structures continue to evolve and the guidance from the I.R.S. and treasury continues to evolve. We'll continue to peak through different alternative structures that might be available to us.
Yes. No, as I've said before I think if anybody is well positioned to analyze a restructuring situation, it should be Lazard. So, I am so sure you guys will continue to work through it. One follow-up on that and thanks for all that color; that was really helpful.
When we think about that double taxation issue and the NOL issue for foreign tax credits. Is that something that as far as you understand that would be structural or is that something that would have a specific duration of a certain number of years and would be worked through overtime?
Look, some of it -- it's a good question. Some of the, as we've said there's many variable to this. With regards to NOL and the OFL, some of that is time-based right over time as those will decline; it's the economics of this will change; and it could make it more attractive.
But there are some structural elements that there are in tax reform with regards to foreign earnings being picked up in the U.S. and other components that are more structural in nature and those won't disappear over time unless the regulation's changed.
Yes. And also, you have to think about what our base was when we were talking about this over the last several months. We were anticipating that our current under our current structure we would be seeing our effective tax rates drifting up into the low-20s and at different points in time we have said in the low-30s.
And what's turned out to be the case is, with tax reform under our existing structure, we're seeing rates in the mid-20s, 23% to 25%, 24%, 25%, is where we are looking. So, the status quo, in other words what we are measuring this again became a higher hurdle than it was pre-tax reform. That's what made I think that's one of the big differences from what we're talking about before.
And Evan's absolutely right. In terms of talking about the NOLs and OFL, there is an element of time duration on those but unfortunately it's not kind of gradual. It's sort of when they in the end, it's not going to gradually end, so it's not gradually going to have an effect which is also part of the difficulty in making this decision.
Sure. No, I appreciate that and also appreciate the shift in the baseline; very fair. Just one clarifying final one from me. Evan, I think you said that a 500 BPS on the tax rate from stock based comp in 2018, is that do we take that and let that down from the mid-20s, the mid-20s is kind of like we go forward and then the 500 is not included in that. Is that correct?
Yes. That's a good question, yes. It's from our mid-20s going steady state of forward rate where we take 500. We are estimating today's again based on today's stock price levels estimating approximately a 500 basis point benefit. Obviously, that's subject to change when comp actually gets set on depending on stock prices at that point time but 500 basis point off of that level.
Great. Thanks for all the color.
We will now take our next question from Steven Chubak of Nomura Instinet. Please go ahead.
Hi, good morning.
Hi, Steven.
Hi. I wanted to stick with the same topic around C corp conversion. The 10% increase in the tax rate that you guided to would put you somewhere in the mid-30s. I understand there is a lot of complicating factors around double taxation but that's about 500 basis points higher than what any other financial company that we track has guided to thus far including those with heavy international gearing and have to look at other areas such as the B provision and are impacted by that which at least tells us at a very high level that your current structure is either sub-optimal or at the very least, inefficient.
I'm just wondering whether you guys would consider re-domiciling and then potentially going down the path to conversion which could potentially mitigate some of those foreign head wins.
Look, our current structure --. Hi, Steven. Our current structure we think is quite attractive producing a mid-20s effective tax rate with a cash tax rate in the mid to high teen. And we believe it is an attractive structure and has been for a while. The 10 points will put us in the through the low to mid-30s is what I would say is what the guidance we're giving, off of the 10 points, off of the mid-20s.
And so, that rate we consider to think is not sub-optimal based on where we are. We just think the current tax benefits that we're getting, the 200 basis points to 300 basis points puts that and make our existing structure quite beneficial.
Got it. So Evan, when you go down the path of that decision tree so to speak, when you consider the various puts and takes, you noted that you're not going to or will go down the path that destroy shareholder value. I could certainly appreciate that consideration.
But you also noted that you would clearly prefer a C corp conversion. And I'm just trying to -- I'm just wondering from my end how you guys are considering the -- like what valuation discount do you see or do you attribute to your current structure based on all the analysis that you've done.
And maybe where is the breakeven point where if you could get the rate to a certain level that you would be inclined to go down the path of C corp conversion?
Look Steven, I think that's exactly the right question and that's the one we've been pondering for a long period of time. And to be blunt about it, when we were looking at our tax rate on our existing structure, which was in the high-20s moving into the low-30s on a statutory basis and moving up over time moving up accordingly on a cash tax basis.
Then we were looking at a 1000 point increase or something less than a 1000 point increase at that point. So, in another words mid-30s versus that. You didn't have to assume much movement in terms of PE to offset the net income decline to get to a breakeven point.
And so, you could make the judgment that okay small movement in evaluation parameters such as PE or if you want to use EBITDA then adjusting per debt and everything else, it didn't take that much to believe that this could easily or more offset the decline in earnings.
The problem we think, the challenge now is we're looking at a 10 point change in statutory rate and a significant difference between cash and tax rate and the kind of movement in multiple hold our price, is significant. And then to expect some pick-up, I think gets into the position of being quite speculative.
And that's been the challenge for us. And as I said before, when the base line was high-20s, low-30s, this was a much more reasonable decision to make. It still had risk associated with it; does multiple adjust on something like this; is it already priced into the stock; what's the benefit of the larger ownership?
I mean, these are all things that went into our consideration. But with that kind of spread, it looked like essentially something that was more be tradeoffs. But when you're looking at a 1000 basis point difference, you can do the math on what that means to statutory taxes and you can do also do the math in terms of what it does to cash taxes.
You start to look at what you have to do to hold your price and then to get any kind of pick-up and everything then becomes much more speculative. And that's what challenged us.
And as I think Evan pointed out and I said this is all based on our preliminary analysis, based on the structures that were available to us today. We're pretty creative as you all know and as I think Brennan pointed out, this isn't something where we're going to sit on our hands and wait on and not continue to analyze.
But on the phase of what we're looking at today, it's just not that attractive unfortunately.
That's extremely helpful color, Kenneth. I thank you for that. It's just not that attractive unfortunately. Just one final one from me. Just looking at the balance sheet, your cash and cash equivalents at $1.5 billion stands at a near record or potentially record level. I was just wondering if you could speak to some of your cash management strategies or how you're evaluating your different capital management priorities given the strength of your liquidity position.
Yes. Even, you want to, why don’t you take this?
Sure. Look, we take a balanced approach to capital management when consider all the firm's capital return from dividend and share repurchases and liability management. And as you saw, we announced a extra-cash dividend yesterday as part of that capital management strategy.
Look, at the end of the year, we always sit at the high point of cash but the first and foremost first step we take is we're looking around at the business and think about what are the growth opportunities where we capital within the business and how we redeploy it.
And so, I think it's a balanced approach. I think we've been consistent in that message. And as we look at the balance sheet at the end, certainly it look very higher. A lot of things go into looking at what hits the balance sheet at the end of the year. Some payments that are going to hit in Q1.
So, some of this is just timing of payments that was going to happen which is over-exaggerating a little bit at the excess cash on the balance sheet today. But sitting at the high point, you'll see as the quarters go through, we continue to analyze and always continue to analyze the best use of cash in the business.
Yes. Let me just add to that. I mean, there's no question we're in a very strong cash position right now, which is in part the reason why we have the special dividends to kind of get that efficiently back into shareholders hand. We also have as only investing of shares that we repurchased and obviously the purchase price because of the movement in the stock is higher than it historically has been.
So, that will be one factor. And then on top of that, we're off to a good start this year. I imagine we're going to generate a lot of cash in the first half of the year. So, we're going to have to think about how we're deploying that over the course of the year. And as Evan has said, we see a lot of investment opportunity in our business right that now.
That doesn't mean we have suddenly throw money out to do things that are unwise. I think you guys know we've been extraordinarily disciplined about the use of cash historically. And we will continue to be. But this is an exciting environment for us right now.
Thanks. Well, I appreciate you guys indulging all the questions on the C corp conversion and the results are quite strong. So, congrats on the really good quarter.
Yes. Look Steven, I just want to thank you. I mean, you guys have been very forward on this whole conversion point and we try to be as responsive as we can to it. Now, I hope you understand this is something that we really want to do or would have liked to do. And I appreciate the color that you provided for the market and also the plotting to us on it.
And it's something that we've taken very seriously and we continue to. And so, the questions are good questions and you should just continue asking them.
Thanks very much, Ken. I appreciate that.
Our next question comes from Conor Fitzgerald from Goldman Sachs. Please go ahead.
Good morning.
Good morning, Conor.
So, you've had a lot of success in growing some of your ongoing --. I think you mentioned a shareholder active is in the fence and a couple of other areas. And your business has become a lot more diverse than simply completion fees.
So, my question kind of a two part. One, could you maybe quantify for us how much of a pickup that's been or how much those type of revenues are up. And then second, longer terms we do consider steps that help investors better understand that part of your business maybe by increasing the disclosure or getting a little more granular around your strategic advisor revenue breakdown.
Sure. Look, I think on a lot of the pieces of the business that complement the co-strategic advisory business and the restructuring business. But could you think about those as being the drivers of revenue on the advisory side.
But things that strengthen our ability to acquire a client, provide capability to differentiate us from the competitors who are competing against for that client and increased the stickiness with the client. And very importantly in the case of shareholder advisory, shorten the time that it takes to develop a relationship with the client.
So, I'm sensitive to the question which is how do you quantify the benefits to this. I say, a lot of the quantification is in just the enormous productivity gains we'd had over the last couple of years. I mean, when you look at kind of the growth in revenues on the advisory side in particular and you look at what how we've managed headcount over the same period of time, I think you find that there's been a lot of productivity increase.
And probably the best measure is on per professional basis because there is apples and oranges between firms and how they define MD, Senior MD's and the like. And that's the measure we have. And what we found is by adding shareholder advisory, by adding the capital advisory, by adding the debt advisory capabilities, these are all elements that make, that create competitive advantage for us.
These have been many of our peers and also shorten the time that it takes to develop a relationship with the client. And then also drive more of the potential in a particular situation. So, I think I'm sensitive to how do you break that out. I think the best way to look at it is probably to look at the growth of productivity on a per person basis for us.
And the fact that many of these businesses have been created to accomplish that goal.
That's helpful, thanks. And then you've mentioned you've obviously had a very strong start to the year in January. Is this just you had a lot of deals that were kind of waiting for tax reform to happen and then they're now coming out the sidelines or is this more of a sustainable pickup in the M&A environment that you're seeing just given the broader macro economy?
I think the ones that have been announced for the first few weeks of this year, if I had to characterize them. They've not much to do with tax reform and more to do with the environment right now. I'm not denying that on the larger cap stuff that will evolve over the course of the year, I think that some elements of tax reform will influence that.
Maybe a better way to articulate it is the following. I'm not convinced one way or the other that American or European global companies needed any more liquidity from tax reform to do deals. And I think this was a highly liquid environment. There was plenty of cash available either on balance sheet or through the debt market last year and the year before.
I think what tax reform does is it provides clarity and certainty around what was a pretty uncertain environment around taxes for the last couple of years or so. And I think there were pluses and minuses for different companies with regard to tax reform. But what is really important is the clarity.
And I think the part of the market that impacts the most is large cap M&A, where there was the most uncertainty about what was going to happen. Now that that's clear, I think decision making is a lot easier for big companies to do things. And so, I think that's going to be the real impact of tax reform.
I think the rest of the M&A activity is underpinned by the fact they were in a global macroeconomic recovery right now. And the three factors which we tend to look at that, simple factor is we tend to look at the dry markets; all feel pretty good right now. This is the macroeconomic recovery. Global confident levels are high both in the fields and in boardrooms.
Financing is available as every I guess normal rate picks up a little bit but probably for good reasons because it reflects that central bank's pulling back on quantitative using and also help general health of the overall environment. But rates are still historically low and money is really available.
Evaluations at least in Europe in the emerging markets are still pretty reasonable. I think in the U.S. on the state limit they look pricey but when you take into account strong earnings growth and also the impact of tax reform. On earnings, they start it starts to look a little bit more reasonable.
So, this is a strong set of factors underpinning the M&A environment and I think that's what's going to drive the activity this year.
Thanks, that's helpful. And then just, if I could just squeeze one in on the C corp. 30,000 for view, your tax rate's going to be in the mid-20s which is similar to your peers you operate with how much you've been talking about it, the suboptimal ownership structure.
So, my question on that is, do you feel like it’s a priority for you over time to kind of to overcome that disadvantage. Because I just think from the outside if you have the same tax rate and the suboptimal and for the structure. That screens a disadvantage versus some of your peers?
Well, I think you hit it on the head. I think what we've done is an enormous amount of work. I mean, one of the things we are is pretty analytical. I mean, I think that's what Lazard is pretty well known for.
And in area we studied very carefully for us is really obviously the impact of conversion to C corp, obviously the benefits of extended ownership by inclusion and indexes and attractiveness to a larger group of shareholders. There is no question that there were benefits associated with that.
Either like many of our peers who are publicly traded partnerships, while we are a K-1, we don’t have UBTI. So, we are not locked out of as many active managers as some of our peers are. In addition, when you look at our existing ownership today, actually you will find that our index ownership has actually increased over the last couple of years or so.
Some of that is technical, some of it is just a little bit of luck in terms of the inclusion in some industries that we hadn’t been included in before. Some of that is work on our part to accomplish that.
What we've done over the course of the last several months and in course of the last year as this has unfolded, is we have done a lot of work around trying to identify what's the real universe of people who don’t hold us today that could hold us in the event when unable to transform to the C corp and how we could value that. And there's a lot of work we've done around that.
And that's going to be a major priority for us over the next couple of months or so. We've really buttressed our IR team over the course of the last month or so to really help us achieve that. And that's going to be a major priority for us over the next few weeks.
That's very helpful color. Thanks, Ken.
And anything you guys want to do to help us on that, is welcome.
Our next question comes from Ann Dai of KBW. Please go ahead.
Hi, good morning. Thanks for taking my question. So, first one I have for you, it's kind of a piggy back on to Conor's question on non-M&A and all the different categories in which you compete and maybe just approaching it from a different direction.
My question is given the big footprint you have globally across advisory within so many categories, that there's M&A, non-M&A and all the global capabilities that you have. I think it just becomes a bit tougher to see where you're going to drive that incremental revenue, where you're going to hire the new MD that's going to drive the big revenues or how you're going to achieve that market share growth going forward.
So, could you just from a high level, share for us some areas where you see some meaningful growth within subsectors, geographies or capabilities from where you are today?
Okay. Well, great question. Well, first of all, I think one piece to look at in Lazard is there are over time we think enormous benefits to have a diverse franchise both in terms of the advisory business as well as the asset management business and also the benefit of having the two businesses together.
On the flipside of that, the worlds been a pretty uneven place. The world economic environment's been pretty uneven for the last seven or eight years. You had the recovery from the crisis which initially resulted in a growth in markets but not in M&A activity.
I mean, essentially M&A activity was back from roughly '08, '09 and '09 until really the beginning of '14. At the same time, markets were going up. We benefitted enormously by having an asset management business that was growing with the markets over. And also organically over that period of time from '14 to '17, the M&A markets were -- '16 the M&A markets were quite strong, at the same time, that the equity markets were not as powerful.
And so, the M&A business really drove the franchise during that period of time. '17 was a good year for both businesses but frankly speaking geographically, it was uneven. When you look at the performance in '17, asset management obviously benefitted from the recovery in global stock market, pretty uniformly in the developing markets and then later in the year in the emerging market.
And on the advisory side, it was pretty concentrated to activity in the United States. When you look at '18, I think this will be the first year since really before the crisis where we're seeing global activity strong in the U.S., Europe, Asia, on the advisory side or in the emerging markets increasing on the advisory side.
And on asset management you're seeing strong markets across the globe. Having your global franchise in this environment, I sort of pinched myself, I mean, this is when it really pays off. And so, you look at what you just compare to last year, I think we're going to see a pickup in and we've already seen a pickup of activity in Europe as a consequence of the strengthening of the markets there.
Our position in Europe, in the U.K, and on continental Europe is I think kind of second to none on the advisory side, certainly for any of the independence and I think frankly speaking there even to the diversified global firms.
And then you look at the investments we've made in the emerging market; Latin America, Asia, in recent years. I think we're going to start to see the real benefits from that expansion. And then obviously in the United States we that for us continues to be a lot of white space in terms of our ability to grow in this market.
It's obviously where there is a very large deep pull and very lucrative. So, I think we're likely to see those benefits over the course of this year.
And then on the asset management side of the business. Just having this business which has is diversified globally and is particularly well-positioned in areas where we're able we're differentiated from passive offerings; I think it's been one of the keys to good to our success there.
Okay, that's great color, thanks. Just a quick second question going back to capital management. I guess, I'm just wondering how to think about the modest increase in your special after it's been at the same level for a couple of years.
So, should we be thinking about that as signaling your additional comfort in the trajectory and sustainability of your earning or conversely does it reflect an ongoing absence of interesting acquisition opportunities or just a lack of a desire to do buyback in larger scale at this price?
I think it is probably the first, certainly there is more confidence in our existing business. Second, I wouldn’t look at it at all as a lack of investment opportunity. I think we're seeing a pretty interesting environment for investment for the firm right now, both internally and externally.
And then third, I don’t comment on share price. I always think it's cheap but obviously we're trading at higher levels today than we were a few months ago. But we have large amounts of stock that we're buying back to keep our share count flat with regard to the delusion that comes from share grants and we're very careful about doing that aggressively and trying to do it at the prices that they're issued in the early part of the year.
And as I said earlier, we're going to generate a lot of cash likelihood, is over the course of this year, certainly in the first half of this year. And so, we're going to be very mindful of being a very efficient about the use of that.
Okay, thank you. And I'm sorry, if you could just quickly indulge me on one more. On the enterprise resource management system. How do you implement that? I guess, I'm just curious if this is a question of cost savings and finding inefficiencies within your platform or is there more to it.
You did talk about internal investment and so is that part of it?
Yes. No, this is a very exciting project for us. And hey, this is a -- an important and significant infrastructure build for us and kind of help to take us forward as an organization. I mean, it really is going to unite the firm and really build proper infrastructure and enhance our infrastructure around the back office of our firm and really pull us together and set us up for a level for the next phase of growth of the firm.
I mean, this is going to build, you think about us, 40 office, 45 offices across 27 countries, doing a big infrastructure project like this we think is critical. We think there will be efficiencies that will come out of it. But there ought to be a lot of great things that come from having powerful tools across accounting and treasury and reporting as well as just overall management of the business.
So, it's a pretty exciting project and we think there'll be efficiencies that will come from it as well as a lot of other benefit for many years to come.
Thanks, so much.
Our next question comes from Devin Ryan of JMP Securities. Please go ahead.
Okay, thanks. Good morning, here.
Hi, Devin.
Hi. Maybe one here just on operating margins. When I consider the commentary on the outlook which I think as of now would suggest revenue growth in 2018, assuming that the backdrop remains consistent. Against a year, what you've just completed where you had a 27% operating margin and the comp ratio was kind of at the low end.
The target range and non-comp ratios are at a good level even with investments into the business. I'm just trying to think about how we should think about incremental potential operating leverage here both on comp and non-comp, especially as we're getting this at pretty impressive levels at the firm level.
Sure, very fair question. Look, two components to our expenses; one is the non-comp expenses and the second is the compensation expenses. I think on the non-compensation expenses, we kind of guided people to think about it as roughly 2/3rds fix, 1/3rd variable.
My guess is as we get closer as we keep improving as we gotten higher and higher margins, it probably more think of them about half-and-half at this particular point in time. And my guess is we're going to start to see a little inflation in the environment.
We're starting to feel that a little bit everywhere in the economy, so wouldn’t be surprised to see a kick-in here as well. But that said, with revenue improvement, we should continue to get margin improvements on the non-comp line. That's been something we've been highly disciplined about.
I think you see that in our results this year. And then on the comp line. Obviously, it gets a little bit more difficult when you get to the peak; when you get strong M&A environment; strong asset management environment; pressures on comp increase a bit.
But we've done a pretty good job over the last several for quite a while here right now, continuing to get operating leverage out of compensation. I think the gains are going to start to be a little less than they were in the earlier parts of this cycle but we're optimistic that we could continue to find efficiencies.
Part of this is just a lot of discipline and in terms of hiring and management of people and part of it comes from productivity on both sides of our business.
Great. Thanks for that color. Follow-up here, just maybe your comments on European M&A opportunity. So, you're up clearly, start to see some sparks of activity. But announcement volume in '17 was roughly half of the prior record in 2007.
So, just given that that really isn’t anyone better positioned here than Lazard in my opinion. How would you describe the environment today and how that compares to the past decade? And then, is something I don’t think we do very well as a group is kind of sensitize or kind of where is the magnitude or how much better things could get.
So, not to put forward guidance but just trying to think about maybe where we've been running relative to where you think the potential is for that group. Any color there would be helpful.
Well. Look, I think on the continent, it certainly used to be better than it's been in a long time. I think, France is about as a brilliant environment as I can remember, really since the early-90s when you were talking about the integration; the first integration of the common market, when you're talking about the integration of the common market.
So, this is a great environment. There is real enthusiasm where the macro and reforms, the economy is obviously becoming more competitive. It really looks to us like more investment dollars are going into France; there's tremendous even capital in France that's being unleashed.
And I think the continued uncertainly around BREXIT has made France more important destination for activity than has previously been the case. I think Germany has been a very strong economy for a while. It's been a little unsettled politically but that seems to be settling down right now.
And I think having Germany and France as spinners of stability at the moment is making the rest of the continent stronger. So, all of that creates a much more attractive investment climate than we've seen here in a long time and I think M&A follows from that.
Now, I couldn’t put a figure on it but just knowing how our business performed the second half of last year in that market, in particularly in France. And knowing just looking at this state of announcements in the first part of this year, I'm kind of optimistic about where that market is headed in terms of where it's been in the past and historical levels.
I'm not suggesting we'll have a historical peak market or anything but it feels better than it has in a very long time. I think the U.K. remains a little bit complex because you still have BREXIT, yet when you look at the FTSE 100, it's a very global base of companies.
And so, the activity is not necessarily impacted by the concerns around Brexit. I think that probably or probably applies more to the FTSE 250 which is a little bit more domestic in orientation. And I think we're pretty well positioned in the U.K.
We had actually a strong year last year in the U.K. even in spite of the concerns around Brexit. And so, I think that's the only kind of factor I see as the slight negative in Europe. But generally, it feels good. We're as you said well positioned; we have scale in that market; we have fabulous people; and so I expect it to be a pretty good environment for us in '18.
In currency, the weakening of the dollar, just sort of a bit of a currency tail and that reached on the revenue side.
Yes, okay great. Thanks for that color. Last quick one here just modeling it. I just want to make sure that I'm sure. So, the benefit from GAAP accounting on stock based comp, if I plug that in the model, we should be thinking about kind of around 20% tax rate for 2018 is the way I heard it.
And I just want to make sure that's correct. And then it should from a timely perspective we assume that the year will start at a higher rate and then kind of trend lower as it normally does. I was just trying to think about from model and perspective, how to think about taxes.
Yes. Okay, yes. I'll take that one. Yes, so I think as we said, effective tax rates were mid-20s and more backwards from there. So, that's 500 basis points of benefits. So, I think your math seems to be on point there and that's the right way to think about it.
Most of the benefit associated with this as a discreet item, will hit in the earlier part of the year. So, its most of it in the first quarter; first and second quarters of the year and then will roll in for the rest of the year as well.
Got it, okay. Evan, thanks very much.
Great.
[Operator Instructions] Our next question comes from Michael Needham from Bank of America. Please go ahead.
Hey, good morning. I was wondering if you could elaborate on the investment opportunities you touched on which businesses you think you can grow. Is it mainly asset management business? So, do you think you're going to hire or do something in organic on the advisory side. Thank you.
Okay. So, on the asset management side, we are seeing a lot of flow of opportunity from outside the firm today of what I would describe as individual teams that at different points of time have tried to set up businesses which are more difficult to probably get off the ground giving the environment for new businesses in the hedge front and the asset management space.
So, there I think we've really upped our outreach to teams in that regard and we're trying to find things that really create course of -- create centers of excellence at Lazard to already complement some of the centers of excellence at Lazard and we sort of think about it we've had a lot of success over the last couple of years in our current and both the asset product, both the asset solutions arena.
So, we're going to do things to complement that. We obviously have a great international global franchise around emerging markets. We're looking at teams to complement that as well. And I think you're going to see an increased pace of activity for us there.
And then on the advisory side of the business. Acquisitions on the advisory side are not obvious. Hawkins, a little like what we did with Goldsmith Agio back in '06, '07, those are practical. They are hard to predict and hard to find but if we come across the right one, we would clearly take that.
And I think it really comes down to hiring in areas where we see white space. There is actually quite a bit still left for us in the United States and the other specific markets around the world. We've done a lot to fill out our franchise in the last 12, 18, months. Latin America, Canada, are great examples of that.
I think we, our timing on that is going to probably turn out to be pretty good given the recovery particularly in the emerging markets. And so, I feel pretty good about where we are right now but we're going to continue to invest pretty fairly in that business.
On the advisory side, we also have this luxury of growing our own people and the large number of our partners, well over 50% on the advisory side, come from within. That's probably the great competitive differentiation of the firm today. And that's something that we're going to continue to really do aggressively going forward.
Okay, thanks. And for the asset management business, the clearly like the asset growth has been very meaningful over the last two years. And it looks like, where you guys set for flow this quarter and the flows been doing pretty good.
Is something you could kind of break down moving parts for fund flows; what's selling; what is in. I mean, if you could also touch on the emerging markets franchise, which historically has done very well but I think just the shorter term performance like the 1-3-5 year did slip a little bit versus peers.
Has that had any impact on the flows for that franchise?
Yes. Negligibly on flows impact. And actually when you look at the performance, I think you're right versus up around the growth indexes but when you compare it to the value index which has really helped people evaluate our fund. We've actually done pretty well.
The real performance in the emerging markets have come from the grow key part of the market which are actually some of the Chinese banks and the equivalent of the Chinese bank tech company. But when you look at the performance of our emerging markets on and you compare it to that, it’s real comps which are the value funds; I think we've done quite well.
And so, we feel pretty comfortable with our franchise there and frankly speaking we have seen a lot of interest and activity at the moment.
Okay, Ken. And just outside of emerging markets, I guess the flow is either quarter-to-date or things you think are working; just trying to get sense for like how good the pipeline is and how 2018 could be for both?
Sure. -- And associated top products; it looks very strong right now with increase and inflows in those businesses last year. In international, good performance, decent performance and decent flows.
And what has been a problem area for us over the last few years which has been Thematic. I think we are at the point now where the outflows are -- net flows are essentially neutral at this point; slight outflow. So, it's been across the board it feels pretty good right now.
Okay. Great, thank you.
Yes.
Operator?
Our next question comes from Vincent Hung from Autonomous. Please go ahead.
Hi, good morning.
Good morning.
So, if I look at the components of -- yes. Your benefits have increased 20% year-over-year whereas base salaries have gone up only 9%. So, could you give us some color around this inflation in benefits and also what we should be thinking about going forward?
Probably the biggest component change on the benefits this year was the contribution to pension. And besides that, it's kind of usual to's and pros and change of benefits in different parts of the world. But I think it was the single biggest change from last year is pension.
That should be more of a one timer.
Yes. I mean, a lot of it is, yes.
I mean, some of it's a more time and some of it's you think about it in social charges across Europe that have been increasing over time and a lot of it is coming from international and other places as well.
Thanks.
Operator, next one.
Our final question comes from Jim Mitchell from The Buckingham Research.
Good morning. Quick, just maybe touching –-.
Good morning.
Good morning, Jim.
Hey, good morning. Just on the investment side again, do you feel like the level of investment this year is an acceleration versus last year?
And the reason I'm asking is just trying to get a sense of how you're thinking about the impact on the comp ratio this year plus the puts and takes of asset management's doing better; that's typically at lower comp ratio. Just trying to get a sense of how to think about that in this environment.
Sure. In 2017, we amped investments on the advisory side of the business. In particular, I think you saw the acquisition of our MBA, the bringing in of MBA which is our Latin American business; Canada; Mexico.
That all runs through the comp lines, effectively all runs through the comp line for us. And so, that has driven up comp in part a little bit this year. I would expect to see a more balanced investments over the course of 2018. I think you'll see more on the asset management side and continued investment on the advisory side.
But you think you can kind of hold the line on the comp ratio with the investment?
Look, we've been pretty disciplined around comp and again you have to look at it in two respects. On awarded comp, which is really actually the full expensing of everything.
Yes.
You can see we did a pretty good job in awarded comp in spite of this investment activity. And I think on GAAP comp which tends to lag awarded comp but if you're managing your business well, your GAAP comp and awarded comp are roughly in the same range which it is for us. I think that's something that we have been very focused on for a long period of time.
So, I think we've done a pretty good job with that. That said, look we feel that there is real opportunity to grow the business right now. We're much more confident about how our management capabilities here than perhaps we were eight or nine years ago at a different point in the cycle.
Some of the investments that have been described in systems and ERP, allow us to integrate activities quicker and with much more ease than was the case before. So, I think that gives us some confidence to up the investment activity for growth. Yet, at the same time, as you could imagine, we're going to remain laser focused on cost.
Yes. No, absolutely. If you can hold the line with stepped up investments, that's a good thing. Just maybe one last question on just the restructuring outlook. I don't think that was really discussed too much. I mean I guess it's fair to assume this quarter it sort of started to tail off. Is that we would sort of expect that to continue given the pretty positive economic environment out there?
I think we're going to continue to have a decent level of restructuring activity for the next few quarters or so. We just had a lot of success in the areas of the economy which have been under pressure.
And so, even though the macroeconomic environment is strong and the M&A environment is strong and I think somewhat surprisingly we've had a pretty good restructuring run throughout this period of time. I don't think we're going to see record levels or anything like that but I think it's going to be at a okay pace for this year.
Okay, great. Thanks a lot.
This now concludes the Lazard conference call.
Okay. Thank you, everyone.