Finance

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

One group on Wall Street is counting down alongside Royal Dutch Shell and BG Group as they close in on completing their mega-merger: The advisers who won't get paid until the deal is officially sealed.

For independent firms such as Lazard, the "lumpiness" of this kind of compensation arrangement can cause headaches: Its stock slumped more than 7 percent Tuesday after the company reported full-year results that included record financial advisory revenue of $1.3 billion.

On the Downslide
Independent advisory firms are struggling despite partaking in the recent M&A boom.
Source: Bloomberg

Even though this figure was better than expected, it could have been higher if more than just one of the six mega-deals Lazard advised on in 2015 had closed. (The one that did? Kraft Foods' combination with H.J. Heinz.) 

Lazard, and other publicly traded investment banks like it, face different challenges than other advisers. On the Shell-BG deal, for example, closely held firms such as Robey Warshaw and Rothschild don't have to answer to shareholders. And bulge-bracket banks like Goldman Sachs and JPMorgan Chase aren't as heavily reliant on advisory fees, which were responsible for 10.3 percent and 2.2 percent of their fiscal 2015 revenue, respectively, compared to 53.8 percent for Lazard.  

And the waiting game doesn't only apply to the biggest deals. Lazard still hasn't had its payday from smaller transactions, such as Exelon's $6.8 billion acquisition of Pepco Holdings, which was announced 643 days ago.

It's not the worst thing in the world: Delaying the payoff only bolsters the firm's pipeline of revenue that should hit its books in coming quarters. That said, a bigger issue looms.

Even though fiscal 2016 could see Lazard's advisory revenue hit new highs (already this year it's been involved in Johnson Controls' deal for Tyco International and  Xerox's plan to split into two), it -- and smaller publicly-traded independent advisers -- could face a tougher time when the M&A boom eventually cools. On the back of Lazard's results, shares of Greenhill, Evercore, PJT Partners and Moelis all  slumped.

The concern is that while fees from restructuring advice will climb as the cycle turns, it's unclear if that can offset what could be a sharp decline in M&A and other advisory fees.

When asked on Tuesday's earnings call about the flexibility and ability for bankers to move within M&A and restructuring, Lazard's chairman and CEO Keith Jacobs reiterated the firm has a "very, very deep reservoir of restructuring talent" among its strategic bankers and that its overall capacity isn't too different to 2009.

That year -- as companies worked through the aftermath of the global financial crisis -- restructuring surged to 38.2 percent of Lazard's total financial advisory revenue, up quite a bit from 7.3 percent in 2006. Even so, that was just a quarter of Lazard's overall revenue in 2009, while M&A fees accounted for a third. 

Boom and Bust
Lazard needs restructuring to comprise a bigger portion of financial advisory revenue when the cycle turns.
Source: Company filings

Lazard's stock, after the recent drop, is trading at a forward price-to-earnings multiple of 9.4, encouraging 12 of 16 analysts that cover it to slap a "buy" rating on the shares. The consensus price target of $55.10 represents a 65 percent gain in 12 months. 

With Lazard continuing to target a compensation ratio of between 55 and 59 percent, even if revenue from its financial advisory and asset management arms climbs, it's tough to find reasons to be quite so bullish. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net