Lehman's New Street Smarts

Under CEO Fuld, the bond house has become a dealmaking power

It was late December, but the holidays were not on the mind of Lehman Brothers Inc. (LEH ) Chairman and Chief Executive Richard S. Fuld Jr. In 2003, Lehman had catapulted ahead of a slew of Wall Street rivals to become a serious investment-banking power, and Fuld was not letting up. On his desk, next to a tall Starbucks Mocha Frapuccino, was a list of hundreds of banking clients. He was determined to reach every person by New Year's Day. "When something is on my list," he says, "it will get done."

Well before the ball dropped at midnight a few blocks from his midtown Manhattan office, Fuld had reached almost everyone, just as the final results for 2003 were coming in. Lehman advised on $99 billion in U.S. mergers and acquisitions announced last year, raising its market share by an enormous 6.2 points, to 18.9%, according to Thomson Financial (TOC ). In the process, Lehman leapfrogged over Credit Suisse First Boston (CSR ), Merrill Lynch (MER ), and J.P. Morgan Chase (JPM ), and grabbed fourth place among major Wall Street firms, up from ninth in 2002. Last year, Lehman also raised $314 billion in debt and equity issues for companies, making it the No. 2 underwriter of securities in the U.S. -- behind only Citigroup (C ) -- up from No. 4 in 2002. "It's pretty rare now that we open the paper and there's a big transaction that we're surprised by," says Hugh E. "Skip" McGee, Lehman's head of investment banking.

That hasn't always been the case. The firm's recent successes are the result of years of effort to transform Lehman into more than just a bond house. Despite the three-year deal drought, Fuld stubbornly built the firm's banking capabilities. He poached seasoned bankers from rivals. He shook up Lehman's culture by melding its debt and equity underwriting businesses. And he started holding senior bankers more accountable for bringing in big deals.

The transformation is crucial. As the economy improves and equity issuance picks up, bond issuance is expected to soften. And more than many others firms on Wall Street during the bear market, Lehman benefited greatly from the debt-issuance boom. Fixed-income sales and trading accounted for $4.4 billion of the firm's $8.6 billion in revenue last year. But with Lehman's investment-banking operation running full tilt, a downturn in bonds may not even be noticed. Indeed, Moody's Investors Service (MCO ) raised Lehman's long-term credit rating to A1 from A2 in October to acknowledge the firm's efforts to broaden its business reach. "It is a much more diversified shop than it was five or six years ago, and it operates in an extremely disciplined fashion," says Blaine A. Frantz, a senior credit officer.

UP FROM TAKEOVER BAIT. Fuld, 57, is still charging ahead. To keep up with the firm's growth, he is naming four new members to the executive committee, bringing the total to 13. And he plans to continue adding troops to his current total of 16,000. These moves will give Lehman added heft in areas such as equity issuance, derivatives, convertibles, and merger advice, and help it maintain strength in debt issuance. Fuld's pitch is basic: He wants to advise clients on everything from mergers and raising capital to hedging risk and making debt payments.

Clients are noticing the difference. "When you need to count on them, they're there," says Henry R. Kravis, founding partner of Kohlberg Kravis Roberts & Co. "In today's Wall Street world, I can't say the same about every firm."

Lehman's success is all the more surprising given that for much of the '90s, it was considered takeover bait for one of the bigger and better-capitalized Wall Street houses. For years the firm suffered from internal warfare, ending up a not-so-happy unit of American Express Co. (AXP ). AmEx spun Lehman off in 1994, but that left the firm as merely a bond house -- the lowest form of creature in Wall Street's pecking order -- with virtually no retail or asset-management operations. Fuld, 57 now, who started at Lehman as a commercial-paper trader in 1969, became CEO -- and knew he faced long years of rebuilding.

Ironically, Lehman's investment-banking business began to gel as the bank faced its most severe crisis: the loss of its World Financial Center headquarters in downtown New York after the terrorist attacks on September 11, 2001. Setting up temporary quarters at a Sheraton Hotel in midtown, Chief Operating Officer Bradley H. Jack, then head of investment banking, grouped his bankers by the industry they focused on, not by what type of financing they specialized in, the industry's usual practice. So, for the first time, the bankers who underwrite debt and the ones who put together stock offerings were sitting together -- in the cocktail lounge on the fifth floor. When the firm moved to its new headquarters in 2002, Jack kept the industry groups together. Now, bankers specializing in everything from stocks to bonds to convertibles sit next to each other in rows known as "pods," each representing a different industry. The goal is simple: more communication among bankers working for the same clients, and perhaps more creative financing solutions. "Before the spin-off, success was measured more by what each individual accomplished," says Fuld. "Today, it's all about the team."

The strategy paid off big in the summer of 2002. Tulsa (Okla.) energy trader Williams Cos. (WMB ), which was teetering near bankruptcy, asked Lehman to help it raise $3.4 billion. McGee, then the head of Lehman's energy-banking group in Houston, raced against the clock with a swat team of 30 bankers, working from 7 a.m. to 2 a.m. for days to figure out how to resuscitate the company even as lawyers prepared its bankruptcy filings. In just over a week, Lehman arranged the sale of billions of dollars of assets such as pipelines while organizing financing from Warren E. Buffett and banks secured by natural-gas reserves. Some Williams staffers were in tears; secretaries hugged bankers.

Last January, McGee moved to New York as head of investment banking, and preparations for the long-awaited upturn in investment banking gained momentum. Fuld put McGee in charge of equity and debt issuance as well as M&A. That paved the way for one of McGee's first major moves: rewarding bankers for solving clients' problems rather than selling specific products.

POACHING THE TALENT. McGee also urged his senior bankers to spend less time managing their teams and more time as road warriors, bringing in more deals. "We've had much more of an orientation toward execution rather than going out and getting business," says McGee. When they hit the road, they carry plastic cards listing golden rules for investment banking that McGee and a group of senior bankers drew up. (Rule No. 1: "Investment banking is a team sport -- use all resources.")

Lehman made another decision during the deal slump that left it well-positioned for better times. While other firms laid off as many as half their bankers, Lehman let go only about 15%. "As others were downsizing, we stayed the course, and that has benefited us," says McGee. Adds Sean Foley, treasurer of Cingular Wireless LLC, which selected Lehman as its adviser when it bought wireless licenses from Nextwave last year: "Lehman has been able to maintain continuity, and that helps."

McGee also made key hires. In April, the firm nabbed Mark G. Shafir from Thomas Weisel Partners LLC and made him head of M&A. In August, he hired Casey Safreno, one of Merrill's top bankers in health care. Safreno promptly helped Lehman land one side of the biggest M&A deal announced in the U.S. last year -- Wellpoint Health Networks' (WLP ) $16 billion sale to Anthem (ATH ).

The moves have boosted Lehman's stock price and profits. The shares rose 40% over the past 12 months, to $79, and net income soared 74% in 2003, to reach $1.7 billion. Analysts think the firm will do better still once the benefits of its effort to retool the investment-banking operation, plus the $2.6 billion purchase of asset manager Neuberger Berman LLC last year, kick in.

THE GUYS TO BEAT. Fuld isn't the only Wall Street chief who believes that being able to deliver more than just one product is critical to winning deals. Two other banks, Morgan Stanley (MWD ) and Goldman, Sachs & Co. (GS ), also used the last few years to better integrate their debt and equity divisions so they can offer chief financial officers a broader range of advice. In August, 2002, Morgan Stanley merged its debt and equity capital-markets businesses so that one banker can advise a corporate client on a suite of financing options. Goldman has taken a similar approach in Japan. In December, Morgan also freed 10 senior bankers, including dealmaking hotshot Joseph R. Perella, from management responsibilities to let them spend more time with clients. Morgan and Goldman happen to be two of the firms blocking Lehman's path to the top U.S. M&A ranking, along with Citigroup, which beat out Lehman for third place by $686 million last year.

For all of Lehman's success in the U.S., it's still an also-ran overseas. The firm did gain ground in debt and equity underwriting worldwide in 2003, but it slipped in the global rankings for announced mergers, from No. 8 to No. 9. Fuld hopes to strengthen the firm's overseas franchise in part by adding two top execs in Asia and Europe to the executive committee.

If these steps pay off, Fuld could be adding more international names to his long list of calls next December.

By Emily Thornton in New York

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