The last tycoons: the secret history of Lazard Frères & Co (121 page)

Despite the accord and Michel's comment that he was a great admirer of Bruce, the palpable tension between the two men was on full display during an interview they gave to the
Wall Street Journal
at the Lazard Paris offices. As they sat together at a pear wood table in one of the firm's conference rooms, they acted very much like a warring married couple that had finally filed for divorce. "We have to be as unselfish as we know how to be," Michel said. Bruce compared the Lazard he found upon his arrival in 2001 to a house needing serious renovation. The firm needed "an extra steel beam and a cement support," Bruce said. "Once you have a strong foundation you're ready to go." Michel interjected to insist Bruce failed to consult him "about how the house was reconstructed. I received the bill, and I wasn't perfectly satisfied. I had one power and that was to be unhappy." (Michel later confessed to having one sole regret: not having forged a "better, more intimate relationship with Bruce.")

As to their May 2004 disagreement that led to the public release of their feisty letters about how to look at the firm's profitability, Michel said he felt "very good about the letters I wrote in May." To which Bruce snapped: "I feel good about my letters, too." He added that he intentionally had very little interaction with Michel during 2002 and 2003 so as to make clear that he had no interest in being mesmerized by Michel, as had previous partners. He sought to eschew "the history of ambiguity of authority between Michel and previous managers," he said. "I didn't want a system where we didn't have coherence."

There was no ambiguity, though, in the fact that Bruce had just put his career at Lazard on the line for the chance to get rid of Michel. Marty Lipton, the dean of Wachtell, Lipton and a longtime Lazard lawyer, believed the IPO was a brilliant compromise. "There are clearly two different points of view, and intelligent people sat down"--among them his partner Adam Chinn--"and worked out a resolution of it." But Jean-Claude Haas, Michel's consigliere through the tempestuous negotiations with Bruce, said that for potential investors the Lazard IPO was simply "an act of faith."

FRIDAY, DECEMBER 17, 2004,
at 4:44 p.m. was a moment that few of the tens of thousands of people who had ever had anything to do with Lazard thought they would live to see. At that time, the Securities and Exchange Commission acknowledged receiving a Form S-1 registration statement, under the Securities Act of 1933, for the initial public offering of the investment banking firm now known as Lazard Ltd. By any measure--as originally filed or as subsequently amended over the next few months--the S-1 was a stunning document. For the first time in its 156-year history, Lazard's financial performance was revealed publicly--specifically for the years 2002, 2003, and 2004--as required by the SEC. Some of the data even went back five years. The information showed what many had come to believe of Lazard: until Bruce took over in 2002, the firm was obscenely profitable despite having--or using--little capital. And even under Bruce's command, the firm's operating income and margins were enviable, hovering around 30 percent year after year. What was also clear was the extent of the near meltdown in 2001, when operating income fell to $359 million, from $676 million in 2000, down 47 percent. M&A revenue in 2002 was $393 million, down 46 percent from $725 million in 2000. The effect of Bruce's spending spree throughout 2002 and 2003 could also be appreciated. The partners' capital, which had been built up to $705 million when Bruce took over--well beyond the $17.5 million in capital that Andre intentionally insisted was all that the firm had available--had plummeted to $385 million by the end of 2004, all as a result of absorbing the losses Bruce was racking up. (Goldman Sachs's total capital, meanwhile, both debt and equity, was closer to $60 billion.)

Financial disclosure aside--and truthfully, much of the key data had leaked out over the years--the S-1 filing had the feel of being part of some master plan Bruce had envisioned from the outset. He had continuously shown that he was willing to sacrifice short-term profitability for long-term equity value. He had done that at Wasserstein Perella, when, although the firm nearly ran out of cash, he was still able to sell it to the Germans for nearly $1.6 billion, including retention bonuses. To Michel's ongoing chagrin, he had done the exact same thing at Lazard. Cash dividends to the nonworking shareholders were eliminated as short-term expenses soared. In the fall of 2003, he repeatedly tried to sell the firm in an effort to replicate the Wasserstein Perella experience. He insisted on a high price, for sure, which the market rejected time and again. That was okay, too, for Bruce knew he was rapidly approaching his first window of opportunity to sell the firm publicly. The SEC requires new issuers to include three years of audited financial data in an IPO prospectus. So no matter what, the earliest moment that the filing could have been made to comply with that requirement and to coincide with Bruce's tenure as head of Lazard was December 2004, when he was ending his third year at the helm. Of course, the high tide of the improving M&A market and the performance of Greenhill & Co.'s IPO lifted Lazard's boat, too, and gave the underwriters the confidence a deal could happen, even with the discrepancy between the price the capitalists would receive and the price the public would pay.

Some of his partners have said that Bruce--the Genius--had even anticipated the rebound of the cycle in the fall of 2004; he's just that smart. He even more or less said so himself when speaking to a group of Yale MBA candidates in September 2005. "So we're at the beginning of a resurgence of M&A activity," he lectured. "Cyclically, this has been going on since the Civil War. It goes in spurts every decade or so. There's a five-year period where M&A accelerates, and then it slows down. Lots of things intervene. And right now, we're at the beginning of the surge.

That's my view. So, as it rebounds, of course the critics of M&A resurface, including many members of your faculty, I gather." One of Bruce's former partners at First Boston, Mike Koeneke, who was also once co-head of M&A at Merrill Lynch, agreed Lazard's filing was well conceived. "His timing as always is exquisite," Koeneke told
Bloomberg
of Bruce. "With all the merger news coming out, he's hitting it perfectly. I think it will be well received."

Others were immensely more skeptical. Upon learning that Lazard was attempting an IPO, Damon Mezzacappa, the former head of Lazard's capital markets business, expressed disbelief. "I'll be stunned if this company can go public, but stranger things have happened," he said, adding, presciently, that in his view the only way it
could
happen would be for Bruce to show Lazard's financials on a "pro forma" basis that backed out the hefty compensation guarantees he had been making to new partners.

Felix was more incredulous still, at least at the outset. "First of all, I think Bruce is very intelligent, and therefore whatever I say now, he knows, and therefore there must be something more to it," he began.

It's hard for me to conceive that you can go to the public and sell stock in an enterprise which immediately will use that money to bail out the controlling shareholder at a price two or three times what the stock is worth. And leave behind an overleveraged, weak firm with a history of great internal factions. I don't know how you convince people to do that unless you've got it set up in some way with some institutions that for one reason or another are willing. But it's difficult. But is the firm viable once you've done that? That's why I'm still waiting for the other shoe to drop, [for] somebody to come and buy the firm. Because I think what Michel could have done, if he really wanted, [and] I think he really would like to have this firm back, is say to Bruce, "Look, I'll buy you out. And I'll keep my shares, and I will vote my shares in support of Ken Wilson or Gary Parr or whoever, you know, and I'll be there as the controlling shareholder, but I'll be there supporting the management."...I mean here he stands for the tradition of 150 years, for family ownership, for private ownership, all the things that he says he values, and if this deal happens--which I still don't believe it will--he will strip the firm of any future for the next
X
years.

As the IPO looked increasingly likely, Felix changed his mind and thought the deal would happen. "I was wrong," he said. Despite his blessing, even Michel was skeptical--in January 2005 anyway--that the IPO would happen because of the plethora of problems that needed to be solved.

"I'm very uncertain it will occur," he said. "In my opinion there are quite a few unresolved problems at this time and very few people working on it. I mean, working very hard, but very, very few."

But it was in the S-1's abundant details weaved throughout its 173 legalese-laced pages that Bruce's true genius--and that of his high-priced bankers at Goldman Sachs and lawyers at Wachtell and Cravath--became apparent. The Lazard IPO was nothing less than a testament to Bruce's creative brilliance and audacity. He had many problems to solve simultaneously. And one by one, he solved them. First, he had to focus the offering on those parts of Lazard that would appeal to investors. In this he had help from Goldman, which told him that Lazard Ltd. should look as much like Greenhill as possible and comprise only Lazard's M&A, restructuring, and asset management businesses. (Greenhill's stock had appreciated more than 50 percent between its IPO and Lazard's first filing.) M&A was growing well, and when that slowed, the restructuring business would kick in; the asset management business, meanwhile, provided a steady stream of profitability. That would be the public company, some $1 billion in worldwide revenue and 2,339 people. Left out of the IPO festivities would be Lazard's unprofitable capital markets business and its private-equity fund management business (but the French units in these areas would be part of the public company). Also left behind were "specified nonoperating assets and liabilities" that would detract from the profitability of the public company. These included an unfunded pension liability in the U.K. and the lease payments on Lazard's empty old building in London. The capital markets business, which would continue to be affiliated solely with Lazard, would be owned by all of the working partners, some of whom would be in the public company and some of whom would be at the capital markets business. About half the profits of the capital markets business would be transferred to the public company in recognition of the role the M&A bankers would have in generating financing deals. As for the private-equity business, Lazard would retain a nine-year, $10 million option to buy it, which will no doubt be exercised when the business starts becoming profitable in a few years after investments begin to pay off.

After solving which businesses would be part of the public company, Bruce had to figure out where the money would come from to pay off the inviolate $1.616 billion to Eurazeo, Michel, and his cronies. Actually, Bruce needed even more than the $1.616 billion. He needed to raise more than $1.9 billion in total because he also intended to leave the "separated" businesses--capital markets and private equity--with $150 million of operating capital to cover certain liabilities (mostly for the U.K. pension liabilities) and he wanted to refinance a preexisting $50 million Lazard debt obligation issued in May 2001. There were also $87 million in fees to be paid, to bankers, lawyers, and accountants. The IPO itself--the public sale of the firm's equity for the first time--would raise gross proceeds of $855 million (before a heavily negotiated 5 percent, or $42.7 million, fee to the underwriters; usually the underwriting fee on an IPO is 7 percent. Bruce also ended up capitulating to the demands of underwriters Morgan Stanley, Citigroup, and Merrill Lynch for a more equitable split of the fees with lead underwriter Goldman Sachs.) and net proceeds of $812 million. That left a balance of around $1.1 billion Bruce still needed. For this money, he turned to other sources of capital. His negotiations with Caisse d'Epargne were fruitful and yielded a $200 million investment--$50 million of common stock at the IPO price and $150 million of debt convertible into the Lazard common stock. Another $550 million came from the public sale of new unsecured senior debt.

To raise the remainder of the capital he needed, Bruce got a little creative. He raised $287.5 million through the public sale of "equity security units" that offered investors a combination of interest-paying debt and equity securities. What he was doing with Lazard is known in Wall Street argot as a "leveraged recap," a fairly common structure in the private-equity world. By adding nearly $900 million in new debt to Lazard's formerly pristine balance sheet and then taking that money plus the expected IPO proceeds of $812 million, Bruce was able to buy up all the stock of the existing shareholders and make himself the largest individual shareholder in the process. It wasn't an original structure, but as a way of getting control of Lazard with other people's money while at the same time getting rid of Michel, it was nothing short of brilliant.

More clever still was Bruce's decision to incorporate Lazard Ltd. in Hamilton, Bermuda, a well-known and controversial tax haven for American companies. Bruce is nothing if not creative when it comes to avoiding taxes. Lazard became the first large Wall Street investment bank to incorporate there, after first considering and then rejecting both Luxembourg and Delaware. Since the United States taxes corporations (and individuals) on their worldwide income, regardless of where it is earned, by incorporating in Bermuda, not only would Lazard not have to pay taxes there (there are no income or capital gains taxes on the island), but also its income from outside the States would not be subject to U.S. taxes. Income earned abroad would be subject only to the tax rates of those localities. Critics have called such tax avoidance "unpatriotic" and the "great tax evasion." Stanley Works, a 163-year-old Connecticut-based tool manufacturer, abandoned its plan to reincorporate there after intense criticism.