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Monday, May 29, 2023

Corp Focus


Staff Reporter

Jefferies Group Inc. embodies the new Los Angeles economy: It is comparably small, niche-oriented and growing fast.

The Los Angeles-based brokerage is a leading player in the high-yield bond market, which accounts for around 30 percent of its revenue. It also is active in “off-market” trading, in which institutional buyers and sellers are brought together to trade large blocks of stocks outside established stock exchanges. Such off-market deals are preferred by institutions, because the transactions are less likely to move the market and adversely affect the prices of the stocks they are trading.

“We are a niche player. We have no aspirations to be a mini-Merrill Lynch or Goldman Sachs,” said President and Chief Operating Officer Michael Klowden. “Our goal is to find areas in which we can add value. That’s how we have succeeded so far.”

For the first quarter ended March 31, Jefferies reported net income of $17.5 million (75 cents per diluted share), compared with $11.4 million (51 cents) for the like period a year earlier. Revenues were $209.7 million vs. $153.4 million.

For the year ended Dec. 31, 1997, net income was $63.6 million ($2.80), up from $43.6 million ($1.84) the previous year. Revenues were $764.5 million, up from $516.6 million.

“It’s a good little regional brokerage that is doing a lot of right things,” said Stanley Maack, an analyst at Farmers Insurance Group, which also is an investor in Jefferies.

And yet, Jefferies seems to have hit a speed bump on Wall Street. Its stock has lost ground in recent weeks, falling from $58.63 in April, to close at $42.25 on June 17.

Analysts cite Wall Street’s general shakiness in part due to the Asian crisis for the decline. There also are worries that a prolonged market decline will hurt revenues for Jefferies’ brokerage business.

“If the stock market goes into a serious slump, the stock price is going to go down dramatically,” Maack said.

On top of that is uncertainty about Jefferies’ plan to spin off its 82 percent stake in Investment Technology Group Inc., which provides technology-based equity trading services to institutional investors and is a key component in Jefferies’ off-market trading business.

Current shareholders of Jefferies Group will exchange each of their shares for 0.65 shares of ITG and one share of Jefferies & Co.

In 1997, ITG’s revenues were $137 million, or around 18 percent of the Jefferies Group’s revenues.

The separation of the two companies, which should be complete by the end of the year, is expected to allow for a more accurate valuation of each firm and eventually will benefit their share prices, analysts said.

While Jefferies has been an equity trading firm for over 35 years, it is best known as a leader in the high-yield bond market. In the early ’90s, Chairman Frank Baxter hired a slew of junk-bond traders from the now-defunct Drexel Burnham Lambert who are now paying strong dividends.

Last year, Jefferies ranked fifth in the nation among domestic underwriters of single B bond issues, lead managing nearly $5 billion worth of deals and co-managing another $2 billion worth. Bonds are given a grade based on the level of risk. A bond with a rating of B or lower is often referred to a “junk bond.” As such, they offer a higher interest rate, or yield, and is often avoided by institutional investors.

Despite the higher risk, the default rate on the bonds Jefferies handles is around 1 percent, lower than many of its competitors.

Klowden believes the high-yield market will continue to grow and attract quality companies.

“With interest rates as low as they are, there are more companies that find the high-yield market attractive,” he said. “For that reason, the quality of the issuing companies continues to go up.”

Klowden said Jefferies’ presence in the high-yield debt market may help insulate it in case the economy slows and the equities market heads into a prolonged downturn. While high-yield new issues would decrease under such circumstances, Jefferies’ experience in trading the debt of financially distressed companies should continue to bring it business in lean times.

The fact that Jefferies puts a heavy emphasis on offering incentives to its employees through stock options and bonuses could be another cushion in case the stock market turns bearish, Klowden said.

“Our compensation is tied to our revenue,” he said. “People come here knowing that they can make a lot of money in good times, but in lean times they have to keep finding ways to make money for the company or they won’t make any money.”

The heavy use of stock options is also a major deterrent to larger competitors interested in taking over Jefferies. Managers and employees control nearly 50 percent of the company’s outstanding stock. And Klowden made it clear that management has little interest in selling out.

“There is no question that our goal is to remain independent,” he said. “We think over the next few years that independence is the best way to achieve value for our shareholders.”

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