DLJ was established in 1959 by William Donaldson, Dan Lufkin, and Richard Jenrette. They started with $100,000 to establish an equity research firm catering to institutional shareholders. Over time, DLJ expanded its services and diversified to stay competitive in the market. In 1970, the company went public and offered additional services to its clients. DLJ maintained its membership in NYSE by issuing shares of its own stock to the public. However, in 1985, DLJ sold itself to Equitable due to capital requirements.
Equitable, which was a mutual life insurance company owned by policyholders, saw a change in leadership when Jenrette joined as chief investment officer and later became chairman in 1990. In response to serious issues, he spearheaded a restructuring effort at Equitable with the aim of reducing annual costs by $150 million and selling 49% of the company to AXA, a French holding company. Additionally, he successfully demutualized Equitable through an initial public offering, raising $450 million. By 1995, AXA had acquired around 60% ownership of Equitable.
DLJ’s strategy was focused on building higher margin businesses such as underwriting IPOs and high yield debt, creating specialized issues of mortgage-backed debt, and striving to be a leader in each selected market. It is ranked as the 11th largest securities firm serving institutional, corporate, government, and individual clients as an investment and merchant bank. DLJ’s businesses included securities underwriting, sales and trading, merchant banking, venture capital, financial advisory services, investment research, correspondent brokerage services, and asset management.
Operating through Banking Group, Capital Markets Group, and Financial Services Group, the company assisted clients in raising capital by issuing debt and equity securities in public and private markets. Their competitive advantage lies in focusing on 17 industry sectors. Additionally, the Merchant Banking group invested capital directly into companies. Over the years, DLJ has invested $580 million in 20 companies since 1992 and achieved $610 million from seven partial or whole realizations. With annual returns exceeding 90%, DLJ has earned a reputation as one of the top performing companies in principal investments.
DLJ experienced success in this group and as a result sought to create four new funds: DLJ Investment Partners, DLJ Real Estate Fund, DLJ Senior Debt Fund, and Global Retail Partners L. P. The Banking Group achieved high margins and lower risk in favorable environments, with personnel-related costs making up most of its expenses. On the other hand, Merchant Banking involved more risk as DLJ invested its own capital alongside limited partners to purchase securities in companies. The Capital Markets Group provided trading, research, and sales services for fixed-income and equity securities, focusing on serving its clients.
The Group maintained sizable quantities of stocks and bonds, funded through repurchase agreements, to effectively meet clients’ needs. The Financial Services Group catered to both individual investors and the intermediaries representing them. Its revenue streams were generated through service fees, interest earned on margin trades, and the difference between lending and borrowing rates, similar to a bank.
DLJ was a highly successful company and investors would soon have the chance to share in its success. Its growth outpaced others in the industry over the past 5 years, and its strategy to compete in higher margin businesses was proving effective. Additionally, its revenues and profits were growing at a pace that aligned with its increased market share. Moreover, each of the operating groups were experiencing equal rates of growth. Notably, DLJ did not allocate significant resources to the lower margin business of underwriting and trading investment grade debt and municipal bonds.
However, DLJ also faced criticisms regarding its lack of sufficient overseas operations or larger recurring-fee operations. There were concerns about DLJ’s ability to find new business lines for expansion, which would sustain its profit margins and growth rates. Another issue addressed the maintenance of post-IPO profits. The Stock market value has increased from 1. 896 in ’86 to 4. 789 in ’95, creating an incentive for DLJ to offer an IPO. The strategy involved the IPO allowing employees to exchange their compensation plans for shares and options in DLJ, thereby giving them an incentive to remain with the company.
DLJ going public had both advantages and disadvantages. On the positive side, it provided benefits such as increased liquidity and the ability for founders to monetize their wealth. It also allowed founders to diversify their investments and facilitated raising additional capital for the firm. Furthermore, going public established a clear value for DLJ and expanded its potential markets.
However, there were drawbacks to consider. These included the costs associated with reporting and meeting new disclosure requirements. Additionally, self-dealings could become a concern, and there was a possibility of inactive markets leading to a decrease in the stock price. Moreover, going public meant relinquishing some control over the firm, and maintaining a higher level of investor relations became necessary.
Equitable opted for an equity carve-out approach for DLJ, enabling them to maintain at least 50% ownership of the subsidiary. As a result, they could continue consolidating its financial statements and file a consolidated tax return. This method offers the benefit of the parent company retaining control over its subsidiary. Additionally, both this method and the spin-off method provide the opportunity to sell it proportionally higher than its actual value, allowing for profitability. Furthermore, it generates pure play stocks that investors can assess comparatively easily.
A disadvantage in this situation is the conflict between old stakeholders and new stakeholders. During the underwriting process, DLJ plans to offer 9.2 million shares of stock. Of these, 5.9 million shares are secondary shares sold by Equitable and 3.3 million are primary shares offered by the company itself. The sale of Equitable’s shares does not increase the total number of shares outstanding. 7.36 million shares are to be sold domestically and 1.84 million abroad. Additionally, Equitable grants the underwriters a “green shoe” option, allowing them to purchase an additional 1.8 million shares within 30 days to cover any over-allotments. After the offering, it is expected that there will be a total of 51.5 million shares outstanding, with Equitable owning 83% of DLJ’s stock (or 80% if the green shoe is exercised). DLJ has obtained its own debt rating from Standard & Poor’s, receiving an A- rating, and a Baa1 rating from Moody’s. It is important to note that an increase in DLJ’s leverage would not impact Equitable’s debt rating of A+ and A2. Throughout the underwriting process, DLJ has requested that the underwriters set aside 550,000 shares for sales to directors and current and former employees of both DLJ and Equitable.
These groups were given the chance to buy the reserved shares at a price that is the same as the initial public offering price but after subtracting underwriting discounts and commissions. Additionally, these groups were not allowed to sell these shares for a duration of five months. DLJ was selected as the lead manager of the offering after Goldman Sachs, Merrill Lynch, and Morgan Stanley were chosen as underwriters. The role of the four investment banks was to purchase Equitable and DLJ’s shares and then resell them to investors. In addition, 26 securities firms were invited by the co-managers to participate in the underwriting syndicate, with each firm getting a specific number of shares to sell.
The selling group, consisting of 73 firms, had the option to return unsold shares to the underwriters, thus reducing their risk. After conducting due diligence, the co-manager, DLJ executives, and their lawyers wrote the Form S-1 registration statement. This statement included a preliminary filing range of $26-29, indicating an offering size of $239.2 million to $266.8 million. The filing statement was then registered with the SEC on August 29th, creating the “registration date”.
The S-1 undergoes a 20-business day review and comment period by the SEC. Concurrently, managers and issuers promote the security through a road show and form an underwriting syndicate. During the road show, they collect information from all underwriters to assess demand at various prices and set the issue’s price. Once content with indications and market conditions, managers and underwriters negotiate the security’s price.
The final prospectus would become effective upon the public offering date, when the sale of securities would occur. The underwriters aimed to shorten the time between setting the price—the price at which they agreed to purchase the securities—and selling them to the public. They had to balance the interests of both their clients, which posed a risk. If the security was priced too high or too low, it could result in reduced demand for the security.
To determine DLJ’s fair value per share, we used four different methods. The first method involved using the discounted free cash flow valuation approach. This required finding the firm’s levered beta, cost of debt, applicable tax rate, cost of equity, expected growth rate, and projected cash flows to calculate the weighted average cost of capital (WACC). We calculated the unlevered beta by averaging the betas of the industry. By considering DLJ’s debt/equity ratio and tax rate, we found the levered beta for DLJ to be 0.31.
Using DLJ’s levered beta, we then determined the cost of equity. Assuming a standard Market Risk Premium range of 3.5% to 6.5%, we took it as 5.5%. By dividing the tax expense by pretax income, we obtained a tax rate of 40%, which was applied to a 9% cost of debt. The cost of equity was calculated using a Treasury Bond yield of 6.5% and resulted in an amount of 11.62%.
Considering a composition consisting of 60% equity and 40% debt, we calculated a WACC of 9.13%. For constant growth rate analysis, regression analysis on revenues led us to discover a growth rate of 5.86%.
Using the growth rate, we calculated the future cash flows and discounted them using the WACC. The resulting firm value was $2,430.01 million. After subtracting the debt value of $723.1 million, we divided the remaining amount by the 51.5 million outstanding shares to determine a value per share of $33.14.
Typically, IPOs were priced 10-15% below their estimated value to attract investors and compensate for the lack of prior market prices. Considering this, we adjusted the value per share of $33.14 by 15%, resulting in a value of $28.82 per share.
Another valuation method utilized was the price earnings multiple model.
The estimated share price range of $27-29 was expanded to $26-30 during the calculation of value. This was done by dividing the price per share within each dollar interval by an earnings per share of $1.35. As a result, a price per share range of $35.51-43.13 was obtained, with an average of $39.32. To account for a 15% IPO discount, the value per share was adjusted to $34.19. The book value method involved analyzing industry data on stock price, shares outstanding, EPS in the last 12 months, and BVPS in the last 12 months.
We calculated the value per share of DLJ using three different methods. First, we divided the stock price by the BVPS for each company and took an average of 1.4. DLJ’s BVPS was found to be $16.96, which we multiplied by the average to get a value per share of $23.68. We then adjusted this value by the 15% IPO discount, resulting in a final value per share of $20.60.
The second method we used was the EBIT multiple method. With an EBIT of $132.50 in 1995 and an enterprise value of $1,596.7, we calculated an EBIT multiple of 12.05. Dividing the EBIT by the 51.5 million shares outstanding and multiplying by the EBIT multiple, we arrived at a share price of $31.0. Adjusting for the IPO discount, we found a value per share of $26.96.
It is crucial for DLJ to carefully plan its share price to avoid overpricing or underpricing. Overpricing could lead to difficulties in selling the necessary amount of shares for financing, and even if all shares are sold, the price could drop significantly on the same day, affecting marketability. On the other hand, underpricing would mean DLJ missing out on maximizing funds.
The book provides three reasons why a firm would prefer a lower IPO price rather than a higher one. Firstly, the company aims to generate excitement, which can be achieved through the potential price run up on the first day. Secondly, when only a small percentage is offered to the public, stockholders give away less in terms of underpricing than it may seem. Lastly, firms that intend to have another IPO would certainly prefer a successful previous one. Consequently, we analyzed the four methods used previously to compare the IPO price per share for DLJ. As a result, we determined an IPO range of $20.60-$34.19 per share.
After conducting calculations and averaging, we have determined that the final value of the initial public offering (IPO) is $27.64. However, considering the tendency for successful IPOs to be underpriced, we recommend that DLJ sets a lower IPO price of $25.00. By doing so, this strategy will create enthusiasm among investors for DLJ’s stock and ultimately result in a prosperous IPO. Taking into account DLJ’s 60.7 million outstanding shares and a share price of $25, the overall valuation of DLJ would amount to $1,517,500,000 or $1.517 billion. It is important to note that this valuation is relatively conservative compared to a higher estimate of $1,929,653,000 or $1.929 billion when factoring in the average market price of $31.79.
