1995

DLJ

[VALUATION & CASE ANALYSIS]
This paper contains the details of the valuation & analysis of the operating investment bank ‘Donaldson, Lufkin & Jenrette (DLJ)’. DLJ is planning for a repeat public offering for raising capital & that’s why 4 of the renowned investment banks are appointed as issue manager who are ought to set a offering price of the to be floated shares.

A Case Report On

“Valuation & Case analysis of Donaldson, Lufkin & Jenrette (DLJ)”

Prepared for: Dr. M. Sadiqul Islam Professor Department of Finance Dhaka University

Prepared by: Md. Shaheenur Rahman, S. M. Zubayer Hussain, Md. Tanvir Hossain, Md. Raihan Reza, ID# 20063 ID # 20048 ID# 20013 ID# 20020

Date of Submission: August 10, 2012

Department of Finance Dhaka University Dhaka.

# Valuation & Detailed Analysis of “Donaldson, Lufkin & Jenrette (DLJ)” #

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ACKNOWLEDGEMENT
It’s a matter of great contentment to be able to complete this study project in due time. Our endeavor will be considered successful if the report is of any help to anybody. At the very outset, we would like to express my heartiest gratitude to Almighty Allah for giving me the capacity to complete this task. Then I would like to place my humble gratitude to our respected course teacher Prof. Dr. M. Sadiqul Islam, Department of Finance, Dhaka University for his valuable time commitment, guidance, patience and stimulation made along throughout the total course duration.

We have put our best effort to make this report to serve its purpose; that is, to analyze & valuate the upcoming IPO offering of Donaldson, Lufkin & Jenrette (DLJ). We had to surf around the case for different issues at times & had to gather some information for the analysis from the internet as well.

# Valuation & Detailed Analysis of “Donaldson, Lufkin & Jenrette (DLJ)” #

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2 Industry Analysis: 2.3 Limitations of the research: 1.2 Valuation 3.Table of Contents Declaration: Acknowledgement: Part – 1: Preface 1.1 Problem Statement & related issues 3. Lufkin & Jenrette (DLJ)” # Page | 4 .3 Recommendation 32 35 38 Part -4: Annexure Microsoft Excel Calculations # Valuation & Detailed Analysis of “Donaldson.2 Objectives: 1.3 Details of its Operation 2.4 Methodology: 6 6 7 7 iv v Part -2: Case analysis 2.1 Company Information: 2.1 Origin of the Report: 1.4 SWOT & Ratio Analysis 9 13 19 25 Part -3: Valuation 3.

DLJ PREFACE # Valuation & Detailed Analysis of “Donaldson. Lufkin & Jenrette (DLJ)” # Page | 5 .

Analyze its financial statements & comment about the company performance through ratio analysis.1. At this continuation. Outline the company’s operational activities & discuss about its different business units. Make valuation of the total enterprise & state the proposed stock price for the floatation of IPOs of DLJ. # Valuation & Detailed Analysis of “Donaldson. we got “Donaldson. Lufkin & Jenrette (1995) abridged” as our case problem & we have worked on the analysis & valuation of this firm for their upcoming IPO floatation. 1.1 Origin of the Report The ‘Investment Banking & Managing Assets’ course gives a detailed overview on the total investment banking activity in the capital market & money market zone as well as about the different types of securities. We get the opportunity to work on a case problem at the end of the course for portraying our idea & knowledge of the total course that we have learnt throughout the duration of the course. derivatives & other financial assets of the capital & money market. Lufkin & Jenrette (DLJ)” # Page | 6 .2 The objective of this report is to – Objectives       Analyze the Case at the most detailed level Relate the case proposition with that of our course content Make an industry Analysis of the Investment Banking Industry in 1995.

So. many of the required information crucial to the analysis & valuation was absent within the case.3 Limitations of the research The information availability of our analysis was solely limited to our presented case of DLJ. 1. we interpreted the results through our available knowledge & recommended some points to be taken into consideration. Lufkin & Jenrette (DLJ)” # Page | 7 . Data collection from the Case Data Compilation Analysis & Valuation Results & Recommendation # Valuation & Detailed Analysis of “Donaldson. we had to forecast some parameters on a realistic assumption basis for preparation of the solution report. After making all the valuations. In this regard. We started data mining from the case & later compiled the data in the form helpful for the analysis & valuation of the case. we all started to gather a detailed knowledge about the case as well as the company “Donaldson. After that.4 Methodology At the outset. we exchanged our views & ideas about the case and came to a consensus point for working with the case. Then. So. we used Microsoft Excel 2007 to calculate the different ratios as well make the enterprise valuation of DLJ. Lufkin & Jenrette (DLJ)” for the preparation of this report.1. some of the valuation outcomes may not fully representative or coherent with the company’s information representation. We have also tried to remain as close to the context of the case as possible which we hope reflects at the outcome of the case.

DLJ CASE ANALYSIS # Valuation & Detailed Analysis of “Donaldson. Lufkin & Jenrette (DLJ)” # Page | 8 .

DLJ shook up the financial establishment by becoming the first New York Stock Exchange member to offer its equity securities to the public. Lufkin & Jenrette. the firm had established a corporate pension-fund department and was targeting wealthy individual investors. in 1997. in 1970. Inc.. Richard H. "and we weren't earning that much. They asked a colleague. clearing transactions.institutional investors such as banks. Then. In 1962.2. They made their early reputation with reports on small but promising growth companies for which they hoped to be repaid in brokerage commissions. DLJ made the largest single transaction ever in dollar value on the New York Stock Exchange--a $22. In 1967. mutual and pension funds.000 a year. however. and DuBois Chemicals. Grace & Co. The partners sought as clients .55-million trade of Harvey Aluminum Inc. such as the pollster Louis Harris & Associates. Lufkin & Jenrette (DLJ)” # Page | 9 . and insurance companies. Donaldson and Dan W. # Valuation & Detailed Analysis of “Donaldson. established a holding company that was exempted from the stock exchange's restraints on member firms. Lufkin were former Yale and Harvard Business School classmates who were rooming together while working on Wall Street in 1959. buying a seat on the New York Stock Exchange and opening a small office with a staff of three. Although publicly traded. in contravention of the exchange's regulations. "There wasn't much downside risk since we were all bachelors. The three partners remained the firm's largest single stockholders. a home builder. no more than $7. managing assets. William H. (DLJ) grew in a single generation from its founding to become one of the top ten U.000 to $600. A holding company.000 in startup cash and collateral." Each brought distinct skills to the partnership: the dynamic Lufkin excelled at recruiting clients. Inc. and providing financial research and advice as well as trust services to its clients. investment-banking firms. rather than the general public. Jenrette-also a Harvard Business School classmate--to join them and raised $500. when they decided to go into business for themselves as analysts researching stocks. Going public also allowed DLJ to acquire an assortment of firms unrelated to its core business. and Jenrette gravitated toward administration while also heading a small investment-counseling unit. By 1964. which raised about $11 million in this manner.R. DLJ also acts as a full-service securities broker." Jenrette later recalled.S. DLJ was 80 percent owned by The Equitable Cos. at least according to the firm's own reckoning.1 Company Information Donaldson. Inc. DLJ also trades on its own account as a merchant banker. A survey of DLJ's 51 basic recommendations during 1960-63 found it beating the Dow Jones industrial average by more than 50 percent. Donaldson was the "deal" man. In 1996 it was rated as the leading underwriter of high-yield bonds and fourth as lead underwriter of domestic public issues. common stock. and Meridian Investment and Development Corp. In 1995 one survey ranked DLJ second among 19 firms in the quality of its research.000 or $8. Most of its buy recommendations were companies with new products or services. The firm. It also entered investment banking by placing $10 million in debentures for companies and setting up a merger between W. Donaldson took over investment banking and administration while Jenrette became head of research.

Struthers & Winthrop. Donaldson. With the Arab oil embargo of 1973. The firm was also hurt by the end of fixed commissions in 1973 and consequent competition from new discount brokers..6 million on revenues of $46. DLJ also stepped up its underwriting activities. DLJ's stock.. and net income sank from $7. revenues fell from $32. initially sold to the public at $15 a share. and I didn't want it to be my epitaph that in the first year as chief executive. Lufkin left DLJ in 1971 (although returning briefly in 1974-75). the firm's wisest decision during this period of restructuring was to back off from its announced sale of Alliance Capital Management Corp. but net income was a disappointing $3. a manufacturer of floppy disks." DLJ made its way back to profitability in 1975 by stressing cost controls.9 million in 1970.9 million in 1979. a specialized oilfield-service company. By 1976 the company could offer the institutional investor a full spectrum of investment vehicles. cities and in London.4 million in 1969 to $21. and Wood. In 1977 DLJ made two important purchases: Pershing & Co. Lufkin & Jenrette (DLJ)” # Page | 10 . "American Express made us feel like the end of the world to me. which owned 25 percent of the firm. In hindsight. as president and chief operating officer.75. Inc. an asset-management and brokerage firm. who had been chairman and chief executive officer of the company.5 million on revenues of $60. Paris. Revenues reached $329. and Shugart Associates. I broke the firm.5 million. The company's venture capital operation could boast of having organized such successes as Geosource." Jenrette later told a New York Times reporter. prompting the company to bring in John K. By the end of the decade DLJ had offices in nine U. was so disappointed that it spun off its holdings to its shareholders in the form of a stock dividend. a record it did not top until 1981. When the long bull market of the 1960s suddenly came to an end. Zurich. "That was my lowest day. In 1974 DLJ lost $11. however.3 million in 1972. Inc. This further depressed the stock market and ravaged the bond market which DLJ had entered in 1973. and American Express. This subsidiary subsequently grew into the largest pension fund manager on Wall Street and became the firm's chief source of income. also left in 1973. # Valuation & Detailed Analysis of “Donaldson. Sales from the company's own portfolio. ranging from Treasury bills to venture capital funds. one of the nation's largest trade clearing and cash-and-securities-settlements operations. the world economy fell into deep recession accompanied by double-digit inflation. and by its heavy investment in the unprofitable Meridian real estate investment trust. having amassed a fortune estimated at more than $35 million. DLJ earned $7.3 million. for $7 million. in 1970 placed it in the primary position as investment advisor to state and local retirement systems.5 million to $2.75 million. Jenrette moved up from president and chief operating officer to succeed him. dropped to $1. But I had my pride on the line.DLJ's acquisition of the investment-counseling business formerly conducted by Moody's Investor Service. including Louis Harris and Envirotech -a company DLJ put together itself--returned $75 million to the firm and its partners by the end of 1976. the head of its profit-oriented Sprout Capital Funds.S. and Hong Kong. Castle.

with $338 million in capital. even though Drexel Burnham Lambert foundered and its junk bond chief. Between 1985 and 1990 DLJ executed 23 buyouts. In 1985 DLJ sold its unprofitable futures trading businesses to Refco Inc. DLJ achieved 21 consecutive quarters of earnings increases.5 billion in 11 bridge loans (temporary loans until permanent financing could be arranged) to troubled companies. for about $460 million in cash.9 million in 1983. In 1989 DLJ earned about $90 million before taxes on revenues of about $950 million. insurer. The stakes that DLJ ventured in these deals. The firm's net income reached $24 million on revenues of $462. was managing $20 billion in pension fund assets. which accounted for 40 percent of DLJ's profits. Despite suffering an embarrassing setback when it paid $5. DLJ also staked about one-fifth of its equity capital of $900 million on leveraged buyouts. Michael Milken. the third largest U. DLJ also set revenue and earnings records in 1991. The Alliance unit was separated from DLJ by Equitable and taken public in 1988. according to estimates. The company's activities included many lucrative stock underwritings. Under Jenrette's watchful but encouraging eye. Nevertheless. a lucrative but sometimes controversial means (often involving the issuing of junk bonds) of taking public companies private that was highly popular in the 1980s. went to jail. the company's earnings on equity were only about 70 percent of the industry average. up from 24th in 1982. were immense: from the seven companies DLJ took private and then sold. During the 1980s the junk bond percentage of the firm's underwritings trailed only Drexel Burnham Lambert Inc. worth $13. The October 1987 one day stock market crash did not shake DLJ's faith in this means of financing. the year that junk bonds crashed. Pretax profits slumped but remained impressive at an estimated $50 million in 1990. He left the company. DLJ was the 12th largest brokerage firm in the United States. cities besides New York and in 14 countries on four continents. Lufkin & Jenrette (DLJ)” # Page | 11 . The Alliance subsidiary. but his retirement proved short-lived as he became Equitable's chief investment officer in 1986 and its president and chief executive officer in 1990. trading in mortgage-backed securities and junk # Valuation & Detailed Analysis of “Donaldson. an investment company controlled by Saudi Arabian investors who first bought shares in the firm in 1975. nine of them in support of the leveraged buyouts it had helped to finance.6 million plus interest to settle charges by the Securities and Exchange Commission that the company illegally used customers' stock in the care of its back offices. DLJ raised its commitment to the high-yield but risky securities known as junk bonds.. With offices in 16 U.Under Castle's administration. About 22 percent of DLJ's shares were being held at this time by Competrol Ltd. In 1990 DLJ further enhanced its junk bond activities by hiring at least 20 former Drexel investment bankers. Another 22 percent of shares were controlled by officers and directors of the company. Much of this money was provided by Equitable. and the profits made from them.5 billion. either alone or with partners. the company reaped compounded yearly gains of 140 percent. In November 1984 Jenrette agreed to sell the company to Equitable Life Assurance Society. In 1989 alone the firm extended $2. DLJ became one of the top 10 underwriters of stocks and bonds in 1990.S.S.

Institutional Equities. . Principal Subsidiaries Donaldson. Lufkin & Jenrette (DLJ)” # Page | 12 . DLJ's net revenues rose from $1. activities in which its share had been minor only five or six years earlier. MorningStar Foods. to $1. and a thriving restructuring business which helped companies that needed to issue or refinance junk bond debt.45 billion in 1992. and their subdivisions). Merchant Banking Group. Sprout. and Equity Derivative divisions. Lufkin & Jenrette Securities Corp.Capital Markets Group (consisting of the Fixed Income. # Valuation & Detailed Analysis of “Donaldson.bonds. Among such companies were JPS Textile. That year DLJ handled more initial public stock offerings than any other firm except Goldman Sachs and Merrill Lynch. when its pretax profit was an impressive $250 million. a field in which DLJ remained the acknowledged leader. Saatchi & Saatchi PLC.Banking Group (consisting of the Investment Banking Group.9 billion in 1993.Financial Services Group (consisting of the Pershing Division. and Southland Corp. and their subdivisions). and underwrote more than $8 billion worth of junk bonds. and their subdivisions). Much of DLJ's success was attributed to the 500-odd investment bankers the company had hired from other firms after the 1987 crash. Much of the firm's income also came from taxable fixed-income offerings and bond trading. and Emerging Market Group. Mortgage-backed bonds were the company's leading source of profit between 1990 and 1993. Investment Services Group. . when pretax profit passed $300 million. Principal Operating Units . and Asset Management Group.

the bank would sell a series of forward contracts on jet fuel prices to the airline. assisted acquirers in acquisitions by "bridging" the gap in financing until the companies could replace the bridge loan with more permanent capital. The # Valuation & Detailed Analysis of “Donaldson. with a corresponding torrent of debt and equity issuances from companies. and institutions 51. loan-syndication departments in investment banks competed with commercial banks to take commercial loans. Separately. called bridge loans. Syndication constituted one of the commercial banks' most profitable areas. individuals owned 70. Lufkin & Jenrette (DLJ)” # Page | 13 .1 percent. The bank then might sell offsetting positions to another party who wanted exposure to jet fuel prices. They insured against risks ·that corporations desired to shed. With the rise of pension and mutual funds. If they properly executed the transaction. For example. while never taking the loan onto their balance sheet. To accomplish this hedge. Change in the Scope of Operation In search of highest margins.2 CON-CURRENT INDUSTRY OVERVIEW Industry Analysis Introduction of New Products like SWAPs and Yankee bonds As the governments deregulated interest rates and foreign-exchange rates. investment banks came to price and take on event risk. Rise of Derivates With the rise of derivatives. like swaps and Yankee bonds. an investment bank might offer to limit an airline's exposure to fluctuating jet fuel prices. to take advantage of global capital markets. institutional investors came to dominate the market. In 1980. investment banks tailored generic contracts to meet companies' specific needs. In 1994. investment banking firms accepted credit risk by developing bridge loan funds and syndication departments.9 percent of all equities. divide them into smaller loans.2 percent. These loans. individuals owned just 48. and selloff the loans to a syndicate of banks. underwriters introduced products. investment banks moved into new areas. Change of Control from Individual investors to Institutional Investors Power shifted from individual investors to institutional investors during this period.2. deregulation and tighter monetary policies by reserve banks eventually led to a steady decline in interest rates from the early 1980s until 1994. They even moved into nonfinancial businesses. syndicate managers could earn fees for the work. Investment bankers lent money to firms on a short-term basis to facilitate pending M&A transactions.8 percent. Investment banks received less for their services but were more than compensated with higher volumes of transactions and increased trading activity. accepting new risks. This environment translated into an extended bull market. In most developed economies. The derivative market soared to become a multi trillion dollar market. As the derivatives market expanded. or might keep the contract on its books. They blurred the historical lines between financial institutions. To compete with commercial banks. and institutions owned 29. allowing the airline to "lock in" a set price for its fuel needs for the year.

Merrill Lynch created an asset management business that oversaw over $170 billion of assets. Profits could be quite high if the traders were right. in 1995. Morgan Stanley paid $350 million for Miller Anderson & Sherrerd. to bulk up its business. In the 1990s. firms established proprietary trading operations.S. In 1995. while venture-capital investments tended to be in growth-stage companies.74 billion in revenues.from holding more inventory for clients to building overseas operations to merchant banking investments. Many foreign regulatory bodies insisted that branch offices maintain regulatory capital on site. They used their own capital. these businesses provided reliable revenue streams. Morgan Stanley placed great emphasis on growing abroad. and India. Volatility of Earnings All of the changes in the industry necessitated capital.specialized use of derivatives played a large part in the development of the collateralized-mortgage and asset-backed debt markets. garnering annual returns of 30 percent or greater. Merchant-banking deals often involved mature companies and took on large amounts of debt. In effect. but losses could be severe if their insights proved wrong. one of the leading European investment banks. In 1994. Hong Kong. G. generating 40 percent of its revenues. Warburg. Unlike other areas tied to interest rates. With so much capital at risk. investment banks built up trading and corporate finance operations in emerging markets. The expansion required capital for equipment and for regulatory purposes. Building up Asset Management Business Many investment banks built or bought asset management businesses. though the merger fell through. To varying degrees. They risked their own funds to buy all or part of other companies outside the securities industry. Participation in Merchant Banking and Venture Capital Investments Many investment banks participated in merchant banking and venture-capital investments. like Mexico. companies expanded abroad. If the investment strategy proved correct. allocating roughly one-half of its capital overseas. These markets often offered lower levels of competition from local securities firms. to bet on the directions of the markets. Many critics charged Wall Street with a conflict of interest in its principal trading because many of its clients were making similar market bets. largely due to misguided bets on the bond market. critics charged. Morgan made an attempt to merge with S. Lufkin & Jenrette (DLJ)” # Page | 14 . Moving into Principal Trading With their knowledge of the markets and constant flow of information. They earned a fee based on a percentage of assets under management. Salomon Brothers lost $831 million pre-tax. often leveraged. investment banks flocked to Europe and Japan {IS U. roughly enough to cover the entire firm's fixed costs for a year. with firms like Salomon Brothers and Goldman Sachs leading the pack. these investments could provide huge returns to the equity capital invested. an asset manager. investment banks moved into principal trading. excellent growth and higher profits. Expansion in the Global Arena In the 1970s and 1980s. Brazil. the banks competed against their own clients. Even with its strong presence abroad. Annual management fees on the assets generated approximately $1. # Valuation & Detailed Analysis of “Donaldson.

More competition would put further pressure on margins as newcomers competed for market share on price.earnings became more volatile. and advisory services. The repeal of Glass-Steagall. Morgan. and Bankers Trust had successfully requested these powers.S. P. They argued that firms needed a strong international presence to successfully compete for large underwriting assignments and to mitigate oscillations in U. Many analysts expected that the European universal banks and U. PaineWebber. and Morgan Stanley-were sufficiently global and well capitalized as to remain immune from being acquired. Conventional wisdom stated that three firms-Goldman Sachs. J. and the long-expected repeal of the Glass-Steagall regulations.S. Chase Manhattan. They competed with investment banks in trading. and Salomon Brothers were prime merger or takeover targets. debt underwriting. Commercial banks eventually earned the right to petition the Federal Reserve for underwriting powers. Regulators assigned a portion of the blame for the crash on the conflicts of interest in the two businesses. They had limited success in their efforts to underwrite stock offerings. Lufkin & Jenrette (DLJ)” # Page | 15 . would undoubtedly bring more participants to the securities industry. By 1995.S. The Glass-Steagall Act of 1933 separated investment banks and commercial banks after the Crash of 1929. money-center banks would be acquirers of U. Profits could swing drastically with changes in underwriting volumes or interest rates. They hypothesized that two factors would drive consolidation: globalization. interest rates. investment banks once the act was repealed. which many predicted to occur by the end of the decade. Some speculated that Lehman Brothers. Expected Consolidation within the Industry Many analysts expected further consolidation within the securities industry in the future. Merrill Lynch. # Valuation & Detailed Analysis of “Donaldson.

00% 8.06% $14000 $12000 $10000 $8000 $6000 $4000 $2000 $0 5.11% 18.REVENUES AND EXPENSES GROWTH TREND Both the Revenue and expense trend in the Security industry was having a increasing trend during 1980 to 1993 as we can see from the Chart below.000 100.00% 12.000 0 1980 1985 1988 1989 1990 1991 1992 1993 Total expenses Linear (Total revenues) Linear (Total expenses) From the diagram below we can see that the profit faced a decline from 1980 to 1990 as the margin came down to as low as 1. Lufkin & Jenrette (DLJ)” # Page | 16 .000 40.05% 10.20% 10.00% 1980 1985 1988 1989 Pretax profits 1990 1991 1992 1993 Pretax margin # Valuation & Detailed Analysis of “Donaldson.00% 4.00% 0.93% in 1993.00% 16.00% 6.000 20.11% in 1990.000 80.67% 1.00% 11.93%14.00% 2.00% 10. But since then it was having an upward trend as it stood on 11.000 Total revenues 60.94% 13. Pre-Tax Profits (Figures in Million US$) & Pre-Tax Margin (%) 1980-1993 15.26% 3. Revenue & Expense Trends of Security Industry 19801993 Figures in Million US$ 120.

but left open the types of securities to be sold and when they would be brought to market. Guy Moszkowski. the securities industry analyst at brokerage Sanford C. 'The new regulations dissolved the fixed commission structure and allowed investors to negotiate commissions with their brokers. They also demanded that securities firms be ready to buy or sell nearly any security to them. investment banks served as orderly financial intermediaries. underwriting "plain-vanilla" stocks and bonds.5 percent of the value of securities underwritten. and take advantage of economies of scale in the "back office. requiring brokers to establish large securities inventories. the company could quickly issue securities in two days. I. This bidding cut the "gross spread. the SEC introduced Rule 415 which permitted "shelf registration" of securities." the percentage underwriters earned in the issuance' process. Economic Factors Before the mid-1970s. In 1974. Large institutions cut their commissions by t1p to 80 percent instantly. With competition. acting as capital raiser and trusted advisor. III. The managers were compensated according to how they performed relative to the market. In 1982. pension managers diversified their portfolios into new markets. managers grew hungry for financial products that could enhance their performance and manage unwanted risks. By 1993 the gross spread had shrunk to just 0. the government enacted the Employee Retirement Income Security Act (ERISA). Investment banks maintained close relationships with a select group of corporations. "pulling them off the shelf." the processing and record-keeping size of the business. A year later. requiring pension managers to follow the "prudent man" rule when making investment decisions. Bernstein. Lufkin & Jenrette (DLJ)” # Page | 17 . brokering securities for clients for a fixed fee and offering financial advice on mergers and acquisitions when asked. During that period.67 percent.Industry (PEST) Analysis Political Factors The political factors were dominated by three major changes in regulation. both domestically and abroad. In the new environment. estimated that in 1982 underwriters earned 1. The investment # Valuation & Detailed Analysis of “Donaldson. To win their underwriting business. a company filed one comprehensive registration statement to cover the issuance of a fixed amount of capital over a stated period. Companies needed only to make quick updates 10 the initial registration statement. the government hit the brokerage industry with May Day. when fixed brokerage commissions were eliminated. Freed from investing just in bonds and blue-chip stocks. I Smaller brokerages combined with each other to rationalize their businesses. Under a shelf registration. issuers forced underwriters to bid more aggressively for their securities. II. meet capital requirements." to take advantage of favorable rates or conditions. firms started to compete even more intensely with each other for clients.

blossoming fields like derivatives. Social Factors While the DLJ offering was oversubscribed by investors. Insurance companies underwrote event risk. But the things have changed greatly as described in the con-current issues of the industry. some had questioned how successful DU would be in the future. Computers supported the creation and pricing of more complex financial instruments. the function of investment banks was to bear capital market risks. Technological Factors Technology. In an underwriting. too. investment banks purchased clients' securities at a fixed price. these innovations tended to be quickly duplicated by competitors. Nonfinancial corporations accepted business risk. such as derivatives. While margins eroded in the brokerage and underwriting businesses. played a role in shaping the new financing arena. DLJ would have to cope up with the diversified social factors both globally and domestically. In corporate finance. Others questioned if DLJ could maintain its enviable.banks required little capital of their own. junk bonds.' and mergers and acquisition (M&A) services for leveraged buyouts (LBOs) kept overall margins healthy. bankers could test multitudes of capital structures and their effects on a company through the use of spreadsheets. Critics wondered if DU had sufficiently diverse businesses and enough of an international presence to compete in the ever-competitive securities industry. collegial atmosphere in the face of public scrutiny. Commercial banks accepted credit risk: the uncertainty of a borrower's ability to meet contractual interest and principal payments. In this regulated environment. quickly moving securities from corporations to investor’s. Lufkin & Jenrette (DLJ)” # Page | 18 . # Valuation & Detailed Analysis of “Donaldson. the operational risks inherent in their businesses. To sustain in this competitive industry. Though temporarily lucrative for their inventors. rarely holding inventories of securities. Innovation proved profitable for those who could create the newest security or M&A tactic. in contrast to other firms. to resell later in the market at an uncertain price.

Jenrette initiated a restructuring of Equitable in response to serious problems. Restructuring: In the restructuring. DLJ had just over 400 employees with revenues of $21. Their firm prospered. Last week. the New York Stock Exchange. For example. Lufkin & Jenrette (DLJ)” # Page | 19 .2. seeing that institutional investors were not adequately served. and sold 49 percent of Equitable to AXA. the three Harvard Business School graduates William Donaldson. The Business Week reported on the controversial transaction as follows: Wall Street is. Later. To continuing its strategy of diversification DLJ sold itself to Equitable in 1985 for $465 million. Equitable separated DLJ’s original asset-management operations. head of DLJ. when brokerage houses primarily created to individual investors. literally overnight. AXA owned approximately 60 percent of Equitable. If they lose.S. Jenrette cut $150 million in annual cost. owned by policyholders. a French holding company for a group of international insurance and financial service companies. Win or lose. rather proudly. Under Equitable. DLJ offered shares of itself to the public. raising $450 million in an initial public offering (IPO). NYSE prohibited members from having public shareholders> No NYSE members had ever offered shares to the public. Alliance’s market capitalization stood at approximately $2 billion.3 Inception Details of its operation In 1959. 1987 crash-DLJ actively hired select professionals. The firm decided to go public in 1970 for generating more capital. DLJ kept in NYSE membership. they have already set in motion forces that in the coming decade will wrench the sinews of power in every quarter of the U.000 to create an equity –research firm that would serve Institutional shareholders. from DLJ. became member of New York Stock Exchange. joined Equitable as chief investment officer shortly after the merger. and Richard Jenrette set out with $100. In June of 1995. they can increase the value of their firm tenfold. the home of the Big Risk and the Big Stake.9 million. offering sophisticated equity analysis to institutional investors in the hope of receiving their lucrative fixed-commission trading business. and in April of 1970. DLJ built industry and product groups as opportunity itself. He also demutualized Equitable. Alliance Capital Management (“Alliance”). By 1995. DLJ’s strategy was one of the patience. The market valued the company at approximately $115 million. securities industry. after the junk-bond market collapsed # Valuation & Detailed Analysis of “Donaldson. If they win. Richard Jenrette. keeping lean in the good times and taking chances when others saw gloom. when many securities firms fired employees following Black Monday-the October 17. Similarly. However. At the time. $14-milliom firm in one of the most remarkable wages in recent financial history. they forfeit their membership in the nation’s wealthiest club. Equitable sold part of Alliance to the public. Dan Lufkin. three young men staked their 10-year old. He became chairman in 1990. Equitable was then a mutual life insurance company.

821 professionals in the Capital Market Group. DLJ’s business included: Securities Underwriting Sales and Trading Merchant Banking Venture Capital Financial Advisory Services Investment Research Correspondent Brokerage Services & Asset Management DLJ operated through three principal Groups: the Banking Group. and individual client. Capital Markets Group: Institutional Equities Taxable Fixed Income Equity Derivatives Sprout Vevture Capital Banking Group Investment Banking Merchant Banking Emerging Markets Financial Services Group Pershing Division Investment Services Group Wood. DLJ’s careful strategy excelled. In terms of capital. DLJ Business Groups: The company was a leading investment and merchant bank that served institutional. including 431 professionals in the Banking Group. the Capital Market Group.676 people.in 1990. Lufkin & Jenrette (DLJ)” # Page | 20 . and 998 professionals in the Financial Services Group. Struthers & Winthrop DLJ Business Group In 1995. # Valuation & Detailed Analysis of “Donaldson. DLJ and Equitable sought a solution. Together. pushing DLJ up the industry league tables. DLJ ranked as the 11th largest securities firm. DLJ sought out and hired a core group of junk-bond specialists from fallen market leader Drexel Burnham Lambert. and the Financial Services Group. DLJ employed 4. government. corporate.

the Investment Banking Group had Assisted its clients in raising over $150 billion in capital and completed over 300 M & A transactions. The firm also maintained successful groups in private placements. private fund-raising (i. 1995. raising money for LBO fund).P. The Investment Banking Group also provided its clients with financial advice concerning mergers and acquisitions. worth approximately &65 billion. The merchant banking activities earned money by charging a small fixed percentage for asset under management and keeping approximately 20 percent of the profits realized through the investments. and other transactions.The Banking Group: The professionals in the Banking Group assisted clients in raising capital through the issuance of debt and equity securities in the public and private markets. DLJ earned one of the highest returns among principal investors. The bridge fund had completed 74 transactions totaling $12 billion of commitments to clients. and restructuring. DLJ had placed $580 million in 20 companies and realized $610 million from seven partial or whole realizations.e. structured finance. Since 1992. # Valuation & Detailed Analysis of “Donaldson. and DLJ Bridge Fund In 1985. DLJ utilized two investment funds with combined capital of $2. Since 1990. The fund had $230 million of bridge loans outstanding as of June 30. The bridge operations earned money for committing to lend money and on the interest on money it lent out. with Mergers & Acquisitions Restructuring and other transaction Private Placement.P. The Merchant Banking Group invested capital directly into companies. Lufkin & Jenrette (DLJ)” # Page | 21 . Priva te Fund Raising Structured Finance & Restructuring annual return thought to exceed 90 percent. DLJ then planned to form four new funds in the near future: DLJ Real State Fund Funds DLJ Senior Debt Fund DLJ investment Partners Global Retail Partners L. the group had invested in 46 companies with an aggregate purchase price over $18 billion. restructurings.25 billion:   DLJ Merchant Banking Partners L.

S. DLJ focused on serving its clients and had not undertaken a large amount of proprietary trading. In these markets. The professionals in Sprout worked closely with those in research and Investment Banking. in contrast to taking on trading risk or generating large volumes of generic derivatives. one of the oldest and largest venture-capital operations. bonuses and cost fell. The Taxable Fixed Income division concentrated on serving institutional investors in high-yield corporate. For listed equities. often taking long and short positions to help clients quickly gain liquidity. DLJ also made markets in approximately 350 securities traded on the National Association of Securities Automated Quotation System (NASDAQ). the company provided a limited number of derivative products. These costs were tied to the group’s performance through year-end bonuses. Capital Market Group: The Capital Market Group offered trading. leveraged transactions. The Equity Derivatives division also participated in trading and distributing convertible securities. a South African merchant bank. Additionally. By the Equity Derivatives divisions. if performance fell. and 52 fixed income research analysts. the company acted as principal and agent. and telecommunications.The Emerging Markets Group was founded by DLJ in February 1995 to provide a broad array of investment banking. the company agreed to invest $7 million in Pleiade Investments. mostly equity and index options.S. focusing on investments in business services. The Banking Group produced high margins with lower levels of risk in favorable environments. research.-government (as a primary dealer). Merchant Banking offered more risk as DLJ put in its own capital with its limited partners in purchasing securities in companies. resided in the Capital Markets group. Sprout. Most of its products were tailored to meet a client’s specific needs. Most of its costs were personnel related. health care. Most trades were made in blocks of 10. office automation.000 shares or more. U. computer graphics and peripherals. and trading services to clients in Latin America and Asia. The division employed 450 professionals-including 72 traders. 137 institutional salespeople. retailing. institutions with 100 traders and salespeople. Lufkin & Jenrette (DLJ)” # Page | 22 . The division primarily made markets for stocks of companies that had been underwritten by Investment Banking or covered by the research department. and sales services in fixed-income and equity securities. merchant banking. The Institutional Equities division covered major U. sale. and mortgage backed securities. investment-grade corporate. # Valuation & Detailed Analysis of “Donaldson. Sprout managed over $1 billion in capital.

generally accepted accounting principles (GAAP). Pershing accounted for approximately 10 percent of the daily volume on the New York Stock Exchange. The Investment Services Group (ISG) served high-net-worth investors and smaller institutions. the Capital Markets Group held large inventories of stocks and bonds. In clearing trades for others.000 professionals worked in FSG. DLJ earned interest income by lending to customers to purchase securities and by holding higher yielding inventory funded with lower cost capital. which in turn would impact DLJ’s overall profitability. creating losses and gains that appeared on the income statement. Under U.S. These lenders would carefully watch DLJ and its financial condition in determining the rate they charged DLJ. Struthers & Winthrop in 1977 to provide investment management and trust services to its clients. and Reuters Money Network. While these positions were hedged to varying extents. Pershing’s Financial Network was the largest on-line discount broker in the United States. brokerage firms and lending clients money for margin trades. equity funds and two fixed-income funds. Wood. It financed much of its inventory through repurchase agreements with other financial institutions. Pershing’s clients collectively managed over 1 million accounts with assets of $100 billion. PRODIGY. providing trading through several on -line services. The Pershing Division offered correspondent brokerage services. In this capacity. like American On-Line (AOL). clearing transactions for over 500 U. Lufkin & Jenrette (DLJ)” # Page | 23 . referring to DLJ’s founding as a research firm and continued strength in providing high quality research. Approximately 1. DLJ purchased Wood. DLJ had to continuously mark its positions to market. Financial Services Group: The Financial Services Group (FSG) provided a broad array of services targeted to individual investors and the financial intermediaries who represented them. To serve clients. the average daily volume traded through this service soared at an annual rate of 128 percent.S. Struthers & Winthrop managed $205 billion. Between 1990 and 1994. DLJ made money much like a # Valuation & Detailed Analysis of “Donaldson. ISG gave its clients access to DLJ’s research and sales and trading capabilities.S. their values changed with changes in the overall market.Business Services Retailing Leveraged Transaction Computer Graphics & Peripherals Office Automation Health Care Investing Areas Telecommunication DLJ earned the moniker The House that Research Built. and operated three U.

1 million in net interest income. Approximately 450 independent research firms. DLJ owned Autranet.bank did. on the spread between the rates at which in lent or invested money and the rate at which it borrowed money. DLJ made $288. Separated to the above three group. # Valuation & Detailed Analysis of “Donaldson. who had no affiliation with underwriters. a distributor of independent research. supplied Autranet with research. Autranet distributed the research to over 400 institutions. Lufkin & Jenrette (DLJ)” # Page | 24 . In 1994.

12 0. Long-term borrowing to total capital ratio (Fig.8% 0.0% 6.01 0.0% 1. 1994 (Till 1995(Till Jun 30) Jine 30) 0.1% 55.2% 28.1% 23.47 Six Months Ended June 30. we have calculated and found some of the key ratios shown in the Table below: Key Ratios 1990 Years Ended December 31.91 0. # Valuation & Detailed Analysis of “Donaldson.8) and ROE (Fig.3) is consistent over the years and it is 1:3 for the last two years which is also satisfactory.1% 5.0% 53.5% 8.6% 47.81 0.16 0.1% 0.4 RATIO ANALYSIS OF DLJ: SWOT & Ratio Analysis By examining the Balance sheet and Income statement of DLJ. which is satisfactory for an Investment bank and we have found that the industry current ratio is also somewhat close to 1:1.4% 6.7% 8.96 24.35 58.5) for DLJ is also showing consistent trends and satisfactory in contrast with the industry.86 0.42 1992 729.34 1994 0.4) is very good in terms of the industry and it is around 50% for the last 5 years which suggests the firm has good control over its costs.89 0.1% 0.2% 4.33 17.6) and Pre-tax Return on Average Equity (Fig.9: 1.2% 0.84 25. 1991 0.3% 0.94 17.8% 0. Although ratio of Net Assets to Stockholders' equity(Fig.1) close to 0.3% 28. Return on Asset (Fig.9) is a matter of concern.1% 46.2) has recently shown a downward trend but overall.4% 23.13 22.3% 53.6% 61. Lufkin & Jenrette (DLJ)” # Page | 25 .7) is consistent with the industry.1% 0. although last twelve months' less than average revenue (Fig.98 22. We have also found from the income statement statistics of 1990-1994 that DLJ has performed better than the industry average in terms of revenue growth (Fig.10).93 0.4% 51. The revenue growth found by the Gross Profit Margin (Fig.5% 50.51 1993 0.9% According to the ratio analysis.2.89 22. the ratio is reflecting a positive trend and has not deviated much.30 Current Ratio Ratio of Net Assets to Stockholders' Equity Ratio of Long-Term Borrowings to Total Capital Revenue Growth Gross Profit Margin Gross Profit Growth Net Profit Margin Net Profit Growth Return On Assets (ROA) Pre-Tax Return on Average Equity 0.3% 6. DLJ has a current ratio (Fig. Net profit margin (Fig. Moreover.

0% 2.20 1990 1991 1992 1993 1994 1994 (Till Jun 30) 1995(Till Jine 30) Figure.Trends of these ratios are shown in the figures below to get a synopsis and visual pattern of the ratios: Figure.02 Ratio of Long-Term Borrowings to Total Cap 0.0% 10.60 0.0% 60.40 0.0% 20.0% 40.0% Net Profit Margin Figure.01 Figure.05 # Valuation & Detailed Analysis of “Donaldson.04 Figure.0% 30.0% 4.0% 0. Lufkin & Jenrette (DLJ)” # Page | 26 .0% 8.0% 0.0% 50.0% 6.0% 10.03: Ratio of Long term borrowing to total cap Gross Profit Margin 70.

07408 03 0.13058 35 0.0860 497 0.07 1990-1994 Compound Average Growth Rates: A.0% Pre-Tax Return on Average Equity 70.051876 4 0.089516 2 0.753 8419 Merrill Lynch 0. Lufkin & Jenrette (DLJ)” # Page | 27 .128561 2 0.7% 0.1483 867 0. Edwa ds 0.1248 31 0.4028 112 0.1978 565 0.6% 0.146 1 0.4% 0.7419 628 Bear Stearns 0.0% Figure.02396 08 0.177 2569 0.01077 91 Ind.5% 0.13562 0.124222 5 0.11728 83 0.227 1273 0.2% 0.G.170 2312 0.130287 5 0.3% 0. Brown 0.171 1117 0.10441 25 0.06 Figure.1490 839 0.0% 60.162 4879 0.140 6378 0.2355 782 0.0% 10.145 5411 0.114 1713 0.0% 0.218 8848 0.04917 04 0.099481 1 PaineW ebber 0.203 3051 0.0% 30.149 7025 0.247 1754 Income Statement Statistics Gross Revenues Net Revenues (a) Commissions Investment Banking Revenues Principal Transactions Net Income Alex.12816 06 0.365 7594 # Valuation & Detailed Analysis of “Donaldson.131 4238 0.177 8533 0.09927 27 0.2112 453 DLJ 0.Return On Assets (ROA) 0. Avg.0% 50.1% 0.51738 83 Morgan Stanley 0.2218 169 0.152 0741 0. 0.0% 40.0% 20.13080 73 0.2135 485 0.1700 632 0.

Edwar ds 0.4 0. Last twelve months' Income Statement Statistics: 12000 10000 8000 6000 4000 2000 0 Gross Revenues Net Revenues Commissions Investment Principal Banking Transaction Revenues Revenues Net Income Ind.10401 6 Paine Webbe r 0.36 9858 0.1938 42 Morgan Stanley 0. Lufkin & Jenrette (DLJ)” # Page | 28 . DLJ Figure.23274 1 0.1 0 Gross Revenues Net Investment Principal Revenues (a) Commissions Banking Transactions Revenues Net Income DLJ Ind.21605 3 0.24 9402 0.216 0.26 761 0.6 0.02319 3 Salomon Brothers 0. Brown 0. 0.7 0.219734 0.211644 -0.2290 91 0.2916 64 0.08 0.G. Avg.18 2219 0.9 Table: Analysis of ROE of the Industry: ROEs Averag e 1991 Averag e 1992 Averag e 1993 Averag e 1994 Alex.3 0.1972 18 Bear Stearn s 0.5 0.23593 7 0.3408 55 0.2164 8 0.1629 86 Merrill Lynch 0.2105 57 0.2362 9 0.15 6628 A. Avg.2181 99 0.2295 62 0.19170 1 0. Avg.8 0.2654 42 0.10232 Ind.2640 32 0.229802 0.26583 5 0.2877 42 0.22 1162 0.30 8905 0.Figure.10 7909 # Valuation & Detailed Analysis of “Donaldson.2 0.23504 3 0.1277 07 DLJ 0.

4 percent generating an average annual pretax return on common equity of 33.1 0 Average 1991 Average 1992 Average 1993 Average 1994 DLJ Ind. Avg. Merrill Lynch and Morgan Stanley to continue gaining market share  DLJ does not have sufficient operations overseas or large recurring-fee operations  Its profits were tied to trading activity by its client  It does not have sources of steady revenue stream from asset management activity  Critics were not sure whether DLJ would find new business lines that would maintain its growth rates and profit margins  Increasingly competitive high yield market and lack of diversification may hinder post-IPO profit  Employee retention by DLJ may face public scrutiny  The stock offering by DLJ may that be perceived as the owners' decision of thinking it as a good time to sell the firm and thus become unattractive to the investors # Valuation & Detailed Analysis of “Donaldson.3 0. which are listed below:  Firm's growth has outpaced most of the industry over the last five years  It has a successful strategy of competing in several higher margin businesses like IPO. highyield underwriting and trading. DLJ has the following issues to face:  It would have to increasingly compete with firms like Goldman Sachs. Figure.6 percent  The three operating groups have expanded roughly at equal rates  The investors will have opportunity to share in DLJ's success with the new public offering  Many securities-industry specialists called DLJ one of the most desirable franchise in Wall Street  DLJ has not committed its large amount of resources to the lower margin businesses of underwriting and trading of investment grade debt and municipal bond On the other side of weaknesses and threats. 10 DLJ's Performance and Outlook: On the strength and opportunity side of DLJ. there are several issues to be considered. Lufkin & Jenrette (DLJ)” # Page | 29 .2 0.9 percent  During this period net income has also increased at 75. and merchant banking  The revenue and profits have grown consistently with the increased market share  From 1990 to 1994 revenues have increased at a compound average rate of 21.4 0.0.

Lufkin & Jenrette (DLJ)” # Page | 30 . There will be self-dealings 4. It will permit founders to diversify 3. There will be Cost of reporting 2. Firm will lose some of its control 6. New disclosures are needed 3. It is going to facilitate raising new corporate cash 4. There may be Inactive market and price will reduce 5. It will increase the potential markets  Disadvantages of going public: 1. It will again establish the value for the firm 5. Higher degree of Investor relations has to be maintained # Valuation & Detailed Analysis of “Donaldson.Advantages & Disadvantages Analysis of going public of DLJ:  Advantages of going public: 1. It will increase liquidity and allow founders to harvest their wealth 2.

Lufkin & Jenrette (DLJ)” # Page | 31 .DLJ VALUATION # Valuation & Detailed Analysis of “Donaldson.

and venture capital. though keeping smaller operations and focusing primarily on U. analysts couldn’t accurately predict how the firms would fare" in their principal activities like trading.1 Problem Statement & related issues DLJ expected to sell the stock to investors who wanted exposure to the securities industry. DLJ posed extra valuation challenges due to its concentration in several key areas that were especially difficult to forecast. Regional investment banks and boutiques catered to companies and investors in their regions or industry specialties. # Valuation & Detailed Analysis of “Donaldson. and broad investment-grade debt underwriting and trading operations. Lufkin & Jenrette (DLJ)” # Page | 32 . Realization of profits from principal investments depended upon the opportunity to exit the investment through a public offering or a sale. and results fluctuated from year to year. maintaining extensive staffs domestically and abroad in corporate finance and sales and trading. clients. Most of them concentrated on covering a few key industries. They were the largest firms. Special bracket. Discount brokers The bulge brackets tended to compete for the business of large corporations. offering extensive services in almost every area of investment banking and brokerage. merchant banking. These investors would examine DLJ and its prospects relative to other publicly traded securities firms. extensive principal trading activities. and 4. Bulge bracket.S. and merchant banking. Regional and boutique firms. On the trading side. Picking comparable companies would be fragile. Earnings and cash flows of DLJ were difficult to predict as there were some external factors beyond the industry's control that could affect their business dramatically such as:    Interest rates in the United States and abroad Merger-and-acquisition activity Domestic savings & Investment rates Overall direction of the stock market Additionally. like high yield and IPO underwritings. 2. The market tended to segregate the firms into four categories: 1.3. as many of the other firms maintained large retail divisions. 3. They generally possessed fewer people and less capital than the bulge-bracket firms. Special bracket firms often competed with the bulge brackets for business in selected industries and products. strategies that succeeded in the past might fall low or key traders may not stay till that long.

the estimation of the firm’s future reinvestment needs.929 2. the consideration of the value of cash and non-operating assets (such as marketable securities the firm may own).75 15.98 Morgan Stanley $87. These include the estimation of expected free cash flows.6 $6.787 $16. An important part of the IPO process is the estimation of the value of the firm. During the past five years investors in other brokerage stocks had fared well.710 14. and the impact of the IPO on the control of the current owners.13 Lehman Brothers $22. Securities-industry analyst Guy Moszkowski of Sanford C.7 $10. A standard approach to firm valuation is the DCF valuation.565 104. together with the size of the IPO. we discount expected free cash flows at a rate that reflects the firm’s risk (typically the firm’s cost of capital).00 A.l25 quarterly dividend per share. Lufkin & Jenrette (DLJ)” # Page | 33 . After the intrinsic value per share is estimated. Some of the information is presented in tabular form in the following:Alex. Beginning in the first quarter of 1996. the estimation of the tax rate to be used.3 $1. He stated that he had observed a historical relationship between the current return on equity and the price-to-book ratio for capital markets firms like DLJ. the impact of warrants.6 $2.790 97.50 Salomon Brothers $36. Investors prefer to purchase shares in an IPO under the anticipation that there will be a considerable capital gain in the aftermath.911 173 4.50 at an annual rate. or $0.805 $18. Brown Stock Price as of October 23. investors would count on receiving dividends from DLJ.5 $723 118.Discount brokerages competed on price for retail investors' brokerage business. but generally didn't maintain underwriting or advisory departments.376 62. the issuer and the underwriter will agree on the offering price per share. # Valuation & Detailed Analysis of “Donaldson.4 $3.011 77. the price will be set below its value so that there is a higher likelihood of successfully selling the shares. Moszkowski noted that these firms often possessed a price-to-book ratio of 10 times the current return on equity in this part of the earnings cycle. as dividends from these firms had grown considerably and stock prices had increased. Bernstein & Company offered a separate valuation technique. This.G. will determine the value per share for the firm. In this approach.095 106.719 $4.565 $15.8 $2. In most cases.50 Merrill Lynch $56. the estimation of the discount rate. Edwards $25. 1995 Shares Outstanding (Millions) Market Capitalization Long-Term Debt and Preferred Stock Total Market Capitalization $46. management options and convertible bonds on firm value. DLJ's board of directors planned on instituting a $0.958 $26.775 9.4 $2.50 PaineWebber $21.792 - 13.63 Bear Stearns $20.168 $1.353 $897 $7. This approach is tedious and numerous issues must be addressed throughout the process.353 175.264 Certainly.605 16.

For example. In this approach a firm’s value or the value of its shares is obtained by looking at how similar companies and their shares are currently valued in the market. thus.). after we have derived the value of the firm through the DCF approach. etc. Thus. In any case. In this case. interest rates. we can use them to perform a DCF valuation. in addition to subtracting the cash flows to creditors from the free cash flows to the firm we must also add any cash inflows from new debt that the firm issues. its operating cash flows. this has been around 8%. four to five years. let’s say.In firms like DLJ. One approach is to use the firm’s after-tax earnings after having subtracted reinvestment expenses. This approach uses various multiples. Note. For example. We can think of the free cash flows as including the sum of the cash flows to the firm’s shareholders and bondholders. Lufkin & Jenrette (DLJ)” # Page | 34 . These are also part of the cash flows to shareholders. This rate (g) could be equal to the rate of sales growth that was assumed in the forecasting. and revenue multiples. investment banks may obtain an estimate of a firm’s value and the value of its shares though a relative valuation approach. we would discount these cash flows at the firm’s cost of capital and add to them the firm’s terminal value. we can obtain the value of the firm’s shares by discounting the expected cash flows to shareholders: FCFE = FCFF – debt payments + new debt issued It is notable that. book value multiples. then we must compare the two to ensure that we do not use a rate (g) higher than the nominal GDP rate. This value is calculated by assuming that free cash flows beyond our forecasting horizon will continue to grow at a constant rate. commonly used ratios are: • Price/Earnings per share • EBIT Multiple • Price/Book Value # Valuation & Detailed Analysis of “Donaldson. such as earnings multiples. that the sales growth rate cannot realistically exceed the nominal rate of growth of the economy (GDP) in the long run. the free cash flow to the firm can be given by: FCFF = EBIT (1-tax rate) – (capital spending – depreciation) – change in noncash working capital Accounting for the firm’s reinvestment needs is important because these investments will impact the firm’s current and future growth and. it may simply be very difficult to obtain good estimates of expected cash flows due to the fact that these are affected by several factors that are beyond the control of the company (such as the economic cycle. If there is information about both the sales growth rate during the forecast period and the growth rate of nominal GDP. though. In the US. If we have forecasts of free cash flows for a future period of. we can use a constant-growth-valuation model and calculate the terminal value as follows: TV = (FCFF(1+g))/(WACC-g) More typically.

00% 2.30% 30.637.76 5.61% 1.85 723.150.00 FCFE 112.31 2.384.85% # Valuation & Detailed Analysis of “Donaldson.2% 28.360.30% 10.116.8% 59.09 146. Discounted Cash-flow Method: Cash Flow Enterprise Value Debt Value Equity Value No of Equity Shares FCFF 147. Lufkin & Jenrette (DLJ)” # Page | 35 .81 Market Risk Premium Risk Free Rate Tax Rate in US Cost of Debt Equity beta Rf RM RM-Rf Refer Beta of DLJ US Treasuries traded at a yield of 2.39% 40.301.00% 8.150.00% 7.00 Share Value WACC: RM Rf Tax 10.47 21.00 WACC = Kd (1-t) * Wd + Kp*Wp + Ke* We Cost of common stock Weight of Debt Weight of common stock WACC 10.49 5.30% Rm = Rf + Rp Market risk premium is 20% Ke = Rf + b*(Rm-Rf) 768.2 We have followed the 3 approaches & got the IPO prices like this:- Valuation 1.3.00 1.70% 12.067.

1995 Shares Outstanding (Millions) Last Twelve Months Earnings per Share Last Twelve Months Book Value per Share SP/BV per shares Average SP/BV Per shares BV Per Share (DLJ) Alex.5 0 77.78 3.63 15.67 PaineW ebber 21.50 10.06 56.52 5.13 62.21 A.59 27.06 52. 7 72 1.5 175.26 # Valuation & Detailed Analysis of “Donaldson.G.00 Share Value 25. EBIT Multiple Method: EBIT Multiple Method: EBIT Number of Shares EBIT Multiple 132.58 34. Brown 46. Edward s 25.83 Share Value 29.0 6 1.43 Brot hers 36.75 106. Book Value Method: Book Value Method: Firms Stock Price as of October 23.40 16.40 20.59 1.6 0 4.50 51.3 4 1.72 31.50 Lyn ch Stan ley 87.80 3.2.00 118.26) 15.64 1.39 29.95 0.95 Bear Stearns 20.64 15.50 97.04 1. Lufkin & Jenrette (DLJ)” # Page | 36 .30 2.73 3.58 1.53 1.4 3 0.80 1.9 8 104.59 Brot hers 22.44 (0.

285. The number of shares and options issued would depend on the final offering price.700.00 26.82 26.477.97 # Valuation & Detailed Analysis of “Donaldson.73 29. DLJ offered approximately 500 employees the opportunity to exchange $100 millions of their interests in compensation plans for approximately 5. Employees who opted to not exchange their interests would receive cash instead.31 7.2 million shares of DLJ stock at the offering price. This stock was subject to vesting and forfeiture in certain circumstances.31 22.200.477. Employees' Options: Total Value for 500 Employees: Number of Stocks offered: Average Price Per Stock: Additional Value for 500 Employees: Offer Price of Stock: Number of Stocks Available: Total Number of Shares to the Employees: Average Price Per Stock: 100.000.71 25.60 After considering all the IPO valuation techniques. the recommended price of the DLJ IPO should be $26 per shares. these employees could exchange $55.3. Lufkin & Jenrette (DLJ)” # Page | 37 .00 19.085.000. Their average offered price would be $23.71 2. Additionally.26 21.000 5.26 Recommendation 27.3 DFCFF EBIT Multiple Book Value DFCFE EBIT Multiple Book Value 28.23 55.47 25.81 25.000.7 millions of future compensation under these plans for options to purchase approximately 7.73 29. Employee Options: In conjunction with the offering.2 million shares of restricted stock.

DLJ ANNEXURE # Valuation & Detailed Analysis of “Donaldson. Lufkin & Jenrette (DLJ)” # Page | 38 .

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