Jefferies could yet turn into a Goldman — or a DLJ

April 7, 2011

By Antony Currie
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Jefferies keeps bucking the trend. As many of its larger Wall Street rivals pare operations, the relative minnow has been expanding. The question is whether the firm has the wherewithal to sustain the pace and become a Goldman Sachs in time, or if it will instead go the way of Donaldson, Lufkin & Jenrette.

The nearly half-century-old Jefferies is bigger than a boutique and expanded far beyond equities. Its line-up includes mortgages, municipal and corporate bonds and a much enlarged investment bank. Staffing has increased by more than a third since the financial crisis struck. And now it is adding a commodities and futures brokerage with the $430 million acquisition of Prudential Bache.

Jefferies is still a far cry from the bulge bracket. Net profit last year was just $280 million, barely more than 3 percent of what Goldman harvested. It still has scope to grow, however. New hires arguably have not yet settled in enough to crank out their full earnings potential. Shareholders appear to have baked in a better relative performance at Jefferies: the stock trades at around 1.7 times book value, double Morgan Stanley’s multiple and a third better than Goldman’s.

But expansion comes at a cost. Compensation accounted for just shy of a whopping 60 percent of revenue last year, compared with around 40 percent at Goldman and JPMorgan. And return on equity for the first three months of its financial year was a modest 12 percent, even though leverage ticked up to around 13.5 times equity, roughly the same as in 2007.

Others have trodden this path before. Expanding beyond their sweet spots proved too hard for the so-called Four Horsemen — Hambrecht & Quist, Alex Brown, Robertson Stephens and Montgomery Securities. They sold to far larger banks in the late 1990s, and for the most part were quickly subsumed. Meanwhile, the financial pain of trying to establish a European hub helped persuade bosses at DLJ to accept $11.5 billion from Credit Suisse in 2000.

There aren’t as many obvious buyers these days. And with Wall Street returns lackluster across the board, Jefferies is under no pressure to do anything but grow and improve the bottom line. But in a race with bulge bracket-like expansion, a sale may come first.

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