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Lehman Brothers Going Strong

By Richard McCaffery (TMF Gibson)
June 16, 2000

U.S. investment bank Lehman Brothers (NYSE: LEH) continued its run of strong quarters this morning, reporting second-quarter net income of $378 million, or $2.78 per diluted share, up from $330 million, or $2.09 per diluted share, a year ago.

The company made chop suey of analyst estimates, beating the First Call/Thomson average estimate by $0.29 as equity sales, trading, and origination activities boosted net revenues (revenues minus interest expense) to $1.75 billion, up from $1.45 billion a year ago. Actually, analysts lowered estimates based on the second quarter's tougher financial environment. The S&P 500 is up less than 1% this year, the initial public offering market dried up months ago, and there's less trading activity overall. Sequentially, Lehman's net revenue fell 20% from $2.2 billion in the first quarter. That's life in the financial services business when the markets turn down and interest rates rise. So far, however, Lehman has done a good job of weathering the storm.

Since American Express (NYSE: AXP) spun off Lehman in 1994, the company has tried to diversify its revenue stream and expand from the fixed-income securities business into higher-margin services like equities, investment banking, and high-margin bonds. Nowhere is its success more apparent than in Europe, which accounted for 49% of net revenues in the second quarter. Typically, European revenues account for about 30% of business.

Lehman showed strong topline growth in almost all of its businesses this quarter. Total interest and dividend revenue, its largest revenue category by far, grew 31% to $4.5 billion, up from $3.6 billion a year ago. The category includes financing activities mainly from its bond business.

But the company showed good growth in newer businesses as well. Total principal transactions revenue, commissions revenue -- a line item Fools don't much like since it represents money generated from the which represents money from trading activities in the secondary market, grew 27% to $685 million. Total frictional costs of making trades -- grew 35% to $226 million. Over the last four years principal transactions and commissions have grown at a 39% and 35% compound annual growth rate, respectively. Basically, the company has done what it said it was going to do -- broaden its revenue base and increase growth rates.

The concern generally raised about Lehman is its debt. The company doesn't provide a full balance sheet in its financial releases, but you can see where things stand from the debt figures in its most recent 10-Q. Lehman's long-term debt-to-total capital ratio, which tells investors how much of the company's total financing comes from long-term debt, stands at about 78%, compared to about 67% for well-heeled competitor Goldman Sachs (NYSE: GS) .

Investors have to consider the extra risk that goes along with higher debt in their analysis.

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