Case 25

Version 1.3

Donaldson, Lufkin & Jenrette, 1995 (Abridged)

Teaching Note

Synopsis and Objectives

This case describes the series of decisions associated with the
initial public offering of shares of Donaldson, Lufkin & Jenrette (DLJ)
in 1995. The firm faced increasing financing requirements in the
future. DLJs owner, The Equitable Companies, considered various
possible responses to the financial challenge, including internal
financing. Equitable chose an equity carve-out and public offering of
a 20 percent interest in DLJ. This case describes the IPO process in
some detail, and challenges the student to choose an offering price.

Suggestions for
complementary cases
regarding issuance and
management of the firms
equity: eBay Inc. (A) (case
26); Planet Copias & Imagem
(case 27); and Eastboro
Machine Tools (case 24).

This case, combined with any epilogue information that the instructor may wish to present,
can be used to support these teaching objectives, among others:

Survey the initial public offering underwriting process, and the risks assumed by the
underwriter.

Explore the strategic considerations of equity carve-outs and compare them to spin-offs,
divestitures, and internal financings.

Exercise equity valuation skills. The case gives ample information on comparable
companies and their multiples on which to base a pricing decision.

Introduce investment banking and the securities industry. In addition to describing the
business sectors in this industry, the cases survey the major forces of change in recent years.

This teaching note was written by Robert F. Bruner and Douglas Fordyce. Copyright 1996 by the University of
Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to
dardencases@virginia.edu.. No part of this publication may be reproduced, stored in a retrieval system, used in a
spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying, recording, or
otherwisewithout the permission of the Darden School Foundation. Rev. 12/01.

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Suggested Questions for Advance Study

1. Why is Equitable considering selling an interest in DLJ? In answering this question, account
for Equitables perspective, DLJs strategic position, and major forces of turbulence in the
industry.
2. What are the relative advantages and disadvantages of (1) carve-out, (2) spin-off, (3)
divestiture through cash sale, and (4) continued complete ownership by Equitable? Why did
Richard Jenrette choose an equity carve-out for DLJ?
3. Prepare to describe the equity underwriting process, and the particular concerns of an initial
public offering. Who is the lead manager in this instance, and what is that firms role?
What are the risks?
4. What is your estimate of DLJs fair value per share? In answering this question, please draw
on as many valuation approaches as you can. Give special attention to the valuation
multiples of DLJs peers. Who are those peers? Why do they qualify as peers?
5. At what price should DLJ be offered? Think carefully about your answer here. The offering
price need not be identical to your answer to question 3. If answers to 3 and 4 differ,
however, please prepare to explain why.
To emphasize the strategic dynamics of setting the price for an IPO, the instructor can
assign teams of students to represent a type of equity investor. At least two teams of each
kind of fund should be represented. The purpose of this is to illustrate the process of
building a book of demand for DLJ shares (described below):
6. You have been assigned to represent one of the following institutional investors. You must
determine the number of shares your institution will demand at the following per-share
offering prices: $16, $18, $20, $22, $24, $26, $28, $30, $32, $34, $36, $38, $40, $42, and
$44. Each institution should assume that the maximum number of shares available at any
price would be 9.2 million shares, which could be increased by 1.38 million shares under the
terms of the green shoe option.
!

Formula One Hedge Fund. This fund has $2 billion under management, with $100
million uncommitted at the moment, and the capacity to borrow $500 million to
support trading activities. The objective of the fund was active market trading,
speculation, and investment in aggressive market positions, with the aim of beating
the market by 10 to 20 percentage points each year.

Henry Hudson Fund held $50 billion under management, placed almost exclusively
in common stocks. The manager of this fund sought to beat the market by 2 to 5
percentage points in return each year largely through careful investing in undervalued

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357

stocks and growth-oriented companies. IPO investing was an ongoing favorite of this
manager. The manager of this fund held $4 billion in cash and equivalents with
which to seize special market opportunities.
!

Golden Years Retirement Fund managed assets of $14 billion. About 60 percent of
the fund was in high-quality bonds and preferred stocks. The remainder was invested
in blue chip dividend-paying equities. The objective of the fund was the
preservation of investment capital, and high current income. The manager of this
fund had been under pressure to boost performance in recent quarters and had
invested in IPO shares with good results. The manager was willing to commit up to
$400 million to IPO shares in the current quarter.

Spreadsheet File
The spreadsheet file UVA-S-F-1447.XLS, version 1.3, supports student preparation of the
abridged case. Use of this file is optional and not necessary for adequate preparation. There is no
instructor spreadsheet file.

Suggested Supplementary Readings

This case has been taught successfully without the support of supplementary readings. The
following citations are offered for the benefit of the instructors own preparation, or for use in special
assignments such as term papers or team projects.
1. Roger G. Ibbotson, Jody L. Sindelaar, and Jay R. Ritter, The Markets Problems with the
Pricing of Initial Public Offerings, Journal of Applied Corporate Finance (Spring 1994):
66-74. This presents a good summary of research on the three classic anomalies of IPOs:
underpricing, the existence of hot and cold IPO markets, and the long-term
underperformance of IPO securities. This reading would give a nice survey of background
issues for DLJs IPO.
2. Chris Muscarella and Michael Vetsuypens, A Simple Test of Barons Model of IPO
Underpricing, Journal of Financial Economics 24 (1989): 125-35. This article has great
relevance to the DLJ IPO since it tests underpricing of shares of investment bankers in their
own IPOs. One hypothesis of the underpricing anomaly is that investment bankers somehow
exploit their clients. This study reveals that when investment-banking firms go public, their
IPOs are underpriced by about as much as other IPOs.
3. Robert Hansen, Evaluating the Costs of a New Equity Issue, Midland Corporate Finance
Journal 4 (Spring 1986): 42-55. This gives a very clear presentation of the issuers costs in
an equity offering. Many students are surprised to learn that the cost of issuance goes well

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beyond the fees paid to the underwriter, and constitutes 15 to 20 percent of the gross
proceeds of the offering. Hansen breaks these costs down and compares them to other
methods of equity offering.
4. Marco Pagano, Fabio Panetta, and Luigi Zingales, Why Do Companies Go Public? An
Empirical Analysis, Journal of Finance 53 (February 1998): 27-63. This article presents an
interesting profile of IPO issuers and suggests that issuers go public to rebalance their capital
mix of debt and equity after a period of rapid growth, as opposed to financing new rapid
growth. The implication of this for most companies is the need to build a track record
before attempting to go public.
5. Katherine Schipper and Abbie Smith, Equity Carve-Outs, Midland Corporate Finance
Journal 4 (Spring 1986): 23-32. This article provides general background on carve-outs
against which to discuss Equitables carve-out of DLJ. The authors report a 2 percent
positive market-adjusted return at the announcement of carve-outs, and argue that this is due
to the resolution of information asymmetry between insiders and investors about the
subsidiary. The article contrasts the carve-out with spin-offs and seasoned equity offerings.

Hypothetical Teaching Plan

The instructor can take numerous paths with these cases. The general teaching strategy is to
address the industry situation and motivation for equity carve-out early in the discussion. This
leaves somewhat more time for the valuation and IPO pricing aspects.
1. Assuming your roles as institutional investors, please give the number of shares you would
demand at the various prices.
I like to start the discussion by polling the groups and deriving the resulting aggregate
demandthen I leave it on the board to continue discussion on other points, returning to it
toward the end of class. By constructing a simple table on the chalkboard, the instructor can
aggregate demand across all institutions and prices. This is an illustration of the bookbuilding process common to equity underwritings in the United States: the underwriters
task is to set a price that will clear the market (i.e., rather than set a quantity that will clear
the market at a certain price). The result of the exercise will be the familiar downwardsloping demand curve.
2. Why is Equitable considering a carve-out for DLJ? How does a carve-out compare to other
possible restructuring strategies, such as spin-off or divestiture? Why did Jenrette choose
the carve-out alternative?

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Here the discussion can range across the nature of investment banking, forces of change in
the industry, and strategic concerns for the future.
3. What does John Chalsty have to do to implement the carve-out plan?
This segment should address the combined equity and debt offerings, the IPO underwriting
process, and DLJs role as lead underwriter. This is the point to review the delicate balance
the underwriters must achieve between maximizing price and satisfying investors.
4. What is your estimate of DLJs fair market value per share?
Here the class should wrestle with the practical problems of valuing a securities firm. The
approach best supported by the case uses market multiples. The instructor should plan to
query students on their choices of multiples and peer samples.
5. At what price should DLJ be offered?
In this segment, the student should be prompted to contrast offering price with answers in
question 4, and to explain any differences. The instructor can ask students to revisit their
answers to question 4 in light of the demand curve. If the objective is to create some upward
price movement in secondary trading, students will price shares below the maximum marketclearing price. To gain closure, the instructor can ask students to vote among two or three
final pricing alternatives. Ordinarily, students price the offering below the price at which
supply equals demand. The instructor can point out that even lead managers of their own
IPO can underprice an issue (see the article by Muscarella and Vetsuypens, cited above, on
this point).
6. How should we justify this price to John Chalsty?
This closing justification provides an opportunity for students to sum up their thinking on
IPO pricing, and provides a useful closure for their learning in the case.
The instructor can close the class with a review of the IPO outcome (see the epilogue, below) and
with observations on the underwriting process and structural changes in the investment-banking
industry today.

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Case Analysis
Strategic setting and motives for the carve-out
Regulatory effects on the securities industry: Three regulatory changes
Discussion
recast the industry. First, in 1974 the ERISA prudent man rule freed money
Question 2
managers to invest in a wider array of securities. With new demands came new
products. The rule also permitted a wider allocation of funds to invest abroad.
Second, May Day in 1975 eliminated fixed commissions on brokering securities.
Now firms had to negotiate commissions instead of relying on regulated commissions. Firms could
compete on price, breaking up some of the traditional relationships between banks and clients. To
please investors, firms needed to keep a large inventory of securities to sell, and had to be willing to
buy clients securities to give clients liquidity. Third, Rule 415 furthered the industrys capital
requirements and increased competition within the industry. Issuers forced investment banks to bid
on an offering with a gross spread included in the price, instead of negotiating to sell the securities
and putting a gross spread on top. To succeed, securities firms bought an entire issue (or part of an
issue) and then resold it. With little time to premarket an issue, the firms took on more risk. Market
share could be gained through aggressive bidding.
Overall, the net effect of the regulatory change was to raise the capital requirements in the
industry, increase risk, and increase consolidation. Before the changes, the industry could be
characterized as a somewhat cozy, low-capital, high-margin business. With the changes, the industry
became more competitive and innovative, with more capital required to earn lower margins. Case
Exhibits 1 and 2 show the growth of the industry.

Capital requirements of the securities industry. As noted above, firms built up inventory to
sell to customers and to win shelf-registration underwritings. Most responded by either
going public in the late 1970s or early 1980s or by selling out to larger financial institutions.
The notable exception was Goldman Sachs, which sold nonownership interests in the firm to
two limited partners (Sumitomo and Bishops Estate). Other activities increased capital
requirements, too. Necessary expenditures in telecommunications and computer equipment
required capital, as did overseas expansion. Many foreign regulatory bodies demanded that
firms keep some regulatory capital on site. Finally, the increase in principal activities
absorbed capital. Most investment banks took positions in the markets using their own
funds. Many utilized their own funds to participate to some degree in merchant banking and
venture capital investments. In contrast to principal trading activities, these illiquid
investments placed most of the capital at risk for total loss. With such large holdings in
inventory and in trading positions, investment banks grew more vulnerable to sudden
changes in the markets. While all hedged their holdings to some extent, most kept a good
degree of market risk. When rates changed, firms could experience a severe erosion of
profitability, as demonstrated in 1994.

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Changing risk profile of the industry. The industry moved more toward risking its own
capital instead of serving solely as an intermediary. Even as intermediary, investment banks
were forced to take on substantially more risk in underwriting (through Rule 415) and
brokerage (through increased inventories). In response to lower margins and increased
competition in traditional businesses, like investment-grade debt underwriting and seasoned
equity offerings, many firms moved into accepting other types of risks: they sold derivatives
(insurance risk), made bridge loans (credit risk), took principal positions in the markets
(trading/market risk), and made investments outside of investment banking (operating risk).
As 1990 and 1994 painfully reminded, the securities industry remained very cyclical. It was
too sensitive to changes in domestic interest rates. The cost structure of the industry has
always helped mitigate some of the sensitivity. Up to 50 percent of total compensation was
paid in year-end bonuses tied to profitability. Many firms tried to reduce their exposure to
interest rates by expanding into markets abroad and fee-based money management
businesses. An overseas presence could help serve domestic clients who themselves were
expanding abroad. The diversification into asset management relied on synergies generated
by research and brokerage relationships.

Consolidation. Many analysts predicted that the repeal of Glass-Steagall would precipitate a
consolidation of the industry. Large U.S. commercial banks and European universal banks
were the predicted suitors. However, past attempts by financial institutions to purchase and
integrate investment banks had proved less than stellar (Kidder, Peabody and GE, First
Boston and Credit Suisse, Dillon Read and Travelers, for example). Many times cultures
didnt mix. Investment banks had to be willing to make large capital commitments with little
notice to win trading or underwriting business or make trading profits. Investment banks
also tended to pay out a high percentage of revenues to the professionals responsible for
generating the revenues. Any changes in compensation could result in mass departures, as
Salomon showed in its compensation restructuring in 1994 and 1995. Many believed that the
credit decisions in which commercial banks excelled wouldnt translate into success in the
underwriting and trading decisions necessary to run a successful investment bank.
The decision to carve-out DLJ

The motivecapital requirements: DLJ needed more capital to grow. As a subsidiary of

Equitable, DLJ was limited in its ability to borrow from the public markets. This required DLJ to go
to less flexible and higher cost lending sources. Equitable had supported DLJs growth in the past.
In 1993, Equitable contributed $150 million of equity and purchased $20 million of Cumulative
Exchangeable Preferred Stock in a $225-million private placement.
A rough estimate of how rapidly DLJ could grow in the future without an equity infusion
could be estimated using the self-sustainable growth model, where Growth = ROE (1 Dividend
Payout Ratio). Working from DLJs last twelve months results, where

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Return on average equity = $142.5 / [($775.9 + $873.9) / 2] = 17.3 percent;

Dividend payout = $25.4 / $124.6 = 20.4 percent;
Self-sustainable growth = 17.3 percent 79.6 percent = 13.8 percent.
As case Exhibit 10 indicates, DLJ had grown in 1994 at rates well in excess of 13.8 percent.
To grow its operations at rates of recent years, DLJ would need external capital to increase
inventories and underwriting capabilities. It would also need capital for expanding overseas, if it
chose to do so. DLJ would leverage new equity. Each dollar of equity was currently supporting $18
of net assets (assets net of securities purchased under agreements to resell and securities borrowed).
Choice of type of sale: Each option had tax, accounting, control, and valuation ramifications.
For tax purposes, Equitable would incur a gain if it sold shares to the public or another company. A
spin-off would be tax-free. However, a spin-off would separate DLJ from Equitables consolidated
tax group, which should raise effective rates for both parties.
For accounting purposes, Equitable could consolidate DLJ into its own accounts as long as it
held 80 percent. DLJs results had provided a large percentage of Equitables growth in recent years.
If Equitable sold more than 20 percent, it would be able to include DLJ under the equity method,
where Equitable would only show its percent of DLJs net earnings for the period and not each line
item.
If Equitable sold all of DLJ, it would lock in its gain. If it opted for a spin-off, it would
ratably transfer DLJs value to its shareholders, with AXA being the majority shareholder. AXA
would then be forced to sell its DLJ shares if it didnt want to hold them. It did not make much sense
from a tax or valuation standpoint to do a spin-off if AXA wanted to keep the shares. DLJ would
invariably trade at a discount if AXA held approximately 60 percent of DLJ.
By selling part of DLJ in 1995, Equitable could take advantage of a strong equity market and
establish a price for the rest of its holdings. If it kept a majority position, Equitable effectively still
controlled the fate of DLJ. It could force the sale of the company at a later date if it chose to do so.
Equitable could be seen as buying a call from the new minority public shareholders. If Equitable
thought that DLJ would appreciate in the future, it kept some potential upside for itself. Equitable
had already chosen an equity carve-out for Alliance Capital.
As for valuation, selling all of DLJ would most likely fetch a higher price because a buyer
might see synergies and be willing to pay a control premium. Equity market valuations (as shown
more expressly in the B case) were quite high, though, for investment banking stocks.
DLJs place in the securities industry
DLJ held an interesting place in the securities industry. It was comparable in size (assets,
revenues, employees, etc.) to many of the special bracket (i.e., second-tier) firms. Yet, it earned a

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higher average ROE than most of the bulge bracket (i.e., top-tier) firms and competed successfully
against them in selected areas. It had top positions in higher-margin categories, like IPO and highyield underwriting. DLJ seemed to fall in between the two brackets.
Investors would value DLJ relative to firms they thought most comparable. The
underwriters believed that DLJ was most like Alex. Brown, Bear Stearns, and Morgan Stanley.
Exhibit TN1 offers a matrix comparing DLJ to its peers in several categories. The shaded areas
show the casewriters estimates of comparability.
Many investors wondered where DLJ would end up in the coming years. It was getting close
to outgrowing its special bracket status. If DLJ wanted to move into the bulge bracket, it would need
to increase employment for greater investment banking and trading coverage and expand overseas.
Alternatively, DLJ could remain focused on growing in higher-margin areas.
Investors who purchased DLJs shares would be betting that DLJ could either successfully
make the jump to bulge bracket or find new high-margin areas in which to expand. Critics
questioned DLJs ability to do either. Other investors suggested that Equitable might be selling out
at the top of the market for investment banking stocks.
Valuation
The case suggests three different valuation techniques: dividend growth
model, market multiples, and the price/book ratio determined by expected ROE
(from Sanford C. Bernstein & Co.). Exhibit TN2 outlines the results of these
analyses. DLJs figures come from case Exhibits 5 and 6, while the numbers for
comparable companies come from Exhibits 8 to 10.

Discussion
Question 4

Briefly, the dividend growth model proved deficient in accurately predicting the prices for
DLJ and the other comparable companies (the comps) in the industry. Investors have received
substantial price appreciation in the past and must be expecting more of the same given the results of
the dividend growth models, even using dividend growth estimates in perpetuity above any
sustainable level.
The market multiples approach was what the underwriters actually used. They felt that DLJ
was most comparable (discussed above) to Alex. Brown, Bear Stearns, and Morgan Stanley. They
especially focused on Morgan Stanley. The valuation estimates that resulted from using DLJs
results multiplied by the average multiples from all of the comps and the average of the three focus
companies accurately predicted DLJs offering price. The underwriters used this type of comparable
multiples analysis in the marketing of the security to suggest that DLJ was fairly valued in the $26.00
$29.00 range. Remember, too, that the comps had traded down roughly 7.5 percent in the last
month, as well.

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The accuracy of the multiples analysis should come as no surprise. DLJs original filing
range of $26.00$29.00 per share was estimated using the same type of analysis. Second, financial
stocks, like investment banks, tend to trade in tight ranges of multiples of book value and earnings.
The actual price of $27.00 implied an average IPO discount of approximately 9 percent.
Finally, the model of Sanford C. Bernstein & Co. really was an estimation of price at 10
times expected E.P.S. (roughly, the average multiple for price to expected 1995 earnings for the
comps). The model assumed that the price would equal the expected ROE (approximated here from
expected E.P.S. divided by current book value per share [BVPS]) times 10 times book value per
share, or:
Price = Exp. E.P.S./ BVPS 10 BVPS, where BVPS cancels leaving
Price = Exp. E.P.S. 10.
The Bernstein analyst, Guy Moszkowski, used this model to predict prices by estimating potential
ROE in particular phases in the securities industry cycle. At the peak of the cycle, he would lower
the multiplier below 10 times.
The case moves students away from performing a discounted cash flow valuation of DLJ.
The primary reason for this is the incredible complexity of the cash flows to be forecast, and their
underlying assumptions.1 The cash flows were too dependent on macroeconomic factors, like
interest rates, market directions, domestic savings, etc. Future cash flows also greatly depended on
microeconomic factors like DLJs ability to gain market share domestically and abroad, maintain
margins, and realize merchant banking profits. To give the underwriting group a model of their cash
flows might have divulged to competitors DLJs strategic plans. Instead, underwriters and issuers
used a multiples approach when discussing DLJs valuation with potential investors. They did not
use DCFs, as that would require giving predictions about future performance to investors. These
predictions create legal liability. In addition, few investors would trust the projections, anyway.
Negotiation among parties
Each party in the IPO may have a different objective in setting the initial
Discussion
price. (An interesting exercise in teaching the case would be to assign each student
Question 5
one of the five roles: Equitable, DLJ as issuer, DLJ employees, investors, and lead
managers. The instructor could invite these role-players to speak up during the
pricing discussions to highlight the interests of their groups.) While market
demand will set a range of prices at which the offering will most likely clear the market, the
underwriters and issuers must come to an agreement and set a single price.

One leading text, Valuation, by Copeland, Koller, and Murrin (Wiley, 1990), discusses in Chapter 13 the difficulties
of valuing banks and other financial institutions using DCF. The chief sources of difficulty are transfer pricing among the
units within the firm, determining the quality of the loan portfolio, and determining what percentage of the accounting
profits results from interest-rate mismatch gains. Presumably, the task is no less complex for valuing an investment bank.

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The matrix below sets out the possible benefits to each party for a higher or lower price. A
benefit in the short term to one party may prove detrimental in the long term. For example, if
Equitable received a premium price in the IPO and the shares fell in after-market trading, it might
receive more cash at issuance, but not be able to sell shares at attractive prices in the future as
investors would remember having been burned at the offering.
Equitable was not selling its own stock, while DLJ was. Also, DLJ was managing the
underwriting, and converting employees interests in long-term compensation plans into stock and
options. Future issuers who did business with DLJ would probably carefully examine DLJs
performance in its own stock issuance.
Benefits of Initial Pricing Level to Different Parties
Equitable

Higher
Price

DLJ - As Issuer

New Shareholders
None

Underwriters
May please issuer

More cash

More cash

Higher initial valuation

Higher initial valuation

Higher underwriting fees

Greater accounting profits

from greater gain on
sale

Less dilution

Reputation with other potential issuers

Less dilution
Create demand for green
shoe and future
offerings
Lower

Employee goodwill as share

exchange & options converted
at lower price
May enhance demand for
future offerings

Price

Successful IPO could improve

demand for concurrent debt
offering

Greater potential
appreciation in near term

Will please investors

Higher appetite for more

shares in after market
and longer term

Less underwriting risk

Reputation with investors

Lower underwriting fees
Successful IPO could improve
demand for concurrent debt offering

The IPO process

The offering process for securities is not that much different from the
marketing process for most goods and services. Financial instruments, like stocks
and bonds, are products in the end. The case attempts to show the reader how
underwriters and issuers estimated a price, marketed the security through various
channels, gauged demand, then priced and sold the security.

Discussion
Question 3

The firms in the syndicate responsible for selling the issue were compensated for the amount
of work they put in and risk they took. The lead managers earned the most, but accepted the greatest
risk. On the other end, the selling group earned the least, but retained the right to put any unsold
stock back to the underwriters. The risks facing underwriters were not just price and profit.
Underwriters also risked their reputations in every deal. They faced a difficult task, described above,
in pleasing issuers and investors while earning a fair return for themselves. Issuers tried to mitigate

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their risk through the due-diligence process, registrations, marketing process, and overallotment
option.
The underwriters utilized two primary channels for selling the stock. The road show,
managed by the lead underwriters, marketed the issue to institutional investors. These investors got
to hear the DLJ story from top management. They were given an audience, either in group form or
individually, with John Chalsty (the CEO of DLJ) and Anthony Daddino (the CFO). They could ask
any questions they wanted.
Underwriters also used brokers and sales people in the syndicate to market the issue to
institutions who didnt see the road show and to individual investors. The brokers and sales people
relied more heavily on the red herring prospectus and internal information regarding the issue to
explain the opportunity to their clients.
Once sufficiently marketed, the lead manager had to gauge demand at different price levels.
More than a numerical assessment, the pricing decision had to account for the firmness of demand,
intent of investors in the aftermarket, past histories of those wanting stock, current prices for
comparable stocks in the market, and overall market conditions. Ultimately, the underwriters
suggested a price that they believed best pleased all parties. The final decision to price remained
with Equitable. They could accept the underwriters opinion, press for a higher price, or pull the
offering.

Epilogue
On August 29, 1995, Equitable and DLJ filed with the SEC for an initial public offering of
DLJs common stock. Equitable included a preliminary filing range of $26.00 to $29.00 per share
for the expected price of the stock. These prices placed a valuation of $1.5 billion to $1.7 billion on
DLJ. Equitables stock increased 6.6 percent on the announcement that it planned to sell part of DLJ
to the public. DLJ was chosen as the lead manager of the 9.2-million-share offering, with Goldman
Sachs, Merrill Lynch, and Morgan Stanley serving as co-managers. Equitable planned to sell 5.9
million secondary shares and DLJ planned to offer 3.3 million primary shares. The proceeds from
secondary shares sold by Equitable would go to Equitable, and DLJ would receive the proceeds from
the primary shares. DLJ slated 7.36 million shares to be sold domestically and 1.84 million shares to
be offered abroad.
Equitable also granted the underwriters a green shoe, a 30-day option to purchase 1.38
million additional shares to cover any overallotments made by the underwriters. DLJ anticipated that
it would have 51.5 million shares outstanding after the offering. Equitable would own
approximately 83 percent of DLJs stock (80 percent if the green shoe were exercised). At the same
time as the stock offering, DLJ registered with the SEC to sell $300 million of Senior Subordinated
Notes for general uses and to repay existing bank borrowings.

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Equitable and DLJ priced the issue at $27.00 per share. The first trade on October 24, 1995,
cleared at $31.50. Jennifer Chalsty, wife of John Chalsty, purchased the shares. The stock (NYSE,
ticker DLJ) traded as high as $32.50, but closed at $30.00 on October 24, with volume of 5.4
million shares. The underwriters later exercised the green-shoe option. At the end of 1995, the stock
traded at $31.25. On April 26, 1996, it traded for $33.75, an increase of 25 percent over the offering
price. For comparison, over the same period the Dow Jones Industrial average increased 16.6
percent, and the S&P Investment Banking and Brokerage index increased 14.8 percent.
With the success of the stock offering, investors wanted more of the concurrent Senior Notes
offering. The issue size was increased from $300 million to $500 million. It was priced at 99.351,
with a 6.875 percent coupon, for a yield of 6.966 percent. This yield represented a spread of 81 basis
points over the comparable interpolated 20-year Treasury.
DLJ did not disappoint its investors. For the fourth quarter of 1995, DLJ earned $0.93 per
share, an increase of 54 percent over fourth-quarter 1994 pro forma earnings per share. The
consensus estimate had been $0.79. In the first quarter of 1996, DLJ increased earnings per share 74
percent to $1.01 per share, versus consensus estimates of $0.85. Return on equity was 19.6 percent.
Also of note, Richard Jenrette stepped down from his position at Equitable and DLJ on
February 14, 1996. He stated, I have achieved all of the major goals that I set out on becoming
CEO of Equitable in April 1990.2 Jenrette planned to write a book on his management experiences,
tentatively entitled The Contrarian Manager. Jenrette said that the message of the book was that
managers should find the hidden advantages in difficult situations.3 In addition to his writing
commitments, Jenrette joined DLJ as a Senior Advisor, joining cofounder William Donaldson, who
joined DLJ in the same capacity in October 1995. Donaldson returned to DLJ after retiring from the
chairmanship of the New York Stock Exchange.
John Chalsty moved into Jenrettes Chairman position, remaining CEO. DLJ named Joe
Roby to be President. Roby had previously been COO and Chairman of the Banking Group.
Hamilton James, Chairman of Merchant Banking, assumed Robys former position as Chairman of
the Banking Group.
In the two years following the IPO, these are ways in which DLJ expanded:

Hired several senior bankers and traders from other firms, including those covering energy,
convertible bonds, and M&A

Announced plans to open offices in Mexico City and Buenos Aires

Equitable Chairman, CEO Richard Jenrette to Step Down, Bloomberg Business News, February 13, 1996.
Bloomberg Forum: Equitable Likely to Keep 80% DLJ Stake for Now, Bloomberg Business News, February 20,

1996.)

368

Case 25 Donaldson, Lufkin & Jenrette, 1995 (Abridged)

Expanded emerging-markets operations, including a new group in London that will trade
securities from emerging European markets

Raised $300 million to enter the bank-loan-syndication market

Made the first investment in the DLJ Real Estate Capital Partners fund

Formed a new fixed-income-asset-management company focused on institutional investors

More-recent developments in the firm may be followed from public analytical sources and DLJs
Web site (http://www.dlj.com/).

Exhibit TN1
DONALDSON, LUFKIN & JENRETTE, 1995 (ABRIDGED)
Selecting Comparable Companies1

Characteristics
Size:
Assets..................
Revenues.............
Mkt. Cap............
Employees..........
Comments.............
4 Yr. CAGR %:
Net Revs.............
Net Income.........
Business Mix:
% Commissions..
% Inv. Banking..
% Prin. Trans....
Strengths..............

3 Yr. Avg. ROE....

D/E Ratio..............
Topical Issues.......

Alex. Brown

Bear Stearns

DLJ

A.G. Edwards

Lehman Brothers

Merrill Lynch

Morgan Stanley

$1,915
717
723
2,300

$79,517
4,020
2,376
7,500
Medium Size

$42,417
3,819
1,608
4,676
Medium Size

$2,617
1,298
1,565
10,751
Med. w/ Large Empl.
Base

$117,518
11,040
2,353
7,771
Bulge Bracket

$185,473
20,704
10,011
46,023
Bulge Bracket

$132,473
10,391
6,790
9,236
Bulge Bracket

$49,545
4,985
2,095
16,025
Med. w/ Large
Empl. Base

$162,586
8,086
3,911
6,400
Bulge Bracket

23.6
74.2

14.8
21.3

21.9
75.4

17.1
24.7

NA
NA

13.6
51.7

12.9
9.9

9.9
-1.1

-17.5
NM

23.8
35.1
18.3
IPOs, Middle Mkt
Clients, Research,
Focus on Selected
Industries

25.8
16.7
41.8
M&A, Middle Mkt
Clients, Mort.
Backed Mkt,
Principal Trading

23.0
40.3
22.1

48.0
7.5
16.7
Retail Distribution,
Midwest Clients,
Focus on Individual
Investors

16.3
23.4
44.1
Inv. Grade Bonds,
Foreign
Transactions,
Especially
Governments,
Principal Trading

29.9
12.0
24.7
All Areas, Global
Leader in D&E
Underwriting, Good
M&A, Lgst Retail,
Gaining Strength
Overseas

12.4
27.9
35.4

37.6
9.6
26.5
Good Middle Mkt
Coverage in
Research &
Underwriting, 3rd
Lgst Brokerage,
Mort. Backed
Markets

13.7
17.1
20.4
Inv. Grade Bonds,
Proprietary Trading,
Complex
Transactions,
Regaining Stature in
M&A and Inv.
Banking

24.0
37.8
Perennial Takeover
Rumors, Many
Consider too
Focused in IPOs

24.4
164.4
Greenberg & Cayne
Credited for
Building Firm,
Succession
Questions

20.3
0.0
Founding Family Still
Runs, Conservative
Management

NA
355.2
Firm-Wide Cost
Restructuring
Nearing Completion,
Profits Hurt Recently

23.8
265.8

17.5
138.3
Restructuring Costs
to Improve
Profitability, Kidder
Integration Taking
Time

11.0
283.9
Treasury Scandal,
Managers Under
Fire from Investors
New Salary Plan
Caused Empl. Probs.

Smaller Size

IPOs, M&A for

Middle Mkt, HighYield, Research,
Specialized Mort.
Backed, Merchant
Bkg, Venture
Capital

27.8
57.3
--

Orange County
Problems, But Still
Leading Industry

Source: Research reports and public filings. Casewriters opinion for comments, strengths, and topical issues.

Complex
Transactions,
Foreign Trans,
High-Yield,
Fortune 500
M&A, Merchant
Banking, Incr.
Presence in HiTech
17.7
186.7
Foreign Presence
Starting to Payoff,
Big Advances in
Domestic M&A
and Underwriting

PaineWebber

Salomon Brothers

370

DONALDSON, LUFKIN & JENRETTE, 1995 (ABRIDGED)

Valuation Approaches

D iv id e n d G r o w th

A le x . B r o w n
I m p l i e d D i v i d e n d . .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .
$
0 .8 0
V a l u e L i n e E s t . D i v i d e n d G r o w t h '9 6 - '0 0 ( a ) .. .. .. . .. .. .. . .. .. . .. .
1 0 .5 %
B e t a . . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. .
R m . .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .
R f ( 1 0 y e a r ) .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. ..
K e .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .

1 .2 7
5 .5 %
6 .0 7 3 %
1 3 .1 %

S i m p l e D i v i d e n d G r o w t h V a l u a t i o n . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. $
A c t u a l P r i c e .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. $
% D i f f e r e n c e . .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. .

3 4 .5 6
4 6 .6 3
-2 5 .9 %

D L J K e C a lc u la tio n
U n l e v e r e d B e t a .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. ..
D L J L e v e r e d B e t a ( c ) . .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . ..

B e a r S te a r n s
$
0 .6 0
8 .0 %

D L J (a )
A .G . E d w a r d s
$
0 .5 0
$
0 .5 6
9 .0 % ( b )
1 1 .5 %

1 .6 4
5 .5 %
6 .0 7 3 %
1 5 .1 %
$
$

9 .1 4
2 0 .0 0
- 5 4 .3 %

1 .1 1

0 .7 4

8 .7 x
1 .6
7 .6
7 .6
1 .7 %

5 .9 x
1 .2
1 1 .8
7 .1
3 .0 %

1 .2 3
5 .5 %
6 .0 7 3 %
1 2 .9 %
$
$

M e r r ill

M o rga n

L ynch
$
1 .0 0
1 1 .5 %

S ta n le y
$
1 .2 8
9 .0 %

1 .2 0
5 .5 %
6 .0 7 3 %
1 2 .7 %

1 .7 9
5 .5 %
6 .0 7 3 %
1 5 .9 %

1 .6 6
5 .5 %
6 .0 7 3 %
1 5 .2 %

1 .4 1
5 .5 %
6 .0 7 3 %
1 3 .8 %

1 4 .1 3
2 7 .5 0 ( c )
- 4 8 .6 %

0 .9 0
1 .2 3

L ehm an
B r o th e rs
$
0 .2 0
1 9 .0 %

(b )

$
$

2 6 .8 2
2 5 .1 3
6 .8 %

NA
2 2 .5 0
NA

$
$

2 5 .2 4
5 6 .9 8
- 5 5 .7 %

$
$

2 2 .4 9
8 7 .5 0
- 7 4 .3 %

1 .4 1

0 .2 7

0 .8 9

0 .8 8

9 .5 x
1 .6
9 .7
9 .0
2 .2 %

1 4 .2 x
0 .8
1 0 .0
9 .2
0 .9 %

1 5 .3 x
1 .8
1 0 .5
9 .7
1 .8 %

2 1 .6 x
1 .7
1 3 .1
1 0 .9
1 .5 %

8 .5 %

8 .9 %

7 .5 %

S a lo m o n
P a in e W e b b e r
$
0 .4 8
1 1 .5 %

B r o th e r s
$
0 .6 4
2 .0 %

1 .6 7
5 .5 %
6 .0 7 3 %
1 5 .3 %
$
$

1 4 .2 4
2 1 .5 0
- 3 3 .8 %

1 .1 3
5 .5 %
6 .0 7 3 %
1 2 .3 %
$
$

0 .9 4

6 .3 5
3 6 .7 5
-8 2 .7 %

0 .3 5

M a r k e t M u ltip le s
S t o c k P r i c e / L T M E a r n i n g s p e r S h a r e .. . .. .. .. . .. .. .. . .. .. .. . .. .. .
S t o c k P r i c e / B o o k V a l u e p e r S h a r e .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .
S t o c k P r i c e / C a l . Y r 1 9 9 5 E s t . E a r n i n g s p e r S h a r e . .. . .. .. . .. .
S t o c k P r i c e / C a l . Y r 1 9 9 6 E s t . E a r n i n g s p e r S h a r e . .. . .. .. . .. .
C u r r e n t I m p l i e d D i v i d e n d Y i e l d . . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .

-1 .0 %

1 9 9 5 - 1 9 9 6 C a l . Y r . E s t . E .P . S . G r o w t h .. .. . .. .. . .. .. .. . .. .. .. . .. .. . ..

6 4 .7 %

NA
NA
NA
NA
NA
1 7 .5 % ( b )

A p p lic a b le In d u s tr y M u ltip le s ( d )
H ig h
Low
A v e ra g e
L T M E a r n i n g s p e r S h a r e . . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . . $
B o o k V a l u e p e r S h a r e .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. .
C a l . Y r 1 9 9 5 E s t . E a r n i n g s p e r S h a r e . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . ..
C a l . Y r 1 9 9 6 E s t . E a r n i n g s p e r S h a r e . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . ..
C u r r e n t D i v i d e n d . . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. ..

I m p l i e d I P O D i s c o u n t a t O f f e r i n g P r ic e o f $ 2 7 . 0 0

DLJ
2 .4 2
1 9 .7 2
2 .8 5
3 .3 5
0 .5 0

2 1 .6 x
1 .8
1 3 .1
1 0 .9
3 .0 %

(b )
(b )

P ric e U s in g A v g . o f
AB, BSC, M S

L T M E a r n i n g s p e r S h a r e . . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . . $
B o o k V a l u e p e r S h a r e .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. .
C a l . Y r 1 9 9 5 E s t . E a r n i n g s p e r S h a r e . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . ..
C a l . Y r 1 9 9 6 E s t . E a r n i n g s p e r S h a r e . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . ..
C u r r e n t D i v i d e n d . . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. ..

2 9 .1 0
2 9 .2 9
3 0 .8 5
2 8 .7 1
2 4 .2 8

O f fe rin g
P ric e
$

2 7 .0 0
2 7 .0 0
2 7 .0 0
2 7 .0 0
2 7 .0 0

5 .9 x
0 .8
7 .6
7 .1
0 .9 %

1 2 .5 x
1 .4
1 0 .4
8 .9
1 .8 %

A vg. of
AB, BSC, M S
1 2 .0 x
1 .5
1 0 .8
8 .6
2 .1 %

NMF
1 .4
4 1 .3
9 .0
2 .2 %

2 0 .1 %

3 6 1 .5 %

P ric e P e r S h a r e A s s u m in g I n d u s tr y M u ltip le s
H ig h
Low
A v e ra g e
$

5 2 .1 4
3 6 .1 7
3 7 .4 4
3 6 .6 3
1 6 .6 7

1 4 .2 3
1 5 .8 7
2 1 .5 7
2 3 .9 2
5 6 .2 5

6 3 .4 x
1 .1
1 0 .5
9 .8
1 .7 %

3 0 .2 7
2 8 .5 4
2 9 .7 7
2 9 .9 3
2 7 .1 5

7 .1 %
P ric e U s in g
A v g . M u l ti p l e s o f
AB, BSC, M S
$

2 9 .1 0
2 9 .2 9
3 0 .8 5
2 8 .7 1
2 4 .2 8

" I P O D i s c o u n t"
7 .8 %
8 .5 %
1 4 .3 %
6 .3 %
- 1 0 .1 %

S a n fo r d C . B e r n s te in & C o . V a lu a tio n T e c h n iq u e
E x p e c t e d R e t u r n o n E q u i t y ( E s t . '9 5 E .P . S / B V P S ) .. .. . .. .. ..
T i m e s 1 0 x = S u g g e s t e d P / B R a t i o .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . ..
A c t u a l B o o k V a l u e p e r S h a r e . .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. ..

2 0 .9 %
2 .0 9
2 9 .5 3

I m p l i e d P r i c e p e r S h a r e . .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .
A c t u a l P r i c e .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . ..
% D i f f e r e n c e . .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. . .. .. .. . .. .. . .. .. .. .
(a)
(b )
(c)
(d )

1 0 .2 %
1 .0 2
1 6 .5 9

1 4 .5 % ( d )
1 .4 5
1 9 .7 2

1 6 .3 %
1 .6 3
1 5 .8 0

8 .0 %
0 .8 0
2 7 .9 5

1 7 .5 %
1 .7 5
3 1 .0 6

6 1 .6 0
4 6 .6 3

1 7 .0 0
2 0 .0 0

2 8 .5 0
2 7 .0 0

2 5 .8 0
2 5 .1 3

2 2 .5 0
2 2 .5 0

5 4 .4 0
5 6 .9 8

3 2 .1 %

- 1 5 .0 %

5 .6 %

T h is im p lie s th is g r o w th r a te to in f in ity , w h ic h is o b v io u s ly to o h ig h . L o w e r ra te s w o u ld g iv e lo w e r v a lu e s .
C a s e w rite r e s tim a te .
A s s u m e s p r ic e e q u a l to m id -p o in t o f f ilin g ra n g e .
E x c l u d e s S a l o m o n 's c u r r e n t P / E a n d P a i n e W e b b e r 's P r i c e / 1 9 9 5 E s t . E P S .

2 .7 %

0 .0 %

-4 .5 %

1 2 .7 %
1 .2 7
5 2 .3 4

3 .5 %
0 .3 5
1 5 .0 4

1 0 .1 %
1 .0 1
3 4 .6 4

6 6 .6 0
8 7 .5 0

5 .2 0
2 1 .5 0

3 5 .0 0
3 6 .7 5

- 2 3 .9 %

- 7 5 .8 %

-4 .8 %

Case 25 Donaldson, Lufkin & Jenrette, 1995 (Abridged)

Exhibit TN2