Booming business overseas, plus healthy M&A activity, offset a lousy mortgage market at home. But can other Wall Street firms keep up?
Lehman Brothers Holdings (LEH) wowed Wall Street on June 12 with record profits, showing big Wall Street firms are still raking it in from waves of mergers and acquisitions, a booming world economy, and rising stock markets.
But hidden in Lehman Brothers' eye-popping numbers were reasons for big investment banks to worry. The chief concern is the woes afflicting U.S. housing, particularly a falloff in the mortgage business. While global business is booming, U.S. revenues are flat.
Goldman Sachs (GS) and Bear Stearns (BSC) report earnings on June 14. Now the question on Wall Street is, will those two powerhouses keep pace?
Net income at Lehman Brothers was $1.3 billion in the second quarter, or $2.21, beating analysts' estimates by 33¢. Earnings per share were 31% higher than the same quarter last year.
Much of that money came from abroad, as Lehman has been spending big to expand internationally, putting its revenues at 48% overseas. With the U.S. barely growing at all last quarter, Lehman is profiting from faster-growing economies in Europe, Asia, and elsewhere. Mergers-and-acquisitions activity helped profits, as did equities trading as stock markets hit records worldwide, including in the U.S. The firm says it's meeting goals to diversify its revenue. "Our global platform is stronger and more balanced than ever," Chairman and Chief Executive Richard S. Fuld Jr. said in a statement.
But the booming international business helped hide a slowdown in U.S. revenues. Lehman Brothers has a big focus on fixed-income business in the U.S., where it's been hurt by the slowdown in housing. "The mortgage business is in a very challenging situation," Lehman Brothers Chief Financial Officer Christopher O'Meara told analysts on June 12. Fixed-income sales and trading revenues fell 14% from a year ago.
In explaining flat growth in the U.S., O'Meara also defended Lehman's domestic divisions: "The U.S. businesses are still strong and have great margins," he said. He added that problems with subprime mortgages were limited because they make up less than 3% of the firm's revenues.
While Lehman Brothers was able to balance problems at home with huge growth abroad, rival Bear Stearns might not be so lucky. "Bear Stearns would seem to be up against it," says Richard Bove, an analyst at Punk Ziegel & Co.. Compared to rivals, Bear Stearns has stuck closer to home, exposing it much more to the slow-growing U.S. economy. Plus, Bear Stearns, like Lehman, specializes in mortgages.
Goldman Sachs should do better, Bove says. It's much more international and it specializes in equities and M&A activity.
Take the M&A Train
Lehman Brothers said on June 12 it has about $580 billion in deals in its investment banking pipeline. But M&As tend to come in cycles, and many wonder how long before global M&A deals peak. Bove doesn't see that happening soon. In Europe, firms are merging to eliminate excess capacity, he says. In Asia, companies are using M&As to add product lines for their growing markets. And in the U.S., companies have a "tremendous amount of excess cash" they're looking to put to work.
"Lehman has set a high bar for others to beat," Bank of America (BAC) analyst Michael Hecht wrote in a June 12 note. (Bank of America owns Lehman Brothers stock and regularly does investment banking business with the firm.) In response to the news, Lehman shares rose about 1% to $76.38 in late-day trading on the New York Stock Exchange. Goldman Sachs was trading slightly higher at $228.54 on the NYSE, and Bear Stearns was off 1.6% at $145.93.