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 means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Rev. 12/01.

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. DLJ�s 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.

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.

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

Suggested Questions for Advance Study

1. Why is Equitable considering selling an interest in DLJ? In answering this question, account for Equitable�s perspective, DLJ�s 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 firm�s role? What are the risks?

4. What is your estimate of DLJ�s 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 DLJ�s 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

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 instructor�s 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 Market�s 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 DLJ�s IPO.

2. Chris Muscarella and Michael Vetsuypens, �A Simple Test of Baron�s 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 issuer�s costs in an equity offering. Many students are surprised to learn that the cost of issuance goes well

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 Equitable�s 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 demand�then 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 �book-building� process common to equity underwritings in the United States: the underwriter�s 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 downward-sloping 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?

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 DLJ�s 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 DLJ’s 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 market-clearing 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.

Case Analysis

Strategic setting and motives for the carve-out Regulatory effects on the securities industry: Three regulatory changes

recast the industry. First, in 1974 the ERISA �prudent man� rule freed money 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 industry�s 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.

Discussion Question 2

• 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 didn�t 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 wouldn�t translate into success in the underwriting and trading decisions necessary to run a successful investment bank.

The decision to “carve-out” DLJ

The motive—capital 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 DLJ�s 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 DLJ�s last twelve months� results, where

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 Equitable�s 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. DLJ�s results had provided a large percentage of Equitable�s 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 DLJ�s 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 DLJ�s value to its shareholders, with AXA being the majority shareholder. AXA would then be forced to sell its DLJ shares if it didn�t 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.

DLJ’s 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

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 high-yield 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 casewriter�s 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 DLJ�s 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 DLJ�s 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. DLJ�s figures come from case Exhibits 5 and 6, while the numbers for comparable companies come from Exhibits 8 to 10. 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 DLJ�s results multiplied by the average multiples from all of the comps and the average of the three focus companies accurately predicted DLJ�s 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.

Discussion Question 4

The accuracy of the multiples analysis should come as no surprise. DLJ�s 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 DLJ�s 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 DLJ�s strategic plans. Instead, underwriters and issuers used a multiples approach when discussing DLJ�s 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 price. (An interesting exercise in teaching the case would be to assign each student 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.

1One 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.

Discussion Question 5

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 DLJ�s performance in its own stock issuance.

Benefits of Initial Pricing Level to Different Parties

Equitable

DLJ - As Issuer

New Shareholders

Underwriters

Higher Price

More cash Higher initial valuation Greater accounting profits

from greater gain on sale

Less dilution

More cash Higher initial valuation Less dilution

None

May please issuer Higher underwriting fees Reputation with other potential issuers

Lower Price

Create demand for green shoe and future offerings

Employee goodwill as share exchange & options converted at lower price

May enhance demand for future offerings

Successful IPO could improve demand for concurrent debt offering

Greater potential appreciation in near term

Higher appetite for more shares in after market and longer term

Will please investors

Reputation with investors

Less underwriting risk

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.

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

Discussion Question 3

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 didn�t 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 DLJ�s 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. Equitable�s 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 DLJ�s 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.

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 Jenrette�s 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 Roby�s 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

2�Equitable Chairman, CEO Richard Jenrette to Step Down,� Bloomberg Business News, February 13, 1996. 3�Bloomberg Forum: Equitable Likely to Keep 80% DLJ Stake for Now,� Bloomberg Business News, February 20,

1996.)

• 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 DLJ�s Web site (http://www.dlj.com/).

Exhibit TN1

DONALDSON, LUFKIN & JENRETTE, 1995 (ABRIDGED)

Selecting Comparable Companies1

Characteristics

Alex. Brown

Bear Stearns

DLJ

A.G. Edwards

Lehman Brothers

Merrill Lynch

Morgan Stanley

PaineWebber

Salomon Brothers Size:

Assets.................. $1,915 $79,517 $42,417 $2,617 $117,518 $185,473 $132,473 $49,545 $162,586 Revenues............. 717 4,020 3,819 1,298 11,040 20,704 10,391 4,985 8,086 Mkt. Cap............ 723 2,376 1,608 1,565 2,353 10,011 6,790 2,095 3,911 Employees.......... 2,300 7,500 4,676 10,751 7,771 46,023 9,236 16,025 6,400 Comments............. Smaller Size Medium Size Medium Size Med. w/ Large Empl.

Base Bulge Bracket Bulge Bracket Bulge Bracket Med. w/ Large

Empl. Base Bulge Bracket

4 Yr. CAGR %: Net Revs............. 23.6 14.8 21.9 17.1 NA 13.6 12.9 9.9 -17.5 Net Income......... 74.2 21.3 75.4 24.7 NA 51.7 9.9 -1.1 NM Business Mix: % Commissions.. 23.8 25.8 23.0 48.0 16.3 29.9 12.4 37.6 13.7 % Inv. Banking.. 35.1 16.7 40.3 7.5 23.4 12.0 27.9 9.6 17.1 % Prin. Trans.... 18.3 41.8 22.1 16.7 44.1 24.7 35.4 26.5 20.4 Strengths.............. IPOs, Middle Mkt

Clients, Research, Focus on Selected Industries

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

IPOs, M&A for Middle Mkt, High-Yield, Research, Specialized Mort. Backed, Merchant Bkg, Venture Capital

Retail Distribution, Midwest Clients, Focus on Individual Investors

Inv. Grade Bonds, Foreign Transactions, Especially Governments, Principal Trading

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

Complex Transactions, Foreign Trans, High-Yield, Fortune 500 M&A, Merchant Banking, Incr. Presence in Hi-Tech

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

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

3 Yr. Avg. ROE.... 24.0 24.4 27.8 20.3 NA 23.8 17.7 17.5 11.0 D/E Ratio.............. 37.8 164.4 57.3 0.0 355.2 265.8 186.7 138.3 283.9 Topical Issues....... Perennial Takeover

Rumors, Many Consider too Focused in IPOs

Greenberg & Cayne Credited for Building Firm, Succession Questions

-- Founding Family Still Runs, Conservative Management

Firm-Wide Cost Restructuring Nearing Completion, Profits Hurt Recently

Orange County Problems, But Still Leading Industry

Foreign Presence Starting to Payoff, Big Advances in Domestic M&A and Underwriting

Restructuring Costs to Improve Profitability, Kidder Integration Taking Time

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

1Source: Research reports and public filings. Casewriter�s opinion for comments, strengths, and topical issues.

L e h m a n M e r r i l l M o r g a n S a lo m o nD iv id e n d G r o w th A le x . B r o w n B e a r S te a r n s D L J (a ) A .G . E d w a r d s B r o th e r s L y n c h S ta n le y P a in e W e b b e r B r o th e r sI m p l ie d D iv id e n d . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 .8 0$ 0 .6 0$ 0 .5 0$ 0 .5 6$ 0 .2 0$ 1 .0 0$ 1 .2 8$ 0 .4 8$ 0 .6 4$ V a lu e L in e E s t . D iv id e n d G ro w th '9 6 - '0 0 ( a ) . . . . . . . . . . . . . . . . . . . . . . 1 0 .5 % 8 .0 % 9 .0 % ( b ) 1 1 .5 % 1 9 .0 % 1 1 .5 % 9 .0 % 1 1 .5 % 2 .0 %

B e ta . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 .2 7 1 .6 4 1 .2 3 1 .4 1 1 .2 0 1 .7 9 1 .6 6 1 .6 7 1 .1 3R m . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 .5 % 5 .5 % 5 .5 % 5 .5 % 5 .5 % 5 .5 % 5 .5 % 5 .5 % 5 .5 %R f ( 1 0 y e a r ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 .0 7 3 % 6 .0 7 3 % 6 .0 7 3 % 6 .0 7 3 % 6 .0 7 3 % 6 .0 7 3 % 6 .0 7 3 % 6 .0 7 3 % 6 .0 7 3 % K e .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 3 .1 % 1 5 .1 % 1 2 .9 % 1 3 .8 % 1 2 .7 % 1 5 .9 % 1 5 .2 % 1 5 .3 % 1 2 .3 %

S im p le D iv id e n d G ro w th V a lu a t io n . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 4 .5 6$ 9 .1 4$ 1 4 .1 3$ 2 6 .8 2$ N A 2 5 .2 4$ 2 2 .4 9$ 1 4 .2 4$ 6 .3 5$ A c tu a l P r ic e .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 6 .6 3$ 2 0 .0 0$ 2 7 .5 0$ ( c ) 2 5 .1 3$ 2 2 .5 0$ 5 6 .9 8$ 8 7 .5 0$ 2 1 .5 0$ 3 6 .7 5$ % D if f e r e n c e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 2 5 .9 % - 5 4 .3 % - 4 8 .6 % 6 .8 % N A - 5 5 .7 % - 7 4 .3 % -3 3 .8 % -8 2 .7 %

D L J K e C a lc u la t io nU n le v e re d B e ta .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 .1 1 0 .7 4 0 .9 0 ( b ) 1 .4 1 0 .2 7 0 .8 9 0 .8 8 0 .9 4 0 .3 5 D L J L e v e re d B e ta ( c ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 .2 3

M a r k e t M u lt ip le sS to c k P r ic e / L T M E a r n in g s p e r S h a re .. . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 .7 x 5 .9 x N A 9 .5 x 1 4 .2 x 1 5 .3 x 2 1 .6 x N M F 6 3 .4 xS to c k P r ic e / B o o k V a lu e p e r S h a re .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 .6 1 .2 N A 1 .6 0 .8 1 .8 1 .7 1 .4 1 .1 S to c k P r ic e / C a l . Y r 1 9 9 5 E s t . E a rn in g s p e r S h a r e . . . . . . . . . . . . 7 .6 1 1 .8 N A 9 .7 1 0 .0 1 0 .5 1 3 .1 4 1 .3 1 0 .5 S to c k P r ic e / C a l . Y r 1 9 9 6 E s t . E a rn in g s p e r S h a r e . . . . . . . . . . . . 7 .6 7 .1 N A 9 .0 9 .2 9 .7 1 0 .9 9 .0 9 .8 C u r r e n t Im p l ie d D iv id e n d Y ie ld . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 .7 % 3 .0 % N A 2 .2 % 0 .9 % 1 .8 % 1 .5 % 2 .2 % 1 .7 %

1 9 9 5 -1 9 9 6 C a l . Y r . E s t . E .P .S . G r o w th .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 1 .0 % 6 4 .7 % 1 7 .5 % ( b ) 8 .5 % 8 .9 % 7 .5 % 2 0 .1 % 3 6 1 .5 % 7 .1 %

P r ic e U s in gA p p l ic a b le In d u s t r y M u l t ip le s ( d ) A v g . o f P r ic e P e r S h a r e A s s u m in g I n d u s t r y M u l t ip le s A v g . M u l tip le s o f

H ig h L o w A v e ra g e A B , B S C , M S H ig h L o w A v e ra g e A B , B S C , M SD L J

L T M E a rn in g s p e r S h a r e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 .4 2$ 2 1 .6 x 5 .9 x 1 2 .5 x 1 2 .0 x 5 2 .1 4$ 1 4 .2 3$ 3 0 .2 7$ 2 9 .1 0$ B o o k V a lu e p e r S h a r e .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 9 .7 2 1 .8 0 .8 1 .4 1 .5 3 6 .1 7 1 5 .8 7 2 8 .5 4 2 9 .2 9 C a l . Y r 1 9 9 5 E s t . E a rn in g s p e r S h a re . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 .8 5 ( b ) 1 3 .1 7 .6 1 0 .4 1 0 .8 3 7 .4 4 2 1 .5 7 2 9 .7 7 3 0 .8 5 C a l . Y r 1 9 9 6 E s t . E a rn in g s p e r S h a re . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 .3 5 ( b ) 1 0 .9 7 .1 8 .9 8 .6 3 6 .6 3 2 3 .9 2 2 9 .9 3 2 8 .7 1 C u r r e n t D iv id e n d . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 .5 0 3 .0 % 0 .9 % 1 .8 % 2 .1 % 1 6 .6 7 5 6 .2 5 2 7 .1 5 2 4 .2 8

P r ic e U s in g A v g . o f O f fe r in g I m p l ie d I P O D is c o u n t a t O f fe r in g P r ic e o f $ 2 7 .0 0 A B , B S C , M S P r ic e " IP O D is c o u n t"

L T M E a rn in g s p e r S h a r e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 9 .1 0$ 2 7 .0 0$ 7 .8 %B o o k V a lu e p e r S h a r e .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 9 .2 9 2 7 .0 0 8 .5 %C a l . Y r 1 9 9 5 E s t . E a rn in g s p e r S h a re . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 0 .8 5 2 7 .0 0 1 4 .3 %C a l . Y r 1 9 9 6 E s t . E a rn in g s p e r S h a re . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 8 .7 1 2 7 .0 0 6 .3 %C u r re n t D iv id e n d . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 4 .2 8 2 7 .0 0 - 1 0 .1 %

S a n fo r d C . B e r n s te in & C o . V a lu a t io n T e c h n iq u eE x p e c te d R e tu r n o n E q u i ty (E s t . '9 5 E .P .S / B V P S ) .. . . . . . . . . . 2 0 .9 % 1 0 .2 % 1 4 .5 % ( d ) 1 6 .3 % 8 .0 % 1 7 .5 % 1 2 .7 % 3 .5 % 1 0 .1 % T im e s 1 0 x = S u g g e s te d P /B R a t io .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 .0 9 1 .0 2 1 .4 5 1 .6 3 0 .8 0 1 .7 5 1 .2 7 0 .3 5 1 .0 1 A c tu a l B o o k V a lu e p e r S h a r e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 9 .5 3 1 6 .5 9 1 9 .7 2 1 5 .8 0 2 7 .9 5 3 1 .0 6 5 2 .3 4 1 5 .0 4 3 4 .6 4

I m p l ie d P r ic e p e r S h a r e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 1 .6 0 1 7 .0 0 2 8 .5 0 2 5 .8 0 2 2 .5 0 5 4 .4 0 6 6 .6 0 5 .2 0 3 5 .0 0 A c tu a l P r ic e .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 6 .6 3 2 0 .0 0 2 7 .0 0 2 5 .1 3 2 2 .5 0 5 6 .9 8 8 7 .5 0 2 1 .5 0 3 6 .7 5 % D if f e r e n c e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2 .1 % - 1 5 .0 % 5 .6 % 2 .7 % 0 .0 % -4 .5 % - 2 3 .9 % -7 5 .8 % -4 .8 %

( a ) T h is im p l ie s th is g r o w th r a te to in f in i ty , w h ic h i s o b v io u s ly to o h ig h . L o w e r r a te s w o u ld g iv e lo w e r v a lu e s .( b ) C a s e w r i te r e s t im a te .( c ) 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 i l in g r a n g e .( d ) E x c lu d e s S a lo m o n 's c u r r e n t P /E a n d P a in e W e b b e r 's P r ic e /1 9 9 5 E s t . E P S .

Exhibit TN2

DONALDSON, LUFKIN & JENRETTE, 1995 (ABRIDGED)

Valuation Approaches