BUYSIDE (cover story), February 2004

THE BIG 6 : PART FOUR

CREDIT SUISSE FIRST BOSTON

MACK'S ATTACK

Can the ex-Morgan Stanley banker move CSFB beyond past scandals and its still-contentious DLJ purchase to improve the bottom line?

BY BEN MATTLIN

On Wall Street, there's a story about Credit Suisse First Boston: Several years ago, the New York-based full-service investment bank that's part of Zürich's 148-year-old publicly-traded Credit Suisse Group tried to recruit a top-notch analyst from rival Donaldson, Lufkin & Jenrette. The DLJ analyst refused. Spurned, CSFB went on to acquire DLJ for some $12 billion in November 2000. But then, rather than gloat that it had won the recalcitrant analyst, who was more highly ranked than his CSFB counterpart, the firm spitefully fired him for snubbing it in the first place.

Whether or not this cautionary tale is true, the image of CSFB as a hotbed of dissatisfaction and internal tumult is so finely etched on some Wall-Streeters minds that one insider, who spoke on condition of anonymity, asserts, "The DLJ purchase was the most asset-destroying takeover in the history of financial services."

Undeniably, that could be a hard case to prove. Last year, shares of Credit Suisse Group, the parent company -- listed in Switzerland, in Frankfurt and on the New York Stock Exchange in American Depositary Shares -- skyrocketed 71%, outstripping the Standard & Poor's 500 benchmark by a whopping 45 percentage points. What's more, CSFB's institutional traders, investment bankers and stock and bond analysts still count among the top 10 by anybody's measure. "They've got a very good equity business and their investment banking is world-class," says analyst Brad Hintz of Sanford C. Bernstein & Co.

So do the ill rumors matter? With the DLJ acquisition and the legal settlements that have rocked much of Wall Street mostly things of the past, is CSFB now well positioned to move forward and change the minds of its skeptics? Chief Executive Officer John J. Mack, now in the third year of his reign, is betting it is. Yet can his widespread management changes, rampant cost-cutting and rigorous attention to the bottom line make enough of a difference? More importantly, what does all this mean for institutional investors?

DIRTY LAUNDRY

Contacted for this piece, CSFB declined to comment by deadline time. Its recent history, to be sure, is somewhat checkered. Though as of this writing the firm hasn't been found guilty of any wrongdoing, it's certainly paid a hefty share of recent legal settlements. In January 2002, CSFB agreed to pay $100 million to the U.S. Securities and Exchange Commission and the National Association of Securities Dealers to settle claims -- without admitting guilt -- that some of its investment bankers allegedly received kickbacks for allocating shares of certain initial public offerings of stock to favored corporate clients, which in turn artificially elevated those IPOs' prices. Then, in October 2001, shortly before Houston-based energy trader Enron Corp. filed for Chapter 11 bankruptcy protection, CSFB analysts were reportedly pressured to issue bullish assessments of its stocks and bonds, while at the same time hypocritically urging the firm's own exposure to the embattled company "needs to be reduced," according to legal documents released in November 2003 in connection with the Enron investigation.

In October 2002, Massachusetts officials -- granted authority by the North American Securities Administrators Association, an organization of state regulators -- charged CSFB with routinely pressuring analysts to produce favorable reports about investment-banking customers and paying the analysts a portion of banking revenue. In connection with that, at the end of 2002, CSFB was one of 10 securities firms that agreed to pay a total of $1.4 billion to the SEC and New York Attorney General Elliot Spitzer to settle claims that research analysts had touted stocks they knew to be dogs. CSFB got the second-highest fine, $200 million, paid in April 2003, for this alleged fraudulent activity.

Despite the enormity of these fines and allegations, perhaps more infamous still is the case of former CSFB investment banker Frank Quattrone. Quattrone brought public many high-technology and Internet companies in Silicon Valley and elsewhere during the late-1990s, and is alleged to have channeled shares of hot IPOs to chief executives of certain technology companies in return for their business. Last fall, Quattrone was tried on charges of obstruction of justice in connection with the destruction of documents relevant to the investigation of such IPO-allocation deals. Specifically, he is accused of sending an e-mail message in December 2000 instructing his staff to "clean up those files" to thwart federal authorities. In October, a mistrial was declared, but Quattrone is due to be tried again in March 2004.

Nevertheless, Quattrone has become a posterboy for the excesses of the Internet boom, alongside Merrill Lynch's Henry Blodget and Salomon Brothers' Jack Grubman.

"MACK THE KNIFE"

The long-term impact of these scandals and legal settlements is hard to measure. But clearly, CSFB has had an expensive past couple of years. Add to the expenses the Credit Suisse Group's habit of growing by acquisition -- the latest, biggest example of which is the 2000 takeover of DLJ. In 2002, the firm reported a net loss of $1.2 billion, considerably worse than the previous year's net loss of $821 million. Though 2003 results aren't available as of this writing, in the most recent quarter CSFB posted positive profits of $224 million, down from $282 million a quarter before. Particularly hard-hit: fixed-income trading revenue, a disappointment attributed to the bank's overly-conservative position last year in regard to U.S. interest-rate volatility. Credit Suisse Group, the parent organization, wielded profits in each of the first three quarters of 2003; year-end results weren't available as of this writing. In the third quarter, the group posted net income of 2 billion Swiss francs ($1.5 billion), up from the preceding quarter's 1.35 billion Swiss francs.

Perhaps the best news in CSFB's recent quarterly results was that operating expenses were way down, with the institutional securities unit reporting a 24% reduction in operating costs compared to the preceding quarter. "Our strict cost management over the last two years has provided us with a more competitive cost structure," said CEO John Mack, who doubles as co-CEO of Credit Suisse Group.

Included in that strict cost management was the selling off of both DLJ-Direct and CSFB-Direct, its online retail stock brokerage businesses. Retail trading is far from a CSFB revenue driver. But an even bigger part of Mack's expense-reduction efforts has been drastic downsizing. Massive layoffs were only to be expected. In 2001, CSFB's compensation expenses were reportedly more than $8 billion or 58% of revenue -- some eight percentage points above average, and the highest on Wall Street at that time. In 2003, the Credit Suisse parent organization slashed more than 17,000 jobs globally. Most of those were reportedly in the CSFB division and instituted by John Mack, who not surprisingly has been dubbed "Mack the Knife" by some detractors.

Mack, 60, joined CSFB as CEO in July 2001 and became co-head of the parent group at the start of 2003. Prior, Mack was president of Morgan Stanley. He joined Morgan Stanley in 1972, a graduate of Duke University who quickly moved up from a position in Morgan Stanley's bond department to head its global taxable fixed-income division in 1985. Eight years later, he was named chief operating officer and then president.

Widely credited with helping Morgan Stanley integrate its acquisition of Dean Witter, Mack came to CSFB just eight months after its DLJ acquisition. In the press release announcing Mack's appointment, then-chairman and CEO of Credit Suisse Group Lukas Mühlemann noted that Mack "knows how to successfully build cohesive, diverse teams with a common vision amid rapid growth." In other words, part of his mission from Day 1 was to unify the troops and smooth out remaining tensions between CSFB and former DLJ stalwarts. At the same time, Mack was also charged with overseeing a reorganization to merge CSFB's investment banking with the Credit Suisse Group's asset management operations, which had been a separate entity.

"Mack's done a good job taking expenses out and focusing on the bottom line," comments Hintz, the analyst at Sanford Bernstein. "I don't think he's cut too deep. But one of the biggest challenges facing him has got to be the continuing culture clash."

Culture clash? Indeed, in November 2003, when quarterly results were published, Mack expressed confidence that the firm would achieve strong results as long as it not only addressed client needs but also built "a unified culture." "Anytime you take an old established firm like First Boston and mix it with another old established firm like DLJ and then slap on top of it a Morgan Stanley head honcho, you've got a whole bunch of different people wearing different colored sweatshirts," says Hintz. "You naturally have to make sure everybody plays nicely together in the same sandbox. But if anybody can lead people on Wall Street it's John Mack. You don't always love him, but he's certainly the kind of guy you would follow into combat."

RAPID TURNOVER

Indeed, many of Mack's old cronies from Morgan Stanley have followed him to CSFB. For example, in January 2004 alone, CSFB hired 19-year Morgan Stanley veteran Jim Little to direct and grow its private client trading business for wealthy individuals; Jerry Wood, another former Morgan Stanley person, to co-head fixed-income services; and Bill White, a banker at Morgan Stanley for 17 years, to co-lead its global debt capital markets operations and try to strengthen its investment-grade bond desk, which reportedly ranked eighth in U.S.-based investment-grade credit issuance, as measured by Thomson Financial's 2003 "league tables." (CSFB came in first, however, in global high-yield issuance.)

But not everybody feels loyal to Mack. In fact, many CSFB research analysts have jumped ship in the past few years. Granted, there are many reasons for job-hopping. But the flight from CSFB has been large enough to be noticed. At Boyden Global Executive Search in New York, Richard Lipstein observes, "Bank of America Securities, for one, has been very successful at recruiting numerous research analysts away from CSFB."

CSFB declined to say how many analysts it currently employs, but the firm's Web site lays claim to coverage of more than 2,500 companies worldwide. One former CSFB bond analyst, who spoke on condition of anonymity, is now on the buy side (not for Bank of America). "For what it's worth, I will tell you that in terms of the sell-side research I look at, I really don't use CSFB's stuff. Most of the research I use comes from analysts at other firms."

Nonetheless, CSFB's research analysts do remain widely respected. They invariably figure among the top 10 in industry surveys. But lately, their rank has been slipping. As a group, CSFB slid to sixth place in Institutional Investor's 2003 All-America Research Team from No. 4 a year earlier, with only 27 "first-team" analysts (down from 44 in 2002). In comparison, top-ranked Lehman Brothers placed nearly twice as many first-teamers, 50, in 2003. What's more, in that magazine's European and global equity-research rosters -- once points of pride, where in 2002 CSFB held second- and first-place honors, respectively -- the firm fell to Nos. 4 and 6, respectively, in 2003. CSFB fared better among U.S. fixed-income and Asia-equity analysts, landing second in each category in 2003 for the second-year running. In The Wall Street Journal's 2003 Best on the Street roster, CSFB ranked fourth.

INVESTMENT-BANKING FRANCHISE

In addition to well-regarded research, the firm remains a dominant player in the world of investment banking. "The banking franchise is a definite strength," asserts Sanford Bernstein's Hintz. "Despite all the trauma the company may have been through over the past few years, CSFB has an investment-banking franchise that's still among the best in North America. That's one of its great advantages."

Besides public equity offerings and private placements of both equity and debt, the firm is active in financial advisory services, especially mergers and acquisitions. In 2003, CSFB was involved in General Electric Co.'s $14 billion merger of its NBC Entertainment unit with Vivendi Universal's entertainment division, Oracle Corp.'s $7.5 billion hostile takeover offer for PeopleSoft, and Hughes Electronics Corp.'s split off from General Motors Corp. and simultaneous sale of 34% of Hughes' outstanding common stock to News Corp., a deal estimated to represent an aggregate value of $6.6 billion.

None of this is surprising, perhaps, for a firm that operates in more than 34 countries in five continents. Its parent organization, Credit Suisse Group, which was launched in 1856, boasts offices in an additional 16 countries and a total staff of more than 61,000 souls. It acquired a controlling stake in First Boston Corp. in 1988, 10 years after the two organizations had already formed a kind of cooperative agreement. But it was not until January 2002 that the group restructured into two distinct business units: Credit Suisse Financial Services, which is mainly responsible for private banking, financial advisory and insurance, and the investment bank Credit Suisse First Boston.

"John Mack has focused the company on making money," posits analyst Hintz. "Not that he doesn't want it to be highly ranked, to do high-profile deals and service clients well. But first of all he's making sure that CSFB earns enough money to justify its own existence."

No doubt if anyone can accomplish that it is John Mack. In 2000, the last year he ran Morgan Stanley's investment banking business, that firm soared to the top of the M&A league tables with a 30.5% market share, representing some $887 billion worth of transactions. It's a different environment now, certainly, but if capital markets are truly on the verge of cresting M&A and underwriting activity, as many economists expect, there's no telling how far Mack will be able to take CSFB. As Hintz notes, "After three lean years, we happen to be in that happy point of the cycle on Wall Street where the good stuff is coming back."