Stifel Who?

Takeover bait. It's a description most regional brokerage firms have become accustomed to — and for good reason. Several have been gobbled up over the years, of course. And, truth be told, there is probably many a midsized broker/dealer who wouldn't mind selling out to the distribution-hungry wirehouses and banks, especially since most regionals aren't as profitable as they used to be. But to Ron Kruszewski, CEO of St. Louis-based Stifel Financial and Stifel Nicolaus, its brokerage arm, the very suggestion that he might sell out is an insult. With profits healthy and forecasts bright, Stifel's independence is a blessing, he says. “Merrill Lynch will go before Stifel Nicolaus,” Kruszewski boasts.

That's big talk from a man who runs — in the scheme of things — a tiny securities company. Then again, he can afford the bravado. Stifel stock has soared under his leadership. Since the end of 1998, his first full year as CEO, the stock is up 727 percent. From the end of 2002 through October 15, it's up 609 percent, topping the impressive gains of fellow regional firms Raymond James (+179 percent) and Jefferies Group (+177 percent), as well as bigwig Goldman Sachs (+251 percent). In the past two years, the firm has doubled its size, both in terms of revenue and financial advisors. In short, Stifel is humming — although small (the retail-brokerage unit has around 1,000 reps who average $450,000 in annual production, and handle nearly $60 billion in client assets). When a company is both humming and small, well, it's easy to understand why the words “takeover bait” occasionally buzz around the firm like gnats.

Indeed, given Stifel's success, and the fact that it is one of the last remaining regional b/ds (see chart), its potential as a bolt-on opportunity for other firms is understandable — if not to Ron Kruszewski. Wachovia's acquisition of A.G. Edwards, Stifel's St. Louis neighbor, for a substantial three- times book value, again stirred speculation of a possible sale — and sent Stifel's stock up 8 percent the following day.

No doubt Stifel could fetch a nifty price. Wachovia paid $6.9 billion (three-times book value), or more than $1 million per financial advisor, for A.G. Edwards, according to research firm Keefe Bruyette & Woods, which reckons that Stifel could get as good or better a multiple. But Kruszewski isn't interested; he says Stifel can do far better on its own. “Selling is capitulation,” he says. “Selling won't achieve my goal.” And with the stock doing as well as it has, and employee stock ownership above 50 percent (Kruszewski owns 4.5 percent), he says shareholders wouldn't let him anyway. “They'd vote me down, and then fire me for bringing it up,” he laughs.

In any case, Kruszewski has been too busy making acquisitions of his own. He has expanded his firm's Midwestern footprint east and west, adding more than 500 reps in the past two years. Two acquisitions have led the expansion: Legg Mason's highly regarded capital markets group, bought in September 2005, and Ryan Beck, the former brokerage unit of Bank Atlantic, picked up in January of this year. Analysts considered the complementary purchases both strategically wise and, at least in the case of Beck, cheap compared to past mergers among peers (1.4-times book). While Stifel digests the purchases, further acquisitions are on hold.

In the meantime, Kruszewski is working on acquiring talent. Stifel hired A.G. Edwards Regional Director John Lee in September. The West Coast regional director was in charge of 72 of Edwards' branches. For Stifel, which has no brokerage branches west of Colorado, Lee's contacts will be key to Kruszewski's plans for expansion. It's all part and parcel of what Kruszewski says has been his goal for the last 10 years: “To make Stifel the premier regional brokerage and investment banking firm in the country.”

Premier is a strong word. But at least two financial analysts like what they see so far. Fox Pitt Kelton and Keefe, Bruyette & Woods, both prominent research firms, began following the stock for the first time in May and September, respectively, with near-term “outperform” ratings and positive long-term expectations. (It should be noted that KBW handled Stifel's financing on the Legg Mason deal.) At the heart of the praise are the Legg and Ryan Beck acquisitions, which more than doubled the size and revenues of the firm. Legg's capital markets group alone, with 500-plus employees, and $246 million in revenue in 2004, was nearly the same size of Stifel in both respects at the time of the deal. Ryan Beck's 450-plus advisors and $22.5 billion in client assets complemented the capital markets business, and turned Stifel into a substantial player in the middle market.

In the past decade, Kruszewski, together with his core executive team — Jim Zemlyak, the CFO, and Scott McCuaig, the president and co-COO, both also former Baird executives to whom he attributes much of the firm's success — has turned the once-beleaguered regional into a tiny juggernaut. Net revenues have grown at a compound annual-growth rate of 20.5 percent since 1997, when Kruszewski came aboard. But success has accelerated the most since 2000, when net revenues were a mere $177 million. This year, KBW analyst Lauren Smith expects nearly $800 million in revenue, a 75 percent increase over 2006. Since 2001, core earnings per share have grown at a CAGR of 72 percent, and more than doubled between 2003 and 2006 to $2.85 per share. Additionally, core earnings were up nearly 50 percent through the first half of 2007 compared to the same time last year, according to Smith. “A firm that's doing that well has no reason to sell,” says Mike Flanagan, an independent analyst with Securities Industry Analytics.

Today, Stifel Financial consists of four main groups: the private client group, which includes Stifel Nicolaus and Century Securities Associates, its independent contractor brand; the equity capital markets group (corporate finance, research, equity trading, institutional sales and trading); fixed income capital markets (public finance, institutional sales, underwriting and trading), and the bank it acquired in April and has renamed Stifel Bank & Trust.

The Power Source

The engine driving the growth is the private client group, which includes the 956 Stifel Nicolaus advisors (including 450 from Ryan Beck) in 152 branches, and 194 independent contractor reps under the Century Securities Associates brand. Together, these operations contributed 55 percent of the firm's total revenues in the first half of this year, a figure that was closer to 75 percent before the addition of Legg's capital markets group. Full-year results from the addition of Ryan Beck reps will likely swing the balance back to retail, according to analysts. Since 1998, Kruszewski's first full year, the CAGR of revenues in the private client group have been 17 percent. This year, revenues are expected to reach $408 million, a 76-percent increase over 2006, with the help of Ryan Beck's advisors, and the $22.5 billion they add to the total client-asset pie (now $58 billion).

The capital markets group of Legg Mason (which remains in Baltimore) was considered among the best in the business, particularly its research department. In The Wall Street Journal's 2007 analyst survey, Stifel ranked 6th out of 85 research firms, with seven analysts getting specific recognition for their talents. “Our analysts are being quoted in the press, on financial news shows — it's been phenomenal for the business,” says Bob Stanczak, a branch manager in Ann Arbor. Still, a household name it's not. The firm has even exhibited a sense of humor about its obscurity: A recent ad read, “It's pronounced (Stee-fuhl).”

Besides award-winning research and a strong middle- market investment bank, Stifel also has a bank, which it bought in April. “Most regional firms concluded correctly that they needed to offer liability-type products to clients,” says Kruszewski. In its first four quarters of operation, Stifel Bank & Trust, formerly First Services Financial Company, generated $1.1 million in net revenues, and $274,000 in operating profit, just a sign of the kind of rapid growth analysts expect in the near future.

Is Kruszewski trying to emulate the wirehouses? “Absolutely not. What we want is to be an alternative to the conglomerates,” he says, one he hopes brokers at some of the regional firms that have been gobbled up — Piper Jaffray, A.G. Edwards, Advest, to name a few — will take notice of, if and when they become disillusioned with their big New York parents.

A Youthful Upstart

In the early 1990s, Stifel was nearly sold on more than one occasion, including a failed deal with Raymond James in 1992. But the firm was in “a different place” back then. Stifel had become embroiled in the “burn-rate” scandal involving kick-backs and bribes in municipal finance deals, such that the firm's board, led by George Herbert (“Bert”) Walker III, the cousin of former president George H.W. Bush, was periodically debating whether to sell or rebuild. “It was clear that the guy who had been brought in [CEO Gregory Taylor] was a bright guy, but he wasn't prepared for this job,” says Charles Dill, who has served as an outside director on the firm's board since 1995. According to those familiar with him, Taylor was smart, but lacked the people skills to inspire and lead a brokerage force. When it was decided that Taylor's contract would not be extended in 1997, a search team began scouring the universe of brokerage executives; unfortunately, “most of the prospects we interviewed were on the descending side of their career,” says Dill.

Then there was Kruszewski. Now retired from the board, Bert Walker, who was Chairman for 19 years and CEO for 14 years, remembers that many board members worried that Kruszewski was “a bit youthful” for the job. It was a consideration, he says, however brief. But in the end, his credentials more than made up for it, says Dill. “He had a resume that was basically an 18-year training program for this job.” And he made a heck of an offer — and a statement about his character — when he took the job. According to Dill, he put up more than $1 million of his own money to buy Stifel stock. “So from day one he has had an owner's perspective,” he says.

Then the CFO of Robert W. Baird, Kruszewski was trained in finance and accounting, so he had the skills of a bean counter, but much more as well. By Kruszewski's own account, he learned the most about running a business during his time at The Illinois Company, a tiny $20 million investment firm in Chicago, where he got to see and put his hands on a lot of things, including trading, operations and compliance. Later, as CFO of Baird, he oversaw to varying degrees an equally diverse arena, including asset management, legal, tech, and finance as well as the investment-banking unit. To the board it was clear he knew the business, could walk the walk, talk the talk, and had boundless energy — exactly what it was going to take to turn Stifel around. Recommendations from respected senior executives at Baird and Raymond James sealed the deal. “If he was half as good as we and the others thought he was, we knew his youth would be an asset in the end,” says Walker.

The Challenges To Come

As for what Ron Kruszewski wants to do next, he may be the only one who knows — he says his board has found him irritatingly vague in the past. “We don't have quantitative goals,” he says, just “opportunities.” For instance, there'll be no discussions with the board of “S.W.O.T,” — a typical boardroom exercise where the executive lays out the firms' strengths, weaknesses, opportunities and threats. Just a financial budget and this statement: “Our business plan is to be in a position to take advantage of opportunities,” he says. Legg and Ryan Beck were just that. “We want to be a quality firm, and quality means quality service and quality culture. And we don't believe that [growing] numbers have to diminish that. But at the same time, we're cognizant of history, and that the larger you get, the harder it is to maintain those qualitative measures.”

Looking down the road, it's easy to see the hiring of A.G. Edwards' Lee, and subsequent opening of Stifel's first California brokerage office in Roseville, as the next battlefront for growth. It won't be easy, especially if all hopes are pinned on A.G. Edwards' reps. The top reps received handsome retention packages, and Wachovia and Edwards have shown themselves willing to sue to keep talent. (Among others, Lee is being sued for allegedly recruiting brokers and clients to join him.) In that suit, the attorney for A.G. Edwards left open the possibility of suing others in its complaint, which means Stifel or Kruszewski could be named at some point.

Lee, like every other A.G. Edwards recruit, received a letter written by Kruszewski as well as an extensive marketing package just after the Wachovia/A.G. Edwards merger announcement. According to one of A.G. Edwards' top reps, one who is content with the merger and plans to stay, Stifel was an unknown entity for the most part, but with one exception. “To be frank, Stifel has traditionally been thought of as the place that A.G. Edwards losers went,” he says, referring to lower-end producers. But the package from Kruszewski was a surprise — one he says made him question his thinking. “They put together one of the most impressive side-by-side recruiting pieces I've ever seen,” he says. Not the typical “think of us” letter from “some marketing guy,” as he puts it, the Stifel package did what nobody else did — “it said, ‘We know what's happening over there, this is what you can expect, here's what you'll get if you stay, here's what you'll get if you come to us,” he says. “It was remarkably accurate,” he says of the Wachovia comparison. “Somewhere along the line they became a lot more sophisticated.”

THE SHRINKING REGIONAL POOL

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