Page 1 of 4

Then he’s not running his investment bank, Bear Stearns Cos. chairman and CEO James Cayne is usually off somewhere playing bridge — friendly matches with the likes of Bill Gates and Warren Buffett or high-level amateur competitions held around the country. To Cayne, bridge isn’t just a game, it’s a way of life, a philosophy. As a young man he paid the bills with bridge winnings and dreamed of making a career as a card shark. Today he has no trouble making ends meet — he earned $28.4 million last year and is worth more than $1 billion — and attributes his success in finance and bridge to the same principle: The best players make the most of the hands they’re dealt. Comparing cards to business, Cayne told a group of interns in July, “Bridge requires skill and preparation, not luck.”

That’s the mind-set with which Cayne approaches his other great love: running Bear. During 13 years as CEO, he has repeatedly foiled predictions of his firm’s imminent decline. Skeptics have long dismissed 83-year-old Bear, the smallest of Wall Street’s

big, publicly traded securities houses, as prime takeover bait, a déclassé firm too narrowly focused to survive in a business where size — and reputation — are all-important. Unlike Goldman Sachs Group and Morgan Stanley, Bear can’t lay claim to an elite client list. It lacks the diversity, global reach and beefy balance sheets of the universal banks, such as Citigroup, Deutsche Bank and JPMorgan Chase & Co., that are making inroads on traditional Wall Street’s turf. And Cayne’s firm has run into regulatory hot water. In March it agreed to pay $250 million to settle Securities and Exchange Commission charges that its clearing unit helped customers engage in illegal late trading of mutual fund shares This came seven years after Bear paid $35 million and hired an independent compliance consultant to settle SEC allegations that it failed to detect and take action against fraudulent conduct by one of its clearing clients, the notorious (and now defunct) boiler room brokerage A.R. Baron & Co. Bear was one of 12 big brokerage houses that in 2003 and 2004 settled charges by federal and state regulators that it had published misleading stock research in an effort to win corporate underwriting and advisory business.

Despite all this, since succeeding Alan (Ace) Greenberg as chairman in June 2001, Cayne has led Bear on a remarkable run during which time it has outperformed nearly every competitor in earnings growth and stock price appreciation. Last year it posted record profits of $1.46 billion, up a dizzying 136 percent since 2001. Through September 30 of this year, the firm had already surpassed that total, earning $1.49 billion. Over the past five years, Bear’s share price has increased by 175 percent, to $151, outperforming white-shoe firms like Goldman (112 percent) and Morgan Stanley (52 percent).

Still, by many measures, Bear remains far behind its rivals. At $22 billion, its market capitalization is barely half that of its next-biggest competitor, Lehman Brothers, and it is dwarfed by Goldman’s $82 billion and Citigroup’s $249 billion. Investors, concerned about the firm’s lack of diversification and its propensity for regulatory run-ins, currently value Bear’s shares at 11 times projected 2007 earnings — lower than all but one of its major competitors (Goldman’s multiple is 10.7). Its price-to-book valuation of 1.97 is the lowest of its peer group.

Cayne has defied skeptics by investing excess cash in unglamorous but fast-growing markets like asset-backed securities, collateralized debt obligations and credit derivatives. Bear is the leading underwriter of mortgage-backed securities. It can’t outperform Citi, Goldman and Morgan Stanley in the high-profile equity underwriting and corporate merger advisory arenas, and it doesn’t try to. Rather, it focuses on serving a small group of corporate clients with whom it has long-standing relationships, such as Verizon Communications and Time Warner, as well as on highly active private equity firms. In a nutshell, the firm has chosen profits over prestige.

Just as important to Cayne’s success has been preserving the firm’s longtime focus on cost controls. Greenberg, his mentor and onetime bridge partner, was renowned for his penny-pinching, urging employees to reuse paper clips and rubber bands. During Cayne’s five years as chairman, annual expenses have grown by just 31 percent, even as revenues have leaped by 51 percent.

“They’re a wealth-creation machine,” says Bruce Sherman, CEO of Private Capital Management, a Naples, Florida–based money manager that owns 6.5 percent of Bear and is the firm’s largest shareholder. “Jimmy’s leadership over the past decade has been central to that.”

Bear has also benefited from good luck and fortuitous timing. Its dependence on fixed income — last year 44 percent of revenue came from debt sales and trading — has long been considered a limitation by critics in the investment community. But lately it has been a key to the firm’s outperformance, as low interest rates and postbubble caution fueled a bond and loan boom. Bear was an early entrant to the business of prime brokerage, which provides hedge funds with a single point of contact for trade execution, securities lending, recordkeeping and other services. Last year Bear collected 15 percent of the $5.5 billion spent by rapidly proliferating hedge funds on prime brokerage, estimates Sanford C. Bernstein & Co. analyst Charles (Brad) Hintz. That puts Bear third in that lucrative arena, behind Goldman and Morgan Stanley.

Because it had a smaller presence in the equity and M&A advisory businesses that tanked after the 1990s stock bubble burst, Bear flourished while its competitors struggled. In 2003 the firm finished the construction of a $500 million, 47-story, octagonal headquarters two blocks north of Grand Central Terminal on Manhattan’s east side. Cayne describes the building as his greatest achievement as CEO — a tangible expression of Bear’s success and staying power. “It’s a square block in the heart of the city,” he notes proudly.

Now, however, Cayne’s winning hand is being challenged: The cycle of low interest rates and investor caution is turning. Rising rates have contributed to a housing slowdown that could hurt Bear’s booming mortgage business, reducing the supply of new loans to be securitized and dampening the enthusiasm of mortgage bond investors. At the same time, the long-dormant equity and M&A markets, in which Bear trails the competition, are reawakening. Worldwide merger volume this year hit $2.9 trillion through October, breaking the $2.8 trillion record for the same period in 2000. Stock underwriting rose 15 percent during 2006’s first nine months over the same period a year earlier. Bear ranks just 12th among U.S. merger advisers on deals announced this year, behind the likes of boutique Evercore Partners and Banc of America Securities; it also registers 12th in U.S. equity underwriting, according to Dealogic.

And Bear is notably weak overseas, especially in the fast-growing Asian and European markets that U.S. firms increasingly see as critical for the future. Globally, Bear ranks 21st in M&A and 17th in equity underwriting. It is alone among its peers in lacking a strategic partner in China, a market that Wall Street has been madly pursuing. (Cayne refuses to comment on reports earlier this year that Bear was in talks to sell a 20 percent stake to China Construction Bank for $4 billion, a deal that would have given the U.S. firm critical access to deal flow in China. Both sides have publicly denied being in negotiations.)

Meanwhile, Bear’s position in prime brokerage is under attack, as firms like Citi, Bank of America Corp. and Deutsche Bank invest in the business, wooing customers with liberal lending terms and expensive state-of-the-art technology. Rather than sticking with one prime brokerage, hedge funds are increasingly playing the competitors against one another. Although the business is growing, Bear is in danger of losing share to its aggressive rivals. Revenues in the firm’s global clearing unit, which includes prime brokerage, declined 7 percent between the second and third quarters of this year.

Together, these developments could leave Bear vulnerable to takeover. Some still view the firm as a target for its competitors, especially because the gaps in its business lines would mean less duplication and layoffs during a merger integration.

“It’s not a company that’s in a desperate position, that has to sell, but it could bring added value to potential purchasers without the large overlapping businesses that many larger firms would bring,” says analyst Hintz.

A chain-smoker of Montecristo cigars — he even puffs them in the firm’s elevators — Cayne came of age in the era before Wall Street’s private partnerships went corporate and its leaders began to stick to polished scripts. He still leaves his door open to everyone from senior managing directors to interns. But in a blink he can go from gregarious to gruff, and he is as adept at dressing down those who aggravate him as he is at glad-handing clients. In a 2004 memo to Bear employees, he admonished co-president Warren Spector for expressing his support for Democratic presidential candidate John Kerry during a company conference call. (Cayne supported President George W. Bush.)

Single Page    1 | 2 | 3 | 4
Related Topics: