Focus on Mid-Cap Business Pushes Investment Film Up.

WALL Street giants like Merrill Lynch & Co. and Goldman Sachs Group are being squeezed by investor wariness and a dearth of mergers, acquisitions and initial public offerings. But Jefferies Group Inc., a middle-market equities brokerage and investment bank based in Los Angeles, is generating record earnings and revenues as its stock hovers near a 52-week high.

Jefferies' keys to success? On the investment banking side, in response to the slowdown in capital financing and M&A activity, the company has beefed up its corporate finance unit, focusing on restructuring deals.

On the securities trading side, rather than going head-to-head with the Wall Street giants that derive much of their business from individual investors trading in large-cap stocks, Jefferies focuses on trading mid-cap stocks for institutional clients.

"There's been some weak pockets in the brokerage business over the past year, especially over the past six months. (But) Jefferies caters to institutional clients on one level or another. They have no retail exposure," said Russell Keene, equity analyst at Keefe Bruyette & Woods Inc., which has an "outperform" rating on Jefferies' stock. "Their institutional business continues to grow...and that part did have a record quarter in the first quarter because of a surge in institutional volumes."

Jefferies Group, which conducts business through its operating entities Jefferies & Co. Inc., Jefferies International Ltd. and Jefferies Pacific Ltd., reported net income of $15.6 million (63 cents per diluted share) for the first quarter ended March 30, up from $15 million (62 cents) in the like year-earlier quarter.

First-quarter revenues were $209.7 million, vs. $194.8 million in first quarter 2000.

Jefferies has managed to fare better than Wall Street houses specializing in institutional clients because it focuses on mid-cap stocks and relies less on investment banking revenues.

What could hurt Jefferies in future quarters is the exchanges' transition this year from fractional prices to decimals. "Decimalization" has dramatically cut the spreads between bid and ask prices. Under the fraction system, spreads -- from which brokerages derive their revenue -- rarely got thinner than one-sixteenth of a point (6.25 cents), while spreads in decimal trading can go as low as a penny.

The consequences have been severe for firms handling large volumes of retail transactions. For example, Merrill Lynch 'announced on June 26 that it would miss its second-quarter earnings estimate by as much as 37 percent, citing its heavy dependence on retail investors. Merrill Lynch's stock as of last week had sputtered to $59, much closer to its 52-week low of $50.31 than to its high of $80.

While Jefferies has been less impacted by decimalization because it deals in mid-cap stocks that generally are less liquid -- and therefore carry bigger spreads than large-caps -- the firm has not completely escaped the fallout from decimalization.

"Decimalization has thrown the whole industry for a loop," conceded Chief Executive Richard Handler. "It's hard to make money with a penny spread, and a number of clients on the buy side are equally frustrated with it, but it's something we'll work through. I think across the board, firms with strong relationships at the end of the day will be in a better position to weather the storm."

As for client relationships, Handler pointed out that Jefferies' account executives have worked for the firm, on average, 12 to 13 years. This provides a broad base of knowledge and deep roots with clients.

"One thing that really stands out is we are a mid-size. firm, where there is very little bureaucracy and it's very entrepreneurial focused," he said of the firm, which is 50 percent owned by employees.

Jefferies employs more than 1,000 people in 21 offices around the world. The company was founded by Boyd Jefferies, a steer roper with an Arizona cattle ranch who started out in the 1960s as a clerk for a Pasadena securities firm on the floor of the Pacific Coast Stock Exchange.

Jefferies was forced to resign from his namesake firm in 1987 after pleading guilty to two felony charges related to manipulating stock prices. He was barred from the securities business and replaced by Frank Baxter, who retired in January of this year and was replaced by Handler.

Jefferies Group Inc.
YEAR (Dec.31)                    2000    1999
Revenue (millions)             $761.8  $640.1
Operating Expenses (millions)   666.5   556.1
Operating Income (millions)      95.4    84.1
Net Income (millions)            55.0    61.7
Earnings Per Share              $2.26   $2.57

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SUMMARY

Business: Securities trading, corporate finance

Headquarters: Los Angeles

CEO: Richard Handler

Market Cap: $810 million

Dividend Yield: 0.6%

Total Liabilities: $3.5 billion

P/E Ratio: 14.3

Long-Term Debt: $152.5 million