Description

SUMMARY:
LaBranche provides an interesting short opportunity given the recent tumult at the NYSE and the growing regulatory risk to specialist businesses. LaBranche has seen a significant drop in profitability in 2003 and received a black eye from its recent dispute with the NYSE. With its entire business susceptible to catastrophic regulatory risk and almost 40% of assets intangibles that are similarly vulnerable, LaBranche faces significant short and mid/long-term risk.

BUSINESS:

LaBranche is the holding company for a number of subsidiaries which include the LaBranche specialist operation. LaBranche is one of the oldest (founding in 1924) and largest specialists on the NYSE and American Stock Exchange. LaBranche is the specialist for over 650 listed companies, including 1/5 of the S&P 500 and over 25% of the dollar volume and shares traded on the NYSE. The company went public in 2000. George LaBranche still own 6.7% of the common equity.

REGULATORY RISK:

With the resignation of Dick Grasso, a staunch defender of the specialist system, the future of this entire industry is in question. ECNs may soon have the opportunity to take the specialist firms’ cash cow away from them. As a case in point, ECNs have captured over 50% of Nasdaq trading activity. Removal or weakening of the NYSE rules that protect specialists could have a devastating impact on LaBranche’s revenue.

While the specialist industry together could wield significant influence to maintain its barriers to entry, many of the leading NYSE member firms (e.g. Spear Leeds and Bear Wagner, largely owned by Goldman Sachs and Bear Stearns, respectively) might actually welcome change. If they believed their own capital positions, technology and order flow from customers would enable them to dominate a more competitive system, they would happily watch the outdated specialist system pass into history.

LaBranche has also been the subject of an investigation by the NYSE into specialist activity. LaBranche made an ill-advised statement by challenging the Exchange’s enforcement powers. Robert Murphy, LaBranche’s CEO, resigned from the NYSE board and the firm publicly and vocally refused to release internal emails to the NYSE (which they have since released). The Company was cited by a NYSE Hearing Panel, which will impose a censure and fine (not yet determined). This black eye may affect LaBranche’s ability to gain new listings.

Meanwhile, NYSE investigation into specialist trading is ongoing. The SEC has also begun to question specialists and may begin a formal inquiry if it is not convinced the NYSE scrutiny is sufficiently rigorous. This cloud over the specialist industry will not dissipate anytime soon.

LaBranche has a solid balance sheet on its face, but its intangible assets are 90% of book value which leaves a P/tangible BV of $9. Of its $2.19B in assets, $872m are intangibles (specialist stock list: $377m, trade name: $25m and goodwill: $470m). These intangibles are susceptible to regulatory changes at the NYSE or possible SEC inquiries into specialist activity.

- Despite its recent troubles, LaBranche is still trading at 16X earnings.
- LaBranche’s net income down from $43m June 30, 2002 to $17m in June 2003.
- Pre-tax margins have dropped dramatically from levels above 35% in 2001 and 2002 to approximately 20% for the first six months of 2003.

RISKS
- LaBranche has already lost 28% of its market value over the last 3 months and is inching closer to its 52 week low of $14.81. The short-term downside may already be factored into the price.
- The specialist business has been very profitable in the past and there are barriers to entry. While this is another reason for increased scrutiny, there is a possibility that the status quo could be preserved.
- If equity trading volume picks up and there are indications that it may, (stock funds had an inflow of $21.38B in July, following an inflow of $18.63B in June), LaBranche’s short-term profitability should improve.

Catalyst

The specialist industry, and LaBranche in particular are under fire with no signs of a return to the status quo. LaBranche has seen its profitability fall and its reputation questioned. Disputes with the NYSE and ongoing investigations into and existential threats to the specialist industry make LaBranche, despite its recent price decline, an interesting short opportunity.