Description
LaBranche & Company (LAB)
LAB is in the (once highly-profitable) business of facilitating securities trades. While it still conducts such activities (at a near historical low levels of market volatility), the introduction of electronic trading platforms, and the adoption of decimalization have all contributed to reduced earnings and speculation LAB may not survive in its current form.
- In July, LAB commenced a strategic review of its business
- In November, competing firms such as Van der Moolen Holdings and Susquehanna International Group announced they would close their NYSE market-making units
Hidden Asset: NYX
However, LAB owned 39 seats on the NYSE prior to its merger with publicly-traded Archipelago Holdings. NYSE seatholders each received 80,177 shares and ~$370,571 in cash upon the merger with Archipelago. Based on its share ownership, LAB owns ~$278mm worth of NYSE, or ~82% of LAB’s own market capitalization.
Adjusted to exclude the implied market value of that stake, the LAB ‘stub’ is worth just $62.2mm, or ~7x consensus 2008 estimates. Despite secular declines and disintermediation, I believe LAB’s earnings could be understated given historical low levels of volatility. Bottom Line: LAB’s specialist business – which handles 731 securities on the NYSE and accounts for ~27% of NYSE listed volume – is valued at $62.2mm.
**Note: In October 2007, the NYSE approved a proposal for a 75% reduction in the required Net Liquid Assets (NLA) to be maintained by cash equity specialists to transact business on the NYSE. If approved by the SEC, this proposal would free up $216mm of LAB’s capital (vs. $340mm market cap and $62.2mm LAB ‘stub’ value) – most likely for debt reduction in 2008
LAB currently incurs ~$50mm in annual interest expenses on $466mm in long-term debt. I conservatively estimate LAB will reduce debt by $225mm in 2008 (assume partial NLA reduction), or a ~$26mm in annual interest cost savings.
Description
LAB is the largest securities specialist firm on the New York Stock Exchange (NYSE). LAB also acts as a specialist for 104 equities and 245 options on the AMEX, and 13 ETFs on the NYSE.
- Of the 1,366 NYSE seats, LAB owned 39, and traded 580 listing (~22.4% of NYSE equity listings)
- In 2005, LAB accounted for 25.4% of NYSE’s daily trading volume
- Historically, LAB made money in both good times and bad, with volatility and volumes being the biggest determinants of incremental profits
- With the advent of electronic trading – specialist firms have seen their market share erode as customers focus speed of execution (and likely eliminate ‘front-running’
Strategic Review
In July, LAB announced it will conduct a strategic review and retained Freeman & Co. Securities LLC and Weil, Gotshal & Manges LLP to assist. Initial speculation was any action would include the NYX shares and callable debt.
- LAB is free to sell two-thirds of its 3.1mm NYX shares and has $200mm of 9.5% coupon debt due May 2009 (callable May 2007)
- On June 8, NYX removed transfer restrictions on one-third of these shares (otherwise restricted until Mar. 2008); the remaining one-third is subject to restrictions til Mar. 2009
Last Friday, LAB announced it concluded its strategic review – LAB will continue to focus on current business activities, and will continue to cut costs and reduce debt. The Board will continue to assess strategic alternative, but offered no guarantees.
Other Value Catalysts
- NYSE Arca: NYSE has created a new category for companies that have not historically met the exchange’s strict listing standards in the hope to attract IPOs that currently list on the NASDAQ or other competitors.
- This tier of companies trade on the NYSE Arca (was AcraEx)
- Only ~1/3 of 2005 IPOs met the NYSE’s requirements (45 of 65 IPOs)
- Trading market share: With the Archipelago merger, the NYSE will likely significantly increase its trading market share in listed exchange shares
- Debt trading: NYSE is seeking SEC approval to trade debt issued by NYSE listed companies on its exchange, or >5k issues of debts that could be tradable on the NYSE vs. <1k currently listed
- Options trading: The options market is another possible market, and much more profitable than large-cap equity; NYSE Arca already does some options trading
- NYSE Euronext: NYX operates the 2nd largest exchange behind Deutsche Borse. Previously, the NYSE restricted itself to large-cap equity, but now is looking to expand into listed options, future and other structured products
- NLA Reduction: Potential free-up of $200mm; if approved by the SEC, it would most likely to reduce net debt and annual interest expense
- Tax Assets: LAB possesses $26mm in tax-deductible intangible assets
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Market Value (mm) |
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Per Share |
Multiples |
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LAB price |
$5.53 |
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Shares |
61.49 |
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Market Cap |
$ 340.04 |
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$5.53 |
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NYX Price |
89.63 |
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Held by LAB |
3.10 |
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Less NYX Value |
$(277.85) |
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($4.52) |
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81.7% |
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LAB 'Stub' Value |
$ 62.19 |
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$1.01 |
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LAB Book Value |
$ 509.90 |
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$8.29 |
0.7x |
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LAB 'Stub' BV |
$ 232.05 |
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$3.77 |
1.5x |
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2007 |
2008 |
2009 |
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EPS |
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$0.03 |
$0.15 |
$0.22 |
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Stub P/E |
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30.6x |
6.7x |
4.6x |
Valuation
While I acknowledge LAB’s core business continues to be under pressure and it is difficult to forecast any of the new business opportunities, I believe the NYSE-Euronext merger will create value and opportunities for LAB over the next 12-18 months with little downside given the NYX stake. Basically, the NYX stake provides a backstop on the stock price, while any of the above catalysts play out. Additionally, any progress on the NLA requirement would create value by reducing LAB’s debtload/interest expense. I anticipate LAB will trade up towards 1x forward book and normalized P/E of 10-14x – utilizing 2009 estimates yields a 12-month target price of $8-12/share.
Catalyst
1) NYX Stake Monetization - currently over 80% of LAB's market cap;
2) NYSE Arca: NYSE has created a new category for companies that have not historically met the exchange’s strict listing standards in the hope to attract IPOs that currently list on the NASDAQ or other competitors;
3) Trading market share: With the Archipelago merger, the NYSE will likely significantly increase its trading market share in listed exchange shares;
4) Debt trading: NYSE is seeking SEC approval to trade debt issued by NYSE listed companies on its exchange, or >5k issues of debts that could be tradable on the NYSE vs. <1k currently listed;
5) Options trading: The options market is another possible market, and much more profitable than large-cap equity; NYSE Arca already does some options trading;
6) NYSE Euronext: NYX operates the 2nd largest exchange behind Deutsche Borse. Previously, the NYSE restricted itself to large-cap equity, but now is looking to expand into listed options, future and other structured products;
7) NLA Reduction: Potential free-up of $200mm; if approved by the SEC, it would most likely to reduce net debt and annual interest expense;
8) Tax Assets: LAB possesses $26mm in tax-deductible intangible assets