Description

MF Global

 [ This idea was presented by another member a couple of years ago. at that time, it was a recovery sotry and the idea worked spectacularly. Today, it is a different story of business transformation and earnings recovery. Its useful to refer to the old writeup for more details regarding the business description]

Thesis-

1) Good capital markets franchise with significant latent earnings power driven by 1) new management 2) higher short term rates

2) New Management with Jon Corzine as CEO who is attempting to convert an inter dealer broker into more of a broker dealer. That will improve margins and ROE and afford a more sustainable book value multiple

3) Since taking charge earlier this year, he is systematically fixing a) balance sheet, b) cost structure, c) business mix, d) franchise power

a. They have already issued equity to reduce the interest coverage burden and put away the threat of a rating agency downgrade

b. They took down compensation ratios and moved many employees froma commission share model to a base+ bonus model

c. Emphasis on improving risk taking and doing more principal agency trading will increase margins and ROE

d. Diversification in the form of asset management, higher principal trading and reduced dependence on low margin inter broker revenues

e. A number of new hires (and firings) have already been done. The next 12 months should show more material results on top of the margin improvement evident in the first 6 months.

4) Huge optionality on rising short term rtes. They hold client balances of $14bn that are invested in short term paper. In this rate environment, that float earns almost nothing. As and when rates do eventually rise, this can add 40c in EPS for every 100bps upwards move in Fed funds rates

5) Currently, the stock trades at tangible book (very liquid, very safe, very reliable assets). As the company produces earnings and moves towards a 10-15% ROE (without help from rates), valuation should improve on an accreting book value. In a higher rate environment, the company can generate > 20% ROEs. In either case, the stock should rerate higher as book value compounds and the company is able to show sustained profitability. As such, for a patient investor, the stock provides a cheap option ona managment turnaround as well as higher short term rates

Catalyst