LABRANCHE & CO INC LAB
January 26, 2011 - 11:56pm EST by
ValueGuy
2011 2012
Price: 3.71 EPS -$2.08 -$78.00
Shares Out. (in M): 41 P/E NA NA
Market Cap (in $M): 150 P/FCF NA NA
Net Debt (in $M): -83 EBIT -38 -32
TEV ($): 67 TEV/EBIT NA NA

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Description

Buy LaBranche because cash will account for 95% of the market cap as of 4Q10E, and management will continue to use cash to buy back stock.  Tangible book is $247mm, the market cap is $150mm (0.6x tangible book), and the wind-down of an options market-making business will add $67mm to the $83mm already on the balance sheet as of 3Q10 = $150mm.  $150mm less $8mm of cash burn in 4Q10 = $142mm, and $142mm cash/$150mm mkt cap = 95%.  The last sell side analyst gave up coverage in January of 2009, and the stock has fallen out of favor.

 

Even if they do nothing but report another mediocre quarter, with cash at 95% of market cap, it’s hard to get hurt. If by year end the company has done nothing but just burn cash and the stock still trades at 95% of cash, the shares would be worth $110mm x 95% = 104.5mm / 41mm shrs = $2.55 ($2.55 / $3.71 - 1 = -31%). At 1x tangible book the stock is worth $247/41mm shrs = $6.02, or roughly 60% upside.  So by year-end the downside would be 30% and the upside would be 60%.

 

LAB should not trade at book value, or a premium to book, unless the company (a) sensibly acquires or builds new and profitable operations or (b) goes private.  Management has made it very clear in public filings that it would sooner return capital than watch it erode. The last time the company had a large cash inflow it de-levered and initiated a tender offer. Since that time, it has been repurchasing shares as rapidly as market conditions have allowed.

 

In January 2010, management commenced a tender offer for 15mm shares (8.5mm shares participated @ $4.60 = $39.3mm, equivalent to 16.6% of the shares then outstanding).  Through 11/5/10 the company has since repurchased an additional 2.26mm shares for $9.3mm, at an average price of $4.13 (1.2mm repurchased in 3Q, and another 385k in Oct and early Nov).  $51.1mm remains on a $100mm buy-back authorization. 

 

LAB was one of the oldest and largest specialists on the New York Stock Exchange until the sale of the NYSE Designated Market Maker business to Barclays for $25mm on 1/22/10.  The sale released $76mm of regulatory capital and allowed for pay-down of the company’s $189mm of corporate debt (done 2/15/10). The debt had covenants that restricted share repurchases.  It was the extinguishment of the debt, and its related covenants, that permitted the company to conduct the tender offer mentioned above (opened 1/29/10, closed 3/1/10).

 

On the 3Q conference call, management was asked why they did not buy back more shares, given the low price to tangible book ratio.  They replied that by statute they are only permitted to account for a fixed percentage of daily volume, and that volume in the quarter was relatively light. In 3Q the max daily repurchase calculation came to roughly 65k shares.  The calculation is performed each week based on the prior week’s volume.  So, they could have bought back (60 trading days * 65k shares/day x $3.94/share VWAP over the period = $15.3mm.  $4.6mm/$15.3mm = 30%; on a dollar basis they bought back about 1/3 of the permitted daily amount. On a volume basis, 1.2mm shares repurchased / 19.7mm shares traded in the quarter = 6%.  On average LAB was 6% of the daily trading volume during the third quarter.  So, management’s answer seems credible; it’s difficult to account for more than five or six percent of a stock’s daily volume without unduly affecting its price.

 

In October, per comments on the 3Q conference call, the $83mm cash number on the balance sheet was already $50-$60mm higher.  LAB is in the process of exiting the majority of its option market making business; the shut down will free up $67mm of capital (similar to the $76mm of capital released upon the sale of the NYSE operation in Jan of last year).  Most of the $67mm is already in hand (i.e. $50-$60mm). So, when the 4Q balance sheet is released, both the asset side and the liability side will have shrunk by roughly $900mm each.  The cash balance will be up ($83mm + $67mm = $150mm, $150mm - $8mm cash burn = $142mm).

 

What remains of LAB uses around $8mm of cash per quarter ($2mm of commission less $10mm of cash costs).  The business still operates a domestic broker dealer, and conducts market making activities for (a) electronic options (b) ETFs and (c) foreign exchange options. LAB also trades foreign exchange on an agency basis. Management has been shutting down unprofitable broker dealer activities and merged two of its broker dealer entities together in 3Q (and took a $1.8mm severance charge). I backed out the $1.8mm severance charge, from the $10mm cash operating cost number above, which would then otherwise be $11.8mm.

 

We may see some small one-time charges related to the close of the option market making business, and a small improvement in the burn rate thereafter. The assets being liquidated are expiring options positions.   

 

Given the speed with which the company is both closing operations and buying back stock, it’s unlikely we’ll get through a full year of cash burn before something happens (i.e. tender, merger, acquisition or going private transaction).  But, to be conservative let’s assume sales remain flat and that costs are cut no further.  That puts the business on track to burn $32mm of cash this year.  By year-end that would still leave the stock trading at 0.7x tangible book ($247 tangible book - $32mm cash burn = $215mm worst case tangible book at year end 2011, and $150mm market cap/$215mm =0.7x).  $38mm of tangible book corresponds to a deferred tax asset, which may be attractive to a prospective acquirer, or which may be useful to offset the profits of a company to be acquired by LAB.

 

Even if they do nothing but report another mediocre quarter, with cash at 95% of market cap it’s hard to get hurt. If by year end the company has done nothing but burn cash and the stock still trades at 95% of cash, the shares would be worth $110mm x 95% = 104.5mm / 41mm shrs = $2.55 ($2.55 / $3.71 - 1 = -31%). At 1x tangible book the stock is worth $247/41mm shrs = $6.02, or roughly 60% upside.  So by year-end the downside would be 30% and the upside would be 60%.

Catalyst

The company should report 4Q10 earnings any day now and at that time the outsized cash balance will be apparent. I would then expect to hear of a transformative corporate action (tender, merger, acquisition or going private transaction). Normally they would have reported last week, and would have put out a press release with the announcement date about a week before the actual report date.

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