Low value and a great balance sheet, combined with a strong quarterly performance, are bringing life back to a 109-year-old Wall Street establishment.
We like LaBranche & Co. (LAB), and it fits our model. Here is our review process, including support for why this is currently one of our top picks.
Step 1. Company with pristine balance sheet
Step 2. Extremely low enterprise value
Step 3. Operation or enterprise driving value to shareholders?
Step 4. Good business?
Step 5. Is the train wreck (and then, the fog from the wreck) clearing?
Company Summary - LaBranche is a 109-year-old investment firm and the parent of LaBranche Structured Holdings, Inc. (whose subsidiaries are market-makers in options, exchange traded funds and futures on various exchanges domestically and internationally), LaBranche & Co., LLC and LaBranche Financial Services, LLC (which provides securities execution, fixed income and brokerage services to institutional investors).
Company with Pristine Balance Sheet
LaBranche has roughly $293 million dollars in cash and liquid assets. After they remove all of their long term debt (they have committed to call these bonds), they will have a net of $5.54 cash, or liquid assets, per share. LaBranche has a very strong balance sheet.
Extremely Low Enterprise Value
When you subtract the cash and debt out of the enterprise, LaBranche's enterprise value is actually negative. Since the value of the ongoing company is so low after subtracting the cash and equity assets, this profitable ($0.07 profit in pro forma) company is valued only partially, which is for merely it's cash and cash related assets. Simply, LaBranche should trade at it's cash level plus the value of it's business operations. To us, this makes LaBranche appear to be trading so low that the 109-year-old business operations are actually trading for free.
Operation or Enterprise Driving Value to Shareholders?
Here, LaBranche receives another "yes." They had an outstanding quarter, showing a profit of $0.07 pro forma while still paying interest on their 11% bonds, which will be called. Taking out the interest expenses associated with the bonds and adding future taxes, our calculation is that their quarter would be at $0.10 cents per share, which is far better than the analyst estimates for a loss of a nickel to six cents.
LaBranche's business model is now focused on ETFs and its global trading operations, and those are good businesses. With the 2009 crash that affected Wall Street and possibly new regulation coming from the Obama administration, many of the traditional investment firms are on shaky ground, allowing a very well financed company with a long history to proceed with their growth plans.
LaBranche has increased their share buyback to $100 million dollars. Knowing that currently their entire stock market capitalization is close to $200 million dollars, even though they have close to $300 in liquid capital, a buyback at the current price of $4.08 would reduce the number of shares by $24.4 million, and the cash and liquid assets per share would also increase to $6.99 per share. This is a very rare instance: purchasing company's stock (of which the cash and assets must be above the current value) where the cash actually increases per share.
Train Wreck Fog Clearing?
Finding companies trading below their cash value, like in the case of LaBranche, is a rare event. Often, what we call a "Train Wreck" is needed for a company to be priced well below liquidation values. We believe the biggest negative issues with LaBranche, which are often needed to create this extremely low value, are the following:
1. The World (especially the finance industry) has been in a great economic tale spin.
2. The New York Floor Specialist trade industry (due to innovation) is in a long term decline.
This economic downturn helped LaBranche foster their need to sell the money losing the New York floor specialist unit (which was a small and shrinking part of it's business), and then eliminate its long term debt. These two large cost saving moves will increase their profitability. But, possibly more importantly, the moves will allow LaBranche to increase their cash availability and finance flexibility while eliminating it's largest negative problem. LaBranche has been known for years in the investment world as a floor specialist, so selling part of their 109-year-old identity and tradition aids our belief that LaBranche is serious about re-establishing a newer, stronger based business model for the new decade.
We're forecasting that LaBranche's normalized pro forma earnings will be $0.10 per share per quarter going forward, giving the company a 2010 estimate of $0.40. Even though many regional investment firms are achieving a 24 PE at this time, we believe the normalized PE should be around 15. Without the buyback, this would give LaBranche a company value of $6.00 a share. Any buyback at these levels would be beneficial to future earning, and $100 million could increase our earnings estimate by over 45%.
LaBranche currently is in a position that we are trying to identify for our clients - a good business with operations that are showing many strong tangible signs of improvement at what, we believe, is an extremely low value or, in LaBranche's case, even below the level of cash and liquid assets. The extremely low value and hard to establish business model combined with the excellent balance sheet gives LaBranche the potential for great appreciation and/or possible buyouts - hopefully, this limits or protects our clients to the downside. Even if the company's operations haven't hit bottom, LaBranche's negative enterprise value alone could be the catalyst for an increase in value.
We believe LaBranche should be valued by it's cash plus business operations. With the cash and liquid assets of $5.54 per share plus the company's business operations value based on 15, our 2010 estimate gives us a $6.00 company value. We believe, at this time, LaBranche's normalized stock value should be around a $11.54 value before calculating in the very large size of the company, a $100 million buyback.
Simply, can you rationalize this? For every 65 cents you invest currently in LaBranche, you own $1.00 worth of liquid assets in addition to the 109-year-old ongoing business for free!
This is obviously a very cyclical industry, where companies batten down the hatches during tough times and makes out-sized profits during the good years.
Disclosure: Durig Capital and clients started buying around $4.09 per share.