Even with the euphoria of the bull market rally, diversified asset management firms such as Ladenburg Thalmann Financial Services Inc. (NYSEMKT:LTS) continue to face some challenges. Sales of energy partnerships have not recovered from the crash in commodity prices. The increased regulatory burden due to the Dodd-Frank Act has reduced profitable annuity sales. With annual revenues of over $1 billion, LTS has the necessary scale to comply with these complex and burdensome new regulations such as the new fiduciary duty rules. Regulatory changes have been especially hard on smaller firms and LTS has been actively acquiring them. This article looks at 11 reasons to consider the LTS-PA preferred stock.
What is LTS-PA?
LTS-PA is a par $25 cumulative preferred issue with an 8.0% coupon. Dividends are paid monthly and LTS-PA now yields 8.6% at a recent price of $23.20. It's a perpetual issue, which means that the company has no obligation to call it. LTS-PA may be called at par starting on 5/24/2018. Dividends are qualified for tax purposes. See prospectus for additional details. There is currently $396 million par value of LTS-PA outstanding with an average daily trading volume of approximately 35,000 shares. Limit orders are recommended when trading.
1. Moderate balance sheet leverage.
The $480 million market capitalization of LTS accounts for a healthy 59% of the $810 million total enterprise value. The enterprise value includes preferred stock and debt net of cash.
2. Debt was reduced by $18 million in Q4.
LTS has increased it's financial flexibility over the last few years by replacing balance sheet debt with preferred stock. Debt was only $48 million as of 9/30/2016. Debt was subsequently reduced to just $30 million with a 10/26/2016 swap for equity. This is detailed in the Q3 earnings press release:
"On October 26, 2016, holders of warrants to purchase an aggregate of 10,699,999 shares of the Company's common stock exercised such warrants in full. The Company issued these warrants in connection with the November 2011 loan used to finance the acquisition of its largest subsidiary, Securities America, Inc. The holders paid the exercise price by cancellation of $17.98 million of indebtedness, which represented the remaining balance of the November 2011 loan. As a result, the Company's shareholders' equity was increased by the amount of the retired indebtedness. An affiliate of Dr. Phillip Frost, the Company's Chairman and principal shareholder, exercised warrants to purchase 9,000,000 shares of common stock for $15.1 million."
3. Massive insider ownership of LTS.
Dr. Phillip Frost is the Chairman and largest shareholder of LTS. Dr. Frost is a famously successful investor with an estimated net worth of $4 billion. He currently owns 66 million shares of LTS and continues to be a pillar of financial support (see item #2) for the company. LTS directors and executive officers as a group own a staggering 47% equity stake as detailed on page #5 of the 4/20/2016 proxy statement
4. Substantial insider ownership of LTS-PA.
It's very comforting for LTS-PA holders to see management own a major stake in the preferred stock as well as the common stock. As per his 11/9/2016 SEC Form 4 filing, Dr. Phillip Frost currently owns 910,000 shares ($22.8 million par value) of LTS-PA.
5. The preferred stock has lagged the common stock.
The performance of the common stock is often the best indicator of a company's health. LTS is trading near it's 3 month high and has rallied almost 50% since it bottomed at $1.63 on 11/4/2016. Despite the rally in the common stock, LTS-PA is still trading near the bottom of it's 3 month trading range. LTS-PA has underperformed LTS and may be due to catch up.
6. The bull market is good for the brokerage unit.
Brokerage revenues should improve in Q4 due to increased bull market activity.
7. Excellent liquidity.
Liquidity is always an important consideration for preferred stock investors. LTS had $106 million in cash as of 9/30/2016.
8. Size matters.
The Securities America unit of LTS has made numerous acquisitions to grow it's network of financial advisors. So far this year they have acquired WealthPLAN Partners, Wall Street Financial Group, Midtown Financial Advisors and Foothill Securites.
9. Regulatory relief may be coming.
President elect Donald Trump has pledged to dismantle the Dodd-Frank Act. If successful, this would reduce costs and increase profitability in key areas such as annuity sales.
10. Recurring revenues have increased.
While we are currently in a bull market, the financial markets are cyclical in nature. Brokerage commissions decline during a bear market due to lower trading activity. In order to reduce risk and make revenues less cyclical, LTS has shifted their focus from brokerage commissions to recurring asset management fees. As of Q3 2016, recurring revenue accounted for 77% of the revenues from the independent brokerage and advisory services units. (see highlights of Q3 earnings press release).
11. The investment banking outlook has improved
LTS Investment banking is focused on the small cap sector and this has been a drag on 2016 earnings. Fortunately this should turn around in 2017 due to lower costs as well as more favorable market conditions. CEO Richard Lampen discussed their 2016 investment banking challenges in the Q3 earnings report:
"Our year-over-year results continue to reflect the significant weakness in Ladenburg's investment banking business. After three years of strong contribution from this business segment, 2016 has been a difficult year as the softness in equity capital raising for small and mid-cap companies continues. We have acted aggressively to reduce the investment bank's cost structure and believe our banking franchise remains well positioned to deliver solutions to our varied client base and to generate long-term returns for shareholders."
Mr. Market is predicting a 2017 recovery in small cap investment banking. Financial stocks with heavy exposure to this area such as Cowen Group Inc. (NASDAQ:COWN) and JMP Group LLC (NYSE:JMP) have moved higher with LTS on the post election day rally.
What are the major risks?
Even with an increased focus on recurring revenues, a recession or bear market would negatively impact LTS revenues. I believe that LTS has the financial strength and diversified business model necessary to successfully weather a market downturn. Financial services is a litigious area. Legal and arbitration accruals totaled $5.4 million for the first 3 quarters of 2016. That level of spending is typical for a financial services firm of this size and does not currently appear to be material. However, legal costs should be monitored. These are detailed on pages 13 - 14 of the Q3 report. Since LTS-PA is a perpetual preferred stock, it could decline if interest rates increase substantially. Adjusted EBIDTA has been weak in 2016, although I expect stronger profitability in 2017 (see items 6,9 and 11).
LTS has a strong balance sheet. The heavy insider ownership and backing by Dr. Frost is very comforting. While LTS has had weak 2016 earnings, stronger results are expected in 2017 as microcap investment banking rebounds from the current slump. LTS is growing revenues at the expense of smaller companies that can no longer compete in today's complex regulatory environment. LTS-PA offers an 8.6% yield with the potential for a moderate capital gain in 2017.
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Disclosure: I am/we are long COWN, LTS-PA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.