Friday, May 15, 2009

MF Global: Reemerging Broker

MF Global is the leading exchange-traded futures and options broker with a global footprint. It emerged following a spin-out from the large British hedge fund MAN Financial several years ago. It went public in the summer of 2007, before the two Bear Stearns hedge funds failed in August that year. MF’s IPO raised more than $4 billion, making it one of the largest that year.

Since then, the company’s stock price has fallen on hard times. It’s down 78% since its IPO, which is significantly more than other brokers like BGC Partners (BGCP; down 70%) and Knight Capital (NITE; up 11%).

Most of the problems the company experienced over that time were of its own making. Just a couple of weeks ago, the company was forced to pay a trader $30 million for deceiving him about the amount of his trading losses 8 years ago. There appears to have been a cavalier culture in the past that has led to other problems. Last year, then CEO Kevin Davis, admitted the firm suffered over $145 million in losses due to a rogue trader in Memphis. The lack of risk management led to Davis’ removal and the appointment of Bernard Dan.

MF’s stock bottomed out late last November at $1.72 – down from its all-time high of $31.08 in December 2007. Today’s it’s at $5.85, up 187% for the year. The new CEO has brought down its debt, bought back convertible notes, and closed down smaller offices in Western Canada.

Just on a pure rebound basis, there’s good reason to think the stock will continue to rise. Late last month, Pali Research initiated coverage on MF Global as a “Buy” with a one-year price target of $8. Consider also that, in early September – prior to Lehman Brothers’ bankruptcy filing – MF was trading at $7.58. Today, the company has a much stronger balance sheet and is benefitting from increased volumes of trading thanks to Lehman being out of the market.

There are several other possible catalysts for the stock. Later this year, we’ll find out if MF gets approved to be a primary Treasury dealer. Also, Wednesday, the Treasury department announced standardized OTC derivative trading. This means that more derivative contracts will be exchange-traded – bringing more volumes to MF.

Despite all these positives, the company should continue to work hard to cut costs out of the business. This is a company whose biggest costs are all employee-related. Globally, they have over 3,300 employees. Their closing of the Canadian offices were a good start, but more work needs to be done across the company in cutting costs in order to boost margins. The company’s operating margins were 10% in the last quarter. FCStone Group (FCSX) – a much smaller competitor, who nevertheless has more employees per dollar of revenue than MF – had operating margins last year of 23%. It should be the larger MF with better margins than the smaller FCSX, not the reverse.

There is always a possibility for a buyout at some point. IntercontinentalExchange (ICE) or CME Group (CME) might be potential buyers who want to move downstream to own the brokers who sell their futures and options. Both of those companies have been on a tear this year and will continue to look for adjacent acquisitions that can keep their growth going.

MF Global remains a broker to watch. They will announce their latest quarterly earnings on May 21st.

[Jackson’s fund is long MF.]

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