“The Penny Stock Behind the NYSE”

By Travis Johnson, Stock Gumshoe, November 16, 2007

This one came in as part of a teaser for a larger program, in an ad for the Alliance from Stansberry & Associates (that’s their package deal that gets you all their newsletters for one giant $5,000 upfront payment plus some kind of annual fee).

The teaser was very brief, but I thought it was interesting so I checked it out: The teaser is that this is like “owning the casino,” owning a piece of a firm that gets a little piece of every trade that they process on the floor of the New York Stock Exchange.

They say that the report on this company is worth $199 … but of course, your friendly neighborhood Gumshoe will take a quick look, gratis.

So, if you’re at all familiar with the New York Stock Exchange you know that this is going to be what they call a “specialist” firm — they’re the ones who actually run the floor trading and mediate the trades, the ones who are responsible for making sure that there’s a match between bid and ask so that a market can be made. And they do indeed make their profit from shaving a hair off of each side — getting a fraction of a cent on each share exchanged. They’re essentially like “market makers” on the nasdaq or for penny stocks, but a bit more official and entrenched.

So if it’s a “penny stock” and it’s a NYSE specialist firm, it’s pretty likely to be ….

LaBranche & Co (LAB)

All of the other firms, what’s left of them, are either private or divisions of larger banks and brokerages. I suppose it could be the ADR for Van der Moolen Holdings, which is slightly smaller and also priced right around $4 and change … but if so, you’re out of luck, as you’ll see in a paragraph or two.

I wouldn’t personally call it a penny stock, since it’s a $300 million firm, but I do know from past sleuthing that Stansberry’s folks are willing to call just about anything under $10 a “penny stock” — including some with market caps of over a billion dollars.

So … is there a point in being a specialist firm in this day of electronic and “hybrid” trading on the floor of the NYSE? Well, that’s certainly a matter for some debate. Taking the NYSE public was undoubtedly a great windfall for the specialists and other seatholders, since they were also the owners of the exchange, but I imagine it has made it much more difficult for the specialists to make consistent profits.

And that’s on top of the last major move before that, nearly forgotten now but probably quite significant in its impact, when the NYSE went to actual penny pricing instead of eights of a dollar — as you can imagine, there was a lot more room to squeeze a marginal profit out here or there when the spread was a bid of 43 and 1/8 and ask of 43 and 1/2, then today when you’ve got a much more efficient spread of a bid of 43.10 and ask of 43.12.

And indeed, their results have been declining … and their last 12 months was not profitable.

But the reason I wanted to note this one today is that of the seven specialist firms, two have decided to quit the business in just the past couple days — Van der Moolen Holdings and Susquehanna International Group have both decided that being a specialist firm on the NYSE is no longer worth their time or capital. And then there were five.

So what’s the problem? Well, the firms are under much more scrutiny now and can’t get away with much in the way of profits in their market-making business, and they also have to guarantee a market for the stocks so they have to take a beating in some markets. The specialists are losing market share to electronic trading and to other exchanges, and they have a very hard time, for the most part, making a profit.

I suppose that there may be some argument that LaBranche is a good investment because their stock list is likely to go up with the defections of other specialists, but in truth it’s very likely, in my mind, that their business is going to continue to deteriorate. It seems to me that the increasing move to electronic trading with little friction and few intermediaries is inexorable, and that betting against it is likely to give you a losing hand. But that’s just me.

Do note, however, how quiet the floor of the NYSE looks during the many CNBC shows that are set there — it’s no longer the constant bustle of specialists and traders, and really, it’s kind of sad. If it weren’t for all the flashing lights, we might really notice how few people are there. I would be more interested in owning any of the exchanges, including the NYSE, the CME, Nasdaq, or most of the others, than in owning a firm that relies on market making to register a profit.

If you’re interested in this one, one valuable thing to check out would be how much of the NYSE/Euronext LaBranche still owns — if any. In my largely uninformed opinion, that’s probably the most valuable thing on their balance sheet. And just to make clear that there is another side here, the NYSE is still trying to fine tune their trading rules to make the job of the specialist more appealing, and possibly attract some new firms to the business, so I may be too pessimistic. And analysts do think they’ll make a profit next year, though the forward PE is awfully high at 34.

Got any intersest in market makers, specialists or exchanges? Share your wisdom!

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One Guy
One Guy
November 16, 2007 6:50 pm

And in the time since I first wrote this, word has leaked that Bear Stearns is considering shuttering its specialist business, too, which would bring the total down to 4. Not a lot of folks making money as specialists these days.

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Marshall Smith
Marshall Smith
July 28, 2008 2:55 am

What is the future of renewable chemicals market and does IBOT.PK being into this business will lead any effect any on it????

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