Specialist finds trade secret and profits

Michael LaBranche went against the common wisdom when he decided to take his specialist firm public on the New York Stock Exchange in August 1999.

It was commonly understood that specialists didn’t want to make public their incredibly lucrative trading business.

And anyway, they were soon to be replaced by electronic trading systems. Yet 18 months later, after a series of acquisitions, the company in charge of trading stocks like AT&T, Merck and Exxon Mobil has proven the naysayers wrong. It is now the biggest and most profitable specialist, with a share price of about $35 – up 150% from its initial public offering price of $14.

And Mr. LaBranche, who saw opportunity when others were predicting doom, says he’s not done astounding the skeptics.

“We’ve become one of the largest stock dealers in the world,” says the 45-year-old chief executive. “We are going to invest in technology and other businesses that fit our strategy of bringing order flow to us.”

Mr. LaBranche will once again have to be nimble. With a 21.8% share of the daily trading volume on the New York Stock Exchange, LaBranche & Co. needs to look elsewhere for rapid growth. It also has become a desirable target for an investment bank eager to get into the specialist business.

The Wall Street firm has come a long way in the 76 years since it was founded by Mr. LaBranche’s grandfather as a specialist firm responsible for trading in four Big Board stocks.

Mr. LaBranche decided to increase his company’s privileged status in Big Board stocks at a time when most of his competitors – mainly private partnerships – were unwilling to invest in new trading technologies and raise more capital in the fast-growing, wildly volatile markets. In the last six years, their ranks shrank to the current 15 specialists, from 36. This created a perfect opportunity for Mr. LaBranche, who believed economies of scale would greatly bolster his business.

Last year, his company used some of the capital raised from its IPO to snap up two smaller competitors, Henderson Brothers and Webco Securities, with stunning results. LaBranche reported net income of $81.92 million, or $1.69 a share, up from $29.03 million, or 72 cents a share, in 1999, when the company paid most of its profits to its partners.

“LaBranche is a quasi-monopoly in the shares of stocks like AT&T, which trade up to 25 million shares a day,” says Charlotte Chamberlain, an analyst at Jefferies & Co. of Los Angeles. “It’s a money-printing business.”

Mr. LaBranche expects to further boost profits. He announced in February that his company would purchase another specialist firm, Robb Peck McCooey, for about $354 million.

The acquisition, which is expected to close this summer, will boost LaBranche’s share of daily share volume on the NYSE to 27%, from 12.7% three years ago. The company will handle 520 common stocks, including such large-volume stocks as Philip Morris, DuPont and Eastman Kodak, compared to 147 three years ago.

What’s more, the latest acquisition will keep it ahead of several equally fierce competitors. Goldman Sachs Group Inc. has bought specialist firms Benjamin Einhorn & Sons and Spear Leeds & Kellogg. Bear Hunter Specialists, which is part-owned by Bear Stearns Cos., has just announced its plans to take over Wagner Stott Mercator.

Fleet Meehan Specialist is also formidable, having purchased a large specialist operation from Merrill Lynch several years ago.

But with the consolidation, there is little potential left on the NYSE. “The acquisition game is over,” says Dean Eberling, an analyst at Keefe Bruyette & Woods Inc. in New York.

That makes some wonder whether a large investment bank might consider snapping up LaBranche.

Mr. LaBranche, who intends to keep his company independent, cannot afford to let his guard down. Profits could be radically affected if trading slows with a bear market. And there is the threat that the Big Board could lose trading volume to electronic trading systems.

It’s also up to LaBranche to gain the upper hand in the fierce fight for new NYSE listings. Last year, its win ratio declined to 45% from 64% in 1999, according to Mr. Eberling.

Now, one of LaBranche’s most pressing goals is to enter other markets. Last year, it bought a small options trading firm on the American Stock Exchange. In addition, it is in discussions with several foreign broker-dealers about giving them electronic access to the NYSE.

But LaBranche’s expansion options are limited. “We are going to stick to what we understand,” says Mr. LaBranche.