LaBranche on a Limb

LaBranche's (LAB) bullish take on the Big Board is trampling the specialist firm's stock.

LaBranche plunged 24% in a single day last week after it warned of a $23 million second-quarter loss. The setback comes as the New York firm's business of trading stocks on the floor of the Big Board comes under increasing pressure from cheaper electronic traders.

But the warning also highlights the risks LaBranche took by sitting out the NYSE Group's ( NYX) $1.5 billion secondary offering this past spring. Observers say LaBranche, which holds $210 million worth of NYSE stock, effectively doubled its bet on its troubled trading business by passing up an opportunity to cash out and invest elsewhere.

"It seems like a lot of shares for the company to hold, and it does not seem like a prudent thing to do on their part," says Tim Ghriskey, chief investment officer at Solaris Asset Management and former LaBranche shareholder. "The market is their business, so certainly their investment leverages them even more to their business."

The NYSE's March merger with electronic exchange Archipelago seemed to put LaBranche in the catbird seat. The trading firm's 39 NYSE membership seats turned into 3.1 million NYSE shares, worth nearly $300 million at one point.

The NYSE duly rolled out a secondary offering that gave insiders a chance to realize gains. But while other NYSE holders rushed to cash in, LaBranche sat tight, citing tax considerations.

In doing so, the firm left on the table some $60 million it could have invested or returned to shareholders. And with NYSE shares falling 13% in the second quarter, LaBranche's hold call is now hitting shareholders right in the pocketbook: Some $17 million of the latest-quarter loss comes from a writedown of the value of LaBranche's NYSE stake.

The setback is nothing new for shareholders. For years, specialists like LaBranche have taken heat from Wall Street. The demand for their services -- matching buyers and sellers on an exchange and smoothing out fluctuations in stock prices -- is declining as electronic trading takes hold.

LaBranche's stock price has fallen as its services become less relevant, and shares now fetch just a third of their 2002 price.

"If you were a LaBranche bear, you would say that their operations are so tied to the floor of the NYSE, that they go away with the floor," says Jamie Selway, a former Archipelago official who now is managing director at White Cap Trading in New York.

"Bulls say that LaBranche will get a productivity boost as the NYSE rolls out the hybrid platform," Selway adds, referring to the electronic trading that Archipelago specialized in. "Still, I don't see how hybrid holds back the tide."

Holding NYSE shares was certainly good to LaBranche and some of its rivals back in the first quarter, when the firm booked some $100 million in profit on the appreciation of its NYSE stake. But while NYSE shares remain above their secondary offering price, their second-quarter drop saddled LaBranche with the big writedown.

The writedown is far from LaBranche's only problem, of course. In the earnings warning, the firm said second-quarter principal trading revenue totaled about $20 million, down $47 million from the second quarter of 2005.

"I would say I'm as concerned about the specialist future as anyone," says Rich Repetto, equity analyst at Sandler O'Neill. "The results are just as volatile as they were in the past. The NYSE could even prosper while LaBranche doesn't. There are so many moving parts in their business, so it's pretty difficult to say."

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