eSpeed Muscles to Second-Straight Profitable Quarter - TheStreet

Updated from 12:04 p.m. EDT

eSpeed turned in its second-ever quarterly profit on a 7% increase in sequential sales. But the company's stock price, which has seen a run-up to match the company's Herculean courage following Sept. 11, finally took a breather despite news the company beat earnings targets and raised its guidance for 2002.

Analysts attributed the 10% hit to its shares to disappointed hopes that the company's energy trading arm Tradespark would fuel even stronger growth in the first quarter, and to frustration over management's decision to reduce already limited disclosure for the unit.

"People really expected them to knock the cover off the ball with their energy business," said CIBC World Markets analyst Kenneth Worthington. "The company has always been hard to analyze because of their lack of disclosure, and now they're pulling back even more. That's tough especially in an environment where people are encouraging additional disclosure."

The electronic trading arm of Cantor Fitzgerald and a tenant of the World Trade Center prior to Sept. 11, eSpeed earned $6.3 million, or 11 cents a share, in the quarter compared with a loss of $2.3 million, or 4 cents a share, in the first quarter of 2001. Analysts on average expected the company to earn 9 cents a share, according to First Call. First-quarter revenue rose 7% sequentially to $30 million.

The shares were recently dropping 10% to $12.57, but the decline followed a 130% run-up since trading resumed after Sept. 11. The company turned its first profit in the fourth quarter of last year, 5 cents a share, including noncash charges and assuming a pro forma 40% tax rate.

At least one analyst was impressed with the company's results. Salomon Smith Barney's Guy Moszkowski raised his price target to $14 from $13, and his 2002 estimates to 46 cents a share from 44 cents a share. The company has not had a banking relationship with Cantor, eSpeed or eSpeed subsidiaries or affiliates in the past three years.

Fully Electronic

Management attributed earnings growth in the first quarter to increased volume in eSpeed's core Treasury trading business, and a substantial shift in its energy trading business from voice-assisted trades to fully electronic trades. The latter are far more profitable for the company. eSpeed's electronic exchange trades a wide variety of domestic and foreign bond and currency products and derivatives.

The company's fully electronic trading volume grew 14% in the first quarter from the fourth quarter, well above the 6% increase in trading volumes recorded in the fixed income markets. Part of that increase was due to the addition of new government bond trading customers from Australia and New Zealand and the reintroduction of some products that were suspended after Sept. 11, including U.S. agency securities, European repurchase agreements and European energy products, as well as fully electronic trading of Eurex futures and municipal bonds.

While fully electronic volume grew versus the fourth quarter, it was down 30% versus the year ago quarter due to a loss of market share right after Sept. 11 and the suspension of certain products.

"Versus the year-ago, clearly they lost market share," said Robertson Stephens analyst Justin Hughes. "But it shouldn't be surprising given the events there, and it's impressive that they have been able to do what they have done in the last two quarters."

New growth should be fueled by continued migration to fully electronic trading from voice-assisted trading and by eSpeed's entrance into new product areas, says Moszkowski. The introduction of new software this year, which allows for more complex combination trades, should also help eSpeed grab a greater share of existing markets, like U.S. Treasuries, analysts said.

As for Tradespark, eSpeed Chief Executive Officer Howard Lutnick said the unit had a very strong quarter, but that it would stop releasing volume statistics due to a tough competitive environment. The recent surge in volumes following Enron's collapse probably won't continue, he said, and questions about credit quality for some of the industry's biggest players cloud the industry's outlook. Meanwhile, Tradespark's biggest rivals don't release such statistics.

"The torrid pace of growth might well not continue over the next quarter or so, but we took that into consideration always," said Lutnick in an interview. "The step-up at Tradespark will hold on and then we'll grow from there." Tradespark's contribution to the company's revenues was already hard to discern, because it listed volume in units that aren't comparable to Treasury trading units.

Green Light

eSpeed projected earnings for the rest of 2002 that beat analyst estimates, despite forecasts for flat trading volumes this year. Management was reluctant to give specific guidance beyond 2002, but it did say it expects to achieve margins of 35% over the next three years, compared with 21% in the first quarter of 2002 and 16% in the fourth quarter of last year.

The company forecast earnings of 11 cents to 12 cents a share for the second quarter, and 43 cents to 48 cents a share for 2002. The average estimate of analysts polled by First Call was for earnings of 10 cents a share in the second quarter and 37 cents for all of 2002.

eSpeed expects to reintroduce electronic trading of zero-coupon U.S. Treasuries, mortgages securities and corporate bonds by the end of 2002. The company also wants to license its software patents to investment banks and energy trading companies.