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March 21, 2010
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March 30, 2010

MF Global

I normally invest in companies, but occasionally, something sets up just right for what I’ll call a trade. A trade is an investment that is intended to last from a few days to a few months depending on various conditions. Basically, this is an investment with a near term catalyst. The goal is to buy shares right away, average down if it goes against me and plan to sell as it goes higher. If it doesn’t start to work quickly, I just get out of the way. With those rules in mind, let’s look at an interesting opportunity.

Every once in a while I see a company make a truly transformative move. Usually it relates to an acquisition or divestiture. Sometimes, it is just a change in management. Let’s look at MF Global (MF: NYSE). MF provides execution and clearing services for exchange-traded and OTC derivative products. Basically, MF is a broker to futures traders. It’s a simple, low margin business. In reality, it is two businesses; the actual commission business and holding the cash for their trading and repo partners. The commission business is very low margin where most of the revenue is used to pay for exchange fees and employee salaries. The cash business is certainly the better business. Here, MF holds cash for customers and earns a small spread between what they can invest the proceeds at and what they pay their customers in interest.

Recently, MF has been hit by two factors. First, commission revenue has stagnated. This is a result of reduced volumes lately. I don’t think this is a serious issue. Trading revenues have cyclical peaks and troughs. The long term trend over the past two centuries is towards increased trading. I think that trend will continue over time and I think MF will continue to take market share both organically and through acquisitions.

The more significant factor impacting the company is the historically low spreads the business earns. With Fed Funds effectively at zero, the company simply cannot make much money at this business. The company currently has 57.7b in total assets (14b in client balances) that are earning barely anything. Based on company estimates, a Fed Fund rate of 2% would net them 35c a share in additional after tax income. A move to 4% would net the company $1.30 a share in additional income. We are talking big numbers here—considering that right now, the company is essentially breaking even. Will Fed Fund rates go up tomorrow? No. Eventually, Fed Funds will revert to higher rates. MF should earn a good deal more money when that happens. However, I’m not waiting around for that. The trade is that Jon Corzine joined the company last night.

Who’s Jon Corzine? Besides serving in the senate and as governor of New Jersey, Corzine was instrumental in seeing Goldman Sachs through a difficult period in the mid 90’s that culminated in an IPO. He cut costs and grew the business. He is at least partly responsible for the current Goldman Sachs powerhouse. After running Goldman for five years, he left amidst a coup orchestrated by other senior partners and decided to enter government. MF is his return to finance.

Why should I care? Corzine is a wealthy guy. He spent $131 million of his own money on his political campaigns alone. MF is small. MF has a market cap of a billion dollars. Corzine is only being paid $1.5 million a year. He’s getting 2.5 million options. I don’t think he’s doing this for the money. He’s doing this because he wants to get back into finance. He enjoys it. He’s doing this because he thinks he can build something using the company as a platform. He probably also wants to prove something to those who pushed him out of Goldman Sachs.

The company is trading at 8.30 pre-market and I apologize for this being a bit sloppy, but I wanted to get it written quickly. At 8.30, it trades essentially at book value. It likely has earnings power of over a dollar a share during a full Fed Funds cycle. That excludes any upside from Corzine’s business acumen. The near-term downside is sort of limited. The upside is tough to quantify, but I think people will come to reassess this company over the next few months. Finally, there are 25.5 million shares short out of a total of 121.5m shares outstanding. If I were short, I would probably be reassessing. This may help the shares go higher in the near term. Ultimately, this isn’t a home run sort of investment, but I feel like I’m risking a dollar or two to make a few times that over the next few months.

Categories: Current Investments
Positions Mentioned: MF

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