When you're trying to sell something, but the bids are coming in dismally low, it helps to get a few more opinions.
That strategy has worked beautifully for Los Angeles-based brokerage Jefferies Group this year. Unable to attract many buyers to its stock, even though the price was less than seven times earnings, Jefferies in March decided to spin out its crown jewel technology unit as a separate entity.
On Wednesday, 3.7 million shares in Jefferies' Investment Technology Group Inc. hit the market at $13 a piece, and quickly jumped to close at $16.25 on Nasdaq. They ended Thursday at $15.875.
Shares of parent Jefferies, meanwhile, have zoomed from $30.50 just before the spin-out announcement on March 15 to $43 on Nasdaq now--even as most brokerage stocks have plunged on worries about the bull market's longevity.
By asking the market to value ITG separately, Jefferies has boosted its own worth because it retains about 82% of ITG's stock. Thus, the better the public reception for ITG, the higher the implicit added value in Jefferies' own stock.
Why was ITG snapped up so readily? Handily, many of the institutions that Jefferies needed to attract to ITG stock were already ITG customers.
ITG's chief asset is POSIT, an automated trading system that allows big investors to trade stocks confidentially among themselves, away from the stock exchanges and the Nasdaq market. Three times a day, POSIT's computer matches buy and sell orders from ITG institutional customers, determines a price for each stock by referencing current market prices, then executes the trades.
Big investors use POSIT partly for efficiency: Rather than deal with brokerages' often wide bid and asked spreads for thinly traded stocks, investors can use POSIT to trade at prices within the official market spread, direct with each other.
More important than price, however, is POSIT's confidentiality. "You can put a million shares up for sale without anyone seeing you," says Jim Goff, money manager at Janus mutual funds in Denver.
When trading stocks in very large blocks, camouflage is often useful. If an institution tries to drop a huge number of shares for sale on the open market, other investors may immediately see that block, and the market price of the stock can dive accordingly. With POSIT, the transactions are visible only after the fact. Thus, big trades can occur without moving the market price of a stock.
POSIT isn't alone in this so-called third-market trading. Instinet, a Reuters unit, also crosses blocks of stocks for big investors. So does the Arizona Stock Exchange in Phoenix. Other systems also compete, and more are proposed.
But POSIT is the largest such system operating during market hours, and its growth has been meteoric. In 1988, average daily trading on POSIT was 288,000 shares. By last year's fourth quarter, POSIT was trading an average of 8.3 million shares a day. Its customer base jumped from 140 institutions to 205 during 1993 alone.
Despite that growth, POSIT and other automated third-market trading systems remain tiny players. POSIT's trades were a mere 2% of total New York Stock Exchange and Nasdaq volume in the fourth quarter of last year.
To fans of the third-market trading concept, however, that as-yet minor market share just means the potential for expansion is huge. While brokerages, the exchanges and federal regulators debate the future of the stock market--and the merits of exchange-floor trading versus Nasdaq--many experts believe the future is already here in more price-efficient systems like POSIT. ITG is seen enjoying a technological lead.
ITG "has been profoundly helped by the total inability of the NYSE to innovate at a pace sufficient to meet the market's needs," says Charles Ronson of IPO Value Monitor newsletter.
ITG's revenues, $50.7 million last year, have surged nearly fivefold since 1990. The company earned 45 cents a share last year, and Ronson expects 73 cents this year, giving the stock a price-to-earnings ratio of 22 on that estimate. If this is a true growth stock, that isn't an outrageous P-E.
What about Jefferies? At $43 a share, its P-E now is 9, based on '93 earnings of $4.88 a share. Given that ITG contributed just 16% of Jefferies' '93 revenues, it's clear Jefferies is still dependent on the traditional institutional brokerage, investment banking and junk-bond businesses that have made it an important niche player on Wall Street since the early-'80s. Because those are highly cyclical businesses (while ITG may or may not be), the market may not be willing to value Jefferies much higher, for now.
But for a company whose stock visibility has been almost as low as that of its POSIT trades, the ITG spin-out may have done wonders to enhance the long-term potential in Jefferies' shares.
The Traders' Broker
Shares of L.A.-based Jefferies Group have zoomed since the firm announced in mid-March a partial public stock offering of its trading systems division.
Jefferies Group biweekly closings on Nasdaq, excent latest: Thursday $43.00