Monday, April 5, 2010

Belzberg's Beelzebub Treatment

Belzberg Technologies (BLZ) provides technology-based brokerage services to institutions and hedge funds in Canada and the United States. This is a highly cyclical business, as seen from the chart below depicting Belzberg's sales over the business cycle:

Consider the magnitude of the year-to-year revenue increases/decreases! As such, when revenues decline, the company will most certainly lose money until it can lower its costs accordingly. Operating profits for Belzberg continue to be negative, as the company is still scrambling to cut its costs in line with this new revenue environment.

But due to the nosedive in the company's revenue and operating margin, the company's stock price may have overreacted. While Belzberg trades for just $8 million, it has $20 million of cash against just $8 million of total liabilities. In addition, the company has a few million dollars of current receivables, sweetening up the offer for potential shareholders.

With such a large margin of safety and no debt against it, the company can continue to lose money for a few quarters before shareholders risk losing capital. However, to see large stock price gains, extraordinary sales or profit growth isn't necessary. If management can cut expenses to the point where the company is at a break even level, shareholders at this price are likely to be rewarded. To that end, the company has announced layoffs and freezes that should help in this regard.

However, the company does have some fixed costs which are likely to be difficult to cut. If these poor revenue conditions continue for several quarters, a merger with a company with similar costs may be the only way to profitability. The current margin of safety on the company's stock may allow shareholders to benefit from either of these options.

Disclosure: Author has a long position in shares of BLZ


Value Investor said...

How do I buy this stock in America? It doesnt show up as a ticker symbol on the exchanges here. =/

widemoatinvesting said...

Thanks for the idea.

Two worries that I have after a brief glance at 2009 results.

Gross margin (or "net revenues" in their case) is declining, in part, because costs are increasing significantly YOY. If the trend continues (and it easily may, given industry moves to electronic trading), I worry that Belzberg may not be able to cut other expenses fast enough.

Second, I am not convinced that their announced and executed cost cuts are enough for them to be break-even on an operating basis going forward. If management drag their feet on this for a year, and duplicate their 2009 performance in 2010, the margin of safety would be gone.

If they are break-even on an operating basis in Q1, I'll take another look.

Of course, if they announce a big cash distribution, things could change dramatically.

Anonymous said...

I agree with the widemoatinvesting comments about the margin of safety potentially being gone this year.
The company announced that it cut 1.4 Million dollars a year in its most recent press release. This hardly makes a dent in the 10+ million dollars it is losing a year in operations alone.
Furthermore its operating losses accelerated from Q3 to Q4. Possibly from fleeing customers who do not want to wait around for bankruptcy.
The company is unhedged with its Forex exposure in an environment where in a recent Globe and Mail article many Canadian companies have mitigated there exposure to a weakening US dollar by hedging.
This company stopped hedging even though it had a successful hedging program for many years under the old management pre 2009.
From Q3 to Q4 2009 a 1 cent movement caused a forex losses of $355,000. From the end of the year to the end of q1 the dollar moved up 3 cents thus another $!,000,000 + in forex losses in q1 2010 is likely (355,000*3).
So far in Q2 the dollar moved up yet another 2 cents or at least $700,000+ in Forex losses if this weak US dollar continues through to the end of June (very possible).
These looses could be quite real as the company is forced to repatriate US dollars in order to finance its growing losses thus actually realizing the forex losses.
Assuming its operating loss remains unchanged (this is conservative as I think further acceleration of losses is likely) combined with its forex losses the company faces losing almost $4,000,000 per quarter for q1 and Q2 2010 or about $8,000,000 thus reducing its working capital by .54 cents per share thus leaving only .50 per share working capital by the end of Q2.
Furthermore almost all of the working capital that would be left as of the start of q3 2010 is tied up in the Broker Dealer thus forced closure by Q3 is very possible as the company would have no usable working capital to operate with.
Closing the company in Q3 would be expensive in terms of severance obligations and terminating leases thus a significant part of the capital that is left would be used up doing this.

Probably about $4,000,000 out of the $7,000,000 that would be left at the end of Q2 would be used in closing costs, thus leaving only $3,000,000 in working capital for shareholders or about .20 per share as of q3 2010.
Given that q1 is now over the so called margin of safety in terms of time is the next 85 days to the end of q2 before possible closure of the company in q3.

Hardly a nice margin of "safety". Especially when one considers that Judith Robertson's last venture as CEO of Block Trade with Perimeter Financial ended up in closure and in fact $70,000,000 of shareholders money was lost when Perimater Financial closed. This was a total disaster for the Perimeter Financial shareholders.
Any suitor for the company would probably analyze the situation and come to the same conclusion and wait for Q3 for a possible receivership.
Good luck but I think this idea is fraught with far too much risk.

Saj Karsan said...

Hi VI,

It's not listed on an American exchange. So, you would have to buy it on the Toronto Stock Exchange. Whether you can will depend on your broker.

Davis said...

Sorry for coming late to the BLZ party but I just now got around to taking a look at this.

Saj, I think it's incorrect to characterize this firm as a provider of trading technology. While they do have trading systems and technology (including Excel-based trade entry systems - yikes!), it's a small part of the business now, and appears to be in a decline as customers go bankrupt. The firm really is focused on its brokerage business, as revenues attest.

I think one of the margins of safety in a company like this is some type of "moat" that provides a little more certainty of a future increase in revenues. However, with the focus on brokerage services, an industry in which transaction fees are always falling and service is becoming a commodity, I think BLZ lacks any sort of moat, and worry that they will be stuck in a sinking ship as they get squeezed on the transaction fee revenue front.

Anonymous said...

Hey, Nice idea. The one thing that looks scary is the top management compensation as listed in the last proxy. The CEO and the President of EBS are taking home a combined salary of 600K. The CEO has very little stock and no real incentive to turn the ship around as she continues to get paid from cash balances. I don't see draconian steps to cut costs but she does have upside with her options, but nothing really to lose.

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