Amid a relatively flat market, Hidden Gems subscribers have watched powerlessly as guest analyst David Gardner's March 2004 pick, electronic debt trader eSpeed (Nasdaq: ESPD), slid 12% in value over the past few months. Which got me to wondering -- what exactly is going wrong with this little can-do company, which not only survived, but thrived in the aftermath of losing most of its employees to the terrorist attack on the World Trade Center?
Nothing internal to its business, apparently. The company's first-quarter earnings announcement was stellar. It met analysts' consensus earnings by posting a simply astounding 72% growth in operating earnings over last year, boosting its operating margin by more than a third, to 40.3%. And while the company disappointed short-term stock traders by projecting second-quarter earnings that were slightly below expectations, the company reaffirmed its operating earnings expectations of $0.80 to $0.84 for the year. If the company can pull that off, its business would actually improve on its performance last quarter, with operating margins nudging over the 41% mark.
Clearly, there are outside factors at work here. Monday's Wall Street Journal made abundantly clear what those factors are, with a headline blaring: "As Bond-Trading Gains Decline, Securities Firms Will Scramble; Some of Them May Be Hit Hard."
Egads! The market reacted violently to that doomsaying yesterday, sending eSpeed down yet another 3%. The investment bankers that (presumably) use its products to buy and sell bonds, the likes of Lehman Brothers (NYSE: LEH), Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MWD) and Bear Stearns (NYSE: BSC), fared little better, falling an average of 1.8%. The thing is, though, that eSpeed is not a "securities firm" -- it just provides the software that securities traders use to efficiently conduct their trading, and collects a fee for every trade made.
So pardon me for running against the herd, but in eSpeed's case, I suspect that Wall Street is overreacting to the risk of interest rate hikes by the Fed. The Street is actually making a huge error here. Far from putting eSpeed's revenues at risk, the prospect of an interest rate hike of unknown proportions and at an unknown time benefits eSpeed's business. The unknowns make debt traders second-guess themselves, buying, then selling, then buying again -- creating volatility, pushing up trading volumes, and boosting eSpeed's revenues.
Not to put too fine a point on it, eSpeed will benefit -- indeed, probably is benefiting right now -- from interest rate volatility. That's my take on the situation, at least, right or not. The proof of that will be in the next 10-Q filing.
Join in the discussion of eSpeed's prospects in a world of rising interest rates on the members-only Hidden Gems eSpeed board, where we've been talking it over for more than a month now.
Fool contributor Rich Smith
owns shares in eSpeed, but not in any of the other companies mentioned in this article.
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