When I was a child growing up in rural Maryland, there were two car dealerships in our town. Unless you wanted to travel to the county seat to buy a new car, these two shops were the only game in town, and they profited handsomely from their lock on the market. How handsomely? Well, the owner of the Ford dealership lived in one of the nicest houses in town, so I presume he was making out pretty well.
What the dealerships had, in essence, was an oligopoly -- or rather, because there were just two players, a duopoly. As long as they both played by the rules of a duopoly system, they could keep their prices high, and each would reap outsized profits. As the saying goes, it's nice work if you can get it. Back in March 2004, our stock-pickers at Hidden Gems thought we found a similarly sweet deal in the form of duopolist bond trader eSpeed
Alas, the other half of the duopoly, Broker-Tec, a subsidiary of Britain's ICAP, didn't play by the rules. While eSpeed kept its prices high and relied on its purportedly superior technology to convince clients to pay them, ICAP cut its rates and was soon gobbling market share hand over fist, and eating eSpeed's lunch in the process.
As we watched eSpeed's situation deteriorate over the months following its recommendation, it became clear that the company would likely survive its death match with ICAP, but it was equally clear that it would not be earning the outsize profits we had hoped for in the foreseeable future. Price wars just aren't very good for business. And so it was that a few months ago we issued a sell recommendation for eSpeed.
Better late than never, it turns out. eSpeed reported its second-quarter earnings yesterday, and the news was not good at all. Over the first six months of 2005, revenues declined 13% against the year-ago period, profits imploded -- down 77% against the first half of 2004 -- and profits per diluted share disappeared entirely. The company earned $0.34 one year ago, but zilch for the first half of this year. Even free cash flow, our lone hope in an era of misleading GAAP financial statements, held no good news for eSpeed shareholders. Last year, the company generated $8.4 million in cash. So far this year, it's managed to burn $8.4 million.
About the only positive developments for the company (warning: I'm being ironic here) were found on the income statement. Operating costs were up 27% against last year despite the 13% decline in revenues. And the largest contributor to those expenses, "compensation and employee benefits," rose 36% year-over-year. Hey, look on the bright side. Even with business as bad as it is, it still looks like eSpeed employees can afford to buy the biggest house in town.
Fool contributor Rich Smith no longer owns shares in eSpeed. Three guesses why not.