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Standby for a Stockbroker surge

Just as nature is dominated by cycles, so business has certain recurring patterns. A classic example is the phenomenon of the team of hungry entrepreneurs who struggle to build up a new business. Once they have made it a success, they sell out to a big institution, which then proceeds to destroy the business. The entrepreneurs leave - and set up all over again. Rewind and repeat.

This curious sequence is frequently played out in stockbroking. Clever, driven individuals strive as motivated owners to generate goodwill and commission. Large foreign banks decide that owning a stockbroker would be a good idea and pay a huge premium to book value for a people business. The ex-owners, now rich, decide they hate working for a faceless organisation and retire - or they quit and set up again to compete with their old business.

Just now is the phase when fledgling, breakaway brokerage firms are sprouting again. Conditions for the established players are tough: bigger brokers are retrenching and it occurs to some of the chaps that it might be more fun to work for themselves.

Oriel Securities, Arden Partners and Arbuthnot Securities are three of the new outfits, all having started up in the past six months. All three firms are institutional agency stockbrokers, aiming to service the small to mid-cap markets. Each has specialisations, but they all offer sales, research and corporate finance covering the neglected lower end of the London Stock Exchange.

The major players, such as Merrill Lunch, CSFB and Deutsche, no longer provide much of a service to this segment, so - in theory - the new boys are accessing unmet demand from both investors and corporate clients.

However, the previous batch of such independent investment banks is still around to compete against them. The star is Collins Stewart, set up by a quartet of refugees from major houses a decade ago. Two of the founders and CVC bought the business from Singer & Friedlander for £122m in April 2000 and floated it six months later for £326m (it now has a market value of £845m). While one made money on the way, the brokers did best - as ever.

Another business started at about the same time is KBC Peel Hunt. Once more the founders did a magnificent job of flogging the business to an obscure Belgian bank for £218m in December 2000. Many Square Mile veterans were baffled at the valuation. It compared with just £4m paid for Old Mutual Securities two years later by Secure Trust, or the £7.4m paid in April this year by Alchemy and management for Seymore Pierce.

No doubt the ambitious types at Oriel and Arden hope to repeat those coups. Their timing is probably good. The stock market has recently bounced after three years of decline. There is even talk of a revival in new issues.

Rising salaries and IT costs, regulation, scandals and ferocious competition appear unattractive to many. Volumes and broker omissions have been under pressure. But as a contra-cyclical play, stockbroking has obvious appeal.

In essence it is a straight-forward and profitable game with high margins and modest cyclical employed. At the smaller end, the winners are boutiques that find a niche or two and develop strong relationships with important clients - both quoted companies and fund managers.

The best firms know how to place stock and product original investment ideas. They generally pay a low basic salary with large bonuses based on performance. They hire staff who can actually sell and analysts who really understand the industry. They build corporate finance business and even a money management arm. And then sell out for a silly price.

There are, of course, a number of existing quoted smaller brokers: Charles Stanley, Brewin Dolphin, Walker Cripps, Numis, Evolution Beeson Gregory, WH Ireland and Teather & Greenwood, among others. Most are institutional agency firms, although some have private client business too. Several have seen a reasonable share price recovery on the back of the market's pick up.

Three of them announced slightly better trading conditions this week. They are a geared play on a new bull market, although several still have overheads that are too high and barely make a profit. Investors who buy such stocks now (and that includes those starting new brokerages) are brave but not mad. In good times, brokers trade on high multiples and huge premiums to book. If we are seeing the start of a new bull market, then stockbrokers will be among the firs to benefit.