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How to save MF Global

October 27, 2011: 11:22 AM ET

The struggling broker-dealer helmed by former Jon Corzine does have options, but it needs to act fast to find a savior.

By Cyrus Sanati, contributor

Jon Corzine

Jon Corzine: After 17 months on the job, crisis hits.

FORTUNE -- The fate of MF Global hangs in the balance as the firm's executives scramble to reassure customers that it won't be the next Bear Stearns or Lehman Brothers. But in the broker-dealer world, confidence and perception are critical, and if enough people believe you're going under, rightly or wrongly, the game is over – fast. Unless perceptions about the firm's solvency change in the next few days, Jon Corzine, MF Global's ambitious and Wall Street-famous chief executive, will face just two options: fire sale or bankruptcy.

Acting quickly to avert a meltdown, MF Global's board retained the boutique investment bank Evercore Tuesday morning to help it explore "strategic options," a person with knowledge of the situation tells Fortune. The news, first reported in the Wall Street Journal Wednesday morning, seems to have stabilized the company's stock, which had fallen earlier in the week by as much as 50%, as rumors to its solvency spread through the market like wildfire.

To restore confidence and to keep its credit lines open, MF Global (MF) needs to quickly raise some fresh capital by whatever means available. Without cash on hand, the firm can't facilitate trades for its clients or meet margin calls for its own proprietary trades. While the firm claims it had some $3.7 billion in available liquidity as of the end of the third quarter, that cash may have since dried up.

The urgency to retain capital becomes clear when you look at the firm's leverage ratio. In the last year the company has lost over $90 million while its market capitalization fell around 80% to around $280 million. Taking into account its $6.3 billion in European sovereign debt exposure, along with all its US government agency debt exposure, the firm has a leverage ratio of around 40 to 1, according to Egan Jones, a rating agency. That's even higher than the approximate 35 to 1 leverage ratio Lehman Brothers was sporting when it fell from grace in 2008. Such a high leverage ratio makes investors extremely nervous, even if a large portion of that leverage ends up being relatively benign government agency debt.

In August, MF Global began to wind down some of its prop trading activities to reduce risk and raise cash, but it could be sitting on a time bomb that no one knows about. Such uncertainty is a killer for a broker-dealer.

Possible buyers

But despite the high leverage ratio and uncertainty, there are options available to MF Global to continue as a going concern. The first would be some sort of passive capital infusion in exchange for a piece of the company. Sovereign wealth funds from oil-rich countries like Dubai and oil-refining hubs like Singapore have made investments in struggling financial companies before and may be tempted to get their hands on MF Global's commodity trading platform, which has a strong presence in oil trading. Corzine, who was the head of Goldman Sachs (GS) in the 1990s and a U.S. Senator and Governor from New Jersey in the 2000s, has strong relationships with foreign funds and could move quickly to seal a deal.

A domestic private equity firm could also provide some assistance by taking the firm private and injecting it with fresh capital. Corzine just happens to be an operating partner in J.C. Flowers, a private equity firm that specializes in buying up distressed companies, especially financial companies. It turns out that J.C. Flowers already knows a bit about MF Global's futures and commodity operations as it was one of the bidders for it back in 2005 when it was then part of Refco. The private equity firm ultimately lost the bid to Man Group, which later spun it off to become MF Global.

There are also some strategic options available. Other independent broker-dealers would love to get their hands on MF Global's customers on the cheap. Interactive Brokers, for example, was another company that sniffed around Refco's commodity division when it melted down in 2005. In addition, NewEdge, one of the top broker-dealers in Europe, is currently being spun out of Societe Generale and Calyon. A keen investor may choose to snap up both firms and create a transatlantic brokering powerhouse.

Who might want to do that is still unclear. The large investment banks like JP Morgan (JPM), which snapped up Bear Stearns in 2008 for a song, or Barclay's (BCS), which ended up taking over the U.S. operations of Lehman Brothers, may be tempted, though neither has expressed interest in growing their broker-dealer operations any further.

One firm that does have the cash on hand to do a deal is Corzine's old employer, Goldman Sachs. Banking analyst Dick Bove of Rochedale Securities said in a note yesterday that buying some or all of MF Global might create "a windfall profit" for Goldman. He argues that Goldman may be considered overcapitalized and therefore has the ability to easily absorb MF Global's portfolio. He also mentioned Citigroup (C) and the large Canadian-based banks as other possible suitors.

No matter what happens, Corzine is going to have to work all his magic to get a deal done in a timely fashion. After all, he has a very personal reason to get this done right. Richard Repetto, the banking analysts from Sandler O'Neill, said in a note yesterday that this is "all about Mr. Corzine's legacy," and "whether he's viewed as going out 'on top or not.'" Being viewed as the man who crashed and burned a broker-dealer after just 17-months on the job, isn't probably what he's looking for in a swan song.

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