Interactive Brokers Group, Inc.

Transcription

1 January 06, 2015 Interactive Brokers Group, Inc. (IBKR-NASDAQ) Current Recommendation NEUTRAL Prior Recommendation Outperform Date of Last Change 07/08/2014 Current Price (01/05/15) $28.88 Target Price $30.00 SUMMARY DATA SUMMARY Interactive Brokers third-quarter 2014 adjusted earnings missed the Zacks Consensus Estimate. Results were adversely affected by significant trading losses in the Market Making segment and higher operating expenses. However, strong performance of the Electronic Brokerage segment along with improvement in daily average revenue trades (DARTs) acted as the positive factors. The company is well positioned for future growth given its betterthan-peer positioning, adoption of technology, spreading of the equity culture and optimization of resource allocation on global electronic networks. Also, the company s healthy capital base and liquid balance sheet will facilitate expansion going forward. However, the increasing competitive environment and Market Making segment s high sensitivity to fluctuating volatility are bound to weigh on its performance in the near term. 52-Week High $ Week Low $20.73 One-Year Return (%) Beta 0.73 Average Daily Volume (sh) 371,151 Shares Outstanding (mil) 58 Market Capitalization ($mil) $1,675 Short Interest Ratio (days) 1.93 Institutional Ownership (%) 75 Insider Ownership (%) 1 Annual Cash Dividend $0.40 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 2.3 Earnings Per Share (%) 5.6 Dividend (%) 14.9 using TTM EPS 40.1 using 2014 Estimate 32.1 using 2015 Estimate 24.5 Risk Level * Low, Type of Stock Mid-Value Industry Fin-Invest Bkrs Zacks Industry Rank * 62 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) A 261 A 319 A 247 A 1,131 A A 284 A 326 A 250 A 1,076 A A 309 A 171 A 412 E 1,247 E ,455 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2012 $0.27 A $0.17 A $0.26 A $0.19 A $0.89 A 2013 $0.14 A $0.21 A $0.32 A $0.07 A $0.74 A 2014 $0.34 A $0.26 A $0.05 A $0.25 E $0.90 E 2015 $1.18 E Zacks Rank *: Short Term 1 3 months outlook 3 - Hold Projected EPS Growth - Next 5 Years % 11 * Definition / Disclosure on last page 2015 Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Headquartered in Greenwich, CT, Interactive Brokers Group Inc. operates as an automated global electronic market maker and broker with 937 employees worldwide as of Sep 30, The company specializes in routing orders, besides executing and processing trades in securities, futures, foreign exchange instruments, bonds and mutual funds on more than 100 electronic exchanges and trading venues worldwide. Incorporated in 1977, the company operates through two principal business segments: Market Making: The company operates the Market Making business through its Timber Hill subsidiaries. Interactive Brokers provides continuous bid and offers quotations on over 985,000 tradable securities and futures related products listed on electronic exchanges worldwide. The company is a market leader in exchange-traded equity options and equityindex options and futures, accounting for approximately 9.0% of equity options traded worldwide. Electronic Brokerage: As an electronic broker, the company executes, clears and settles trades globally for both institutional and individual customers. From a single account in any major currency, the customers can access products traded on more than 100 exchanges and market centers across 24 countries and in 21 different currencies. Full Ye ar 2013 Re venue (Business Segm ents ) Market Making 25% Electronic Brokerage 75% The two business segments are complementary and benefit from knowledge and technological synergies as well as from the combined scale and volume. This enables the company to provide low-cost services to its customers. On May 3, 2007, Interactive Brokers priced its initial public offering (IPO) of the common stock. Prior to the IPO, the company had conducted its business through a limited liability company (LLC) structure. In connection with the IPO, the company purchased 10.0% of the membership interest in IBG LLC. As of Sep 30, 2014, Interactive Brokers primary assets are its ownership of approximately 14.1% of the membership interests of IBG LLC. The remaining 85.9% of the membership interests are held by IBG Holdings LLC. Periodically, Interactive Brokers involves itself in strategic investments and acquisitions. The company has made strategic investments in electronic trading exchanges including Boston Options Exchange LLC, OneChicago LLC, ISE Stock Exchange LLC and CBOE Stock Exchange LLC. Interactive Brokers has Equity Research IBKR Page 2

3 also made investments in Quadriserv Inc., an electronic securities lending platform provider and Factor Advisors, LLC, an Exchange Traded Funds (ETF) issuer. The company acquired FutureTrade Technologies LLC a technology solutions provider to hedge funds and other institutional investors and its wholly owned subsidiary, FutureTrade Securities LLC. As of Sep 30, 2014, Interactive Brokers had $41.6 billion in total assets, $16.3 billion in cash and cash equivalents (including segregated cash and securities of $15.3 billion) and $750.8 million in stockholders equity. REASONS TO BUY Interactive Brokers position with respect to the interface of four broad historical trends is very impressive. The company has positioned itself at the crossroads of globalization, adoption of technology, spreading of the equity culture and optimization of resource allocation on global electronic networks. As part of its globalization, the company processes trades in stocks, futures, options and forex on more than 100 exchanges across 24 countries and in 21 currencies. Unlike many of its peers, the company has a very low level of compensation expense relative to the net revenues, mainly due to its technological excellence. Since its inception, Interactive Brokers has mainly been focused on developing proprietary software to automate broker-dealer functions. As a result, the company has been a pioneer in the field of developing and applying technology as a financial intermediary in the capital markets where it operates. This has allowed it to become one of the low-cost providers of broker-dealer services. In addition, the company has competitive advantages with respect to its trading system containing unique architectural aspects and massive trading volumes throughout the world market. Further, due to its technological superiority, the company has been able to rapidly adjust its systems to comply with many ad hoc trading restrictions imposed by the Securities and Exchange Commission (SEC). Interactive Brokers is an asset for yield-seeking investors. Since the second quarter of 2011, Interactive Brokers has been paying a quarterly dividend of $0.10 per share. Moreover, in Dec 2012, the company paid a special cash dividend of $1.00 per share (totaling $409 million). This reflects management s confidence in its capital-generating strength and thus, in turn, boosts investors confidence in the stock. Interactive Brokers robust capital base and liquid balance sheet with a low leverage sets it apart from its competitors. The company was able to actively manage its excess liquidity and maintain significant borrowing facilities through the securities lending markets and banks. The company continues to maintain excess regulatory capital ($3.25 billion as of Sep 30, 2014) in its brokerdealer companies worldwide. Interactive Brokers has continued to explore opportunities in the emerging markets of Taiwan, Mexico and India. As of Sep 30, 2014, over 60% of its customers are from outside the U.S., resulting in a greater diversification of revenues. With the Central Clearing Houses as its counterparties, sole trading with exchange-listed instruments and continuous monitoring of customer positions, the company has been able to restrict its credit risk to a great extent. Equity Research IBKR Page 3

4 REASONS TO SELL Interactive Brokers DARTs have been under pressure since the beginning Cleared average annualized DART per account has declined every month, except in July, September, October and December. However, both total customer DARTs and cleared customer DARTs showed year-over-year improvement during the third quarter of We believe that the irregular movement in DARTs may keep revenues under strain in the upcoming quarters. According to Interactive Brokers dividend strategy, the regular quarterly dividend will be paid from its Market Making segment. If the segment fails to generate sufficient return for paying dividend, the company will be forced to use its capital for the same. As a result, the segment s capital base could decline over a period of time and the company would eventually lose financial flexibility. In the first nine months of 2014 the segment s pre-tax profit margin declined to 15% from 30% in the corresponding prior-year period. The fall in margin was mainly attributable to unfavorable market conditions prevalent during the third quarter, the continuation of which will likely hamper the segment s profitability in the upcoming quarters. As a market maker, Interactive Brokers mainly derives its profit from the difference between the buying and selling prices of securities. However, competition often forces the company to match the quotes of other market makers and to hold a large amount of securities as inventory. As the company derives considerable revenue and incurs significant expenses in the form of dividend income and expenses from this inventory, besides making payments in lieu of dividends on short positions in securities, any erroneous projection of future dividends may lead to huge trading losses. In case of an ineffective management of such risks, the company s operating results and financial conditions could be impacted adversely. Interactive Brokers dependence on IBG LLC is also an area of concern. The company s primary asset is its 14.1% equity interest in IBG LLC. Also, its controlling interest and related rights as the only managing member of IBG LLC makes it dependent on revenue generation. The company incurs taxes on its proportionate share of the net taxable income of IBG LLC and incurs expenses related to its own operations. If IBG LLC fails to provide sufficient funds to Interactive Brokers to pay taxes or for any other purpose, the latter s financial condition may suffer significantly. RECENT NEWS Interactive Brokers Q3 Earnings Miss on Trading Losses Oct 21, 2014 Interactive Brokers third-quarter 2014 adjusted earnings per share of $0.05 largely missed the Zacks Consensus Estimate of $0.23. Also, the figure came in a massive 84% lower than the year-ago quarter earnings. Substantial trading losses in the Market Making resulted in the overall poor performance. Higher expenses further weighed on the results. However, sustainable performance of the Electronic Brokerage segment as well as improvement in DARTs was the redeeming factor to some extent. On a comprehensive basis, net loss available to common shareholders came in at $7.6 million or $0.13 per share compared with a net income of $20.1 million or $0.39 per share in the prior-year quarter. Equity Research IBKR Page 4

5 Performance in Detail Interactive Brokers net revenue plunged 47.6% year over year to $171.0 million. The decline was primarily driven by significant trading losses, partly offset by an increase in commission and execution fees as well as interest income. Moreover, it compared unfavorably with the Zacks Consensus Estimate of $287.0 million. Total non-interest expenses summed $131.5 million, up 1.2% from the year-ago quarter. The rise was mainly attributable to higher employee compensation and benefits as well as general and administrative expenses. However, these were slightly mitigated by a reduction in execution and clearing as well as communications expenses. Income before income taxes declined 79.9% year over year to $39.5 million. Similarly, pre-tax profit margin fell to 23% from 60% in the prior-year quarter. As of Sep 30, 2014, cash and cash equivalents (including cash and securities set aside for regulatory purposes) totaled $16.3 billion compared with $15.2 billion as of Dec 31, As of Sep 30, 2014, total assets grew 9.9% to $41.6 billion from the Dec 31, 2013 figure. As of Sep 30, 2014, total equity rose 2.0% to $5.3 billion from the Dec 31, 2013 figure. Segmental Performance Market Making: Net revenue came in at a negative figure of $70.4 million compared with the positive figure of $130.9 in the prior-year quarter. Similarly, pre-tax loss amounted to $111.8 million compared with pre-tax earnings of $87.5 million in the year-ago quarter. Further, pre-tax margin reflected a negative return of 159% compared with a positive return of 67% in the year-ago quarter. The weak performance of this segment was triggered by the prevailing competitive situation, lower average volatility, elevated M&A activity as well as a trading error which resulted in a loss of $16 million during the quarter. Electronic Brokerage: Net revenue improved 24.8% year over year to $243.0 million. Pre-tax income escalated 40.6% to $152.4 million. Further, pre-tax profit margin rose to 63% from 56% in the prior-year quarter. Additionally, total DARTs for cleared-only customers increased 14% year over year to 485,000. Dividend Update On Oct 21, Interactive Brokers declared a quarterly cash dividend of $0.10 per share. The dividend was paid on Dec 12 to shareholders of record as of Dec 1. Equity Research IBKR Page 5

6 VALUATION Interactive Brokers currently trades at 32.1x the Zacks Consensus Estimate for 2014, a 40.8% premium to the 22.8x for the industry average. On a price-to-book basis, the shares trade at 0.3x, which is 87.5% below the industry average of 2.4x. Hence, the valuation on price-to-book basis looks attractive. Our six-month target price of $30.00 per share equates to about 33.3x the Zacks Consensus Estimate for Combined with a quarterly dividend of $0.10 per share, this target price implies an expected total return of 4.6% over that period, which is consistent with our Neutral recommendation. Interactive Brokers sports a Zacks Rank #3 (Hold). Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Interactive Brokers Group, Inc. (IBKR) Industry Average S&P KCG Holdings, Inc. (KCG) BGC Partners, Inc. (BGCP) N/A Oppenheimer Holdings Inc. (OPY) N/A GFI Group Inc. (GFIG) 22.7 N/A N/A 9.5 N/A N/A 13.4 TTM is trailing 12 months; F1 is 2014 and F2 is 2015, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Interactive Brokers Group, Inc. (IBKR) Industry Average S&P Equity Research IBKR Page 6

7 Earnings Surprise and Estimate Revision History Equity Research IBKR Page 7

8 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of IBKR. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1142 companies covered: Outperform %, Neutral %, Underperform 5.7%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Coverage Team QCA Lead Analyst Analyst Copy Editor Content Ed. 11A Kalyan Nandy Swayta D. Shah Suchi Agarwal Ishani Mukherjee Swayta D. Shah Equity Research IBKR Page 8