IBKR - Interactive Brokers

[KCLarkin]

Second level thinking would imply that their complex sign up process and intimidating platform are opportunities.

 

Exactly. My point was only that letting people trial there complicated software is probably not going to solve that opportunity. Lot's of low hanging fruit here though.

[yitech]

How do you guys feel about company issuing 8-10% stock options annually?  Growing at 20% is great, but should constant dilution be overlooked?

 

Check out the comments by @Psclfrst

[Liberty]

How do you guys feel about company issuing 8-10% stock options annually?  Growing at 20% is great, but should constant dilution be overlooked?

 

Answer here

[yitech]

How do you guys feel about company issuing 8-10% stock options annually?  Growing at 20% is great, but should constant dilution be overlooked?

 

Answer here

 

Perfect!

[marazul]

How I currently see this. Let´s say the Brokerage segment earns $950mm pre-tax next year and MM segment earns $150mm. That is $1,100 pre-tax. Assuming a 30% tax-rate (I think this number is appropiate going forward for us the minority shareholders), I get $770 in net earnings in 2016. Current market cap is $15,900mm so IBKR is trading at 20.5x forward earnings. Question is how long will the business grow at 15%+. If the answer is for more than 5 years then we will do fine. Other interesting thing is how taxes work. We pay high taxes of ~30% but TP pays very low taxes. I think that if most of the earnings are reinvested into the business and then eventually IBKR gets acquired it will be great for us given our position. We would benefit over the years from some tax-shield as the equity compounds. We have the same economic interest per share as TP so in a possible acquisition we would receive the same value after taking advantage of some of the tax-shield.

[benhacker]

Quoting myself:

 

I have a nearly 10% position in this for my accounts, but I was 15% recently (I sold a large ~20% chunk of my holdings above $44)... Long term I probably should have done nothing... but this stock could easily drop 30% without a ton of folks stepping up to the plate.  At <$30, I'd probably take it back up to 12-15% all else equal.  As they say, lots of reasons people sell (both me and IBKR insiders)... but only one reason to buy more. ;-)

 

and here we are... sub $32 today.

 

Started nibbling a bit to build back up.

 

High priced growth stocks are always volatile I guess, why I size them down and up based on valuation.

[kab60]

What did you think of the results? I really appreciate your thoughts on IBKR.

[muscleman]

IBKR is the stock that I looked at and drew a similar conclusion as this one:

https://punchcardblog.wordpress.com/2014/12/10/interactive-brokers-group-ibkr/

 

What make you think he is wrong?

[KJP]

IBKR is the stock that I looked at and drew a similar conclusion as this one:

https://punchcardblog.wordpress.com/2014/12/10/interactive-brokers-group-ibkr/

 

What make you think he is wrong?

 

Look at slide 30.  It (i) projects significant revenue growth but brokerage margins that are lower than they are today, despite acknowledging that the business enjoys economies of scale; (ii) assigns no value to the market maker; and (iii) puts a 15 PE on the 2023 business.  The author acknowledges he's being conservative, but this seems extreme to me.  If you put in 70% EBIT margins, 25% tax rate, assign value to the still profitable (and NAV positive) market maker and use 20 PE you get a significantly different result.  I'm not saying all of my assumptions will happen, but they are certainly reasonable. 

[frommi]

I see a big problem here that all earnings are just reinvested in the marketmaker at a very low return. If they would dividend out all or could find better uses for all the cash, this investment would probably be a no brainer. Its easy to extrapolate the past growth into the future, but will it really grow at that rate going forward?

[60North Investments]

In the Q4 conference call Peterffy talked about market shares. He mentioned them as 25% of proprietary trading groups, 15% of financially sophisticad individuals, 0.2% of hedge funds, <0.1% of RIAs. 1% hedge fund market share would be roughly $250m in commissions only, 1% of RIAs likely a nice sum too.

 

Currently the e-broker is doing about $1b revenues. I have no idea how big of a share IB could realistically capture of these markets over time. But if one believes that their technological advantage will enable them to win share over time across the board, then it's not hard to see how they could continue growing fast. As an example, getting a combined 5% share of HFs and RIAs would +2x sales.

[frommi]

In the Q4 conference call Peterffy talked about market shares. He mentioned them as 25% of proprietary trading groups, 15% of financially sophisticad individuals, 0.2% of hedge funds, <0.1% of RIAs. 1% hedge fund market share would be roughly $250m in commissions only, 1% of RIAs likely a nice sum too.

 

Currently the e-broker is doing about $1b revenues. I have no idea how big of a share IB could realistically capture of these markets over time. But if one believes that their technological advantage will enable them to win share over time across the board, then it's not hard to see how they could continue growing fast. As an example, getting a combined 5% share of HFs and RIAs would +2x sales.

 

With all thats going on right now and the rise of index funds, isn`t the hedgefund business a shrinking market?  ;D

[KJP]

I see a big problem here that all earnings are just reinvested in the marketmaker at a very low return. If they would dividend out all or could find better uses for all the cash, this investment would probably be a no brainer. Its easy to extrapolate the past growth into the future, but will it really grow at that rate going forward?

 

I thought the company was deemphasizing its market making.  Why do you say that all earnings are being reinvested in that business?

[writser]

I see a big problem here that all earnings are just reinvested in the marketmaker at a very low return. If they would dividend out all or could find better uses for all the cash, this investment would probably be a no brainer. Its easy to extrapolate the past growth into the future, but will it really grow at that rate going forward?

 

I thought the company was deemphasizing its market making.  Why do you say that all earnings are being reinvested in that business?

 

+1. I don't think that is a significant risk.

[Liberty]

I see a big problem here that all earnings are just reinvested in the marketmaker at a very low return. If they would dividend out all or could find better uses for all the cash, this investment would probably be a no brainer. Its easy to extrapolate the past growth into the future, but will it really grow at that rate going forward?

 

I thought the company was deemphasizing its market making.  Why do you say that all earnings are being reinvested in that business?

 

If I remember correctly, they are taking 10% of equity out of the MM unit per year, so if it earns less than 10% ROE, it'll shrink to nothing over time, but if it earns more than that, it'll keep going.

 

But the broker side is growing so much faster than the MM that over time the MM will become relatively less important even if it doesn't shrink in absolute numbers.

 

That's my understanding, anyway.

[frommi]

I thought the company was deemphasizing its market making.  Why do you say that all earnings are being reinvested in that business?

 

If I remember correctly, they are taking 10% of equity out of the MM unit per year, so if it earns less than 10% ROE, it'll shrink to nothing over time, but if it earns more than that, it'll keep going.

 

But the broker side is growing so much faster than the MM that over time the MM will become relatively less important even if it doesn't shrink in absolute numbers.

 

That's my understanding, anyway.

 

Maybe i misunderstood something, wouldn`t be the first time. But then what do they do with the money they earn for me in the brokerage business?

[rpadebet]

There is excess regulatory capital...

they hope to invest it in developing compliance systems globally to gain more customers and open up markets for existing customers. That will be a moat someday. It isn't easy for a new entrant to suddenly replicate all the complex regulations across the globe.

 

IBKR is to the brokerage industry what GIECO was to the auto insurance industry a few decades ago. Unfortunately it isn't required by law that everyone have a brokerage account :), that's pretty much the only difference in the model.

[KCLarkin]

What make you think he is wrong?

 

I like his work but he makes some very curious assumptions. As others have mentioned:

1. Terminal PE = 15. Schwab has averaged 27.7x over the last 15 years, so why 15x?

2. Assumes 50% margins vs 60% margins the last two years. Operating leverage should result in higher margins, not lower.

3. Market maker has $1.7 B in equity. Why do we ignore this value?

3b. ignores dividends in his return calculation

4. Tax rate of 35% seems high given the international operations.

5. Are there other growth opportunities (price increases, new products, better NIM)?

 

So, if you assume significant multiple compression, falling margins, higher taxes, and a write-off of the market making unit...then the returns will be mediocre.

[flesh]

What make you think he is wrong?

 

I like his work but he makes some very curious assumptions. As others have mentioned:

1. Terminal PE = 15. Schwab has averaged 27.7x over the last 15 years, so why 15x?

2. Assumes 50% margins vs 60% margins the last two years. Operating leverage should result in higher margins, not lower.

3. Market maker has $1.7 B in equity. Why do we ignore this value?

3b. ignores dividends in his return calculation

4. Tax rate of 35% seems high given the international operations.

5. Are there other growth opportunities (price increases, new products, better NIM)?

 

So, if you assume significant multiple compression, falling margins, higher taxes, and a write-off of the market making unit...then the returns will be mediocre.

 

Ya the guys valuation was horrid..... he's was right on the qualitative factors, interesting what makes a market.

 

They pay around 10% in tax and in the recent ec the cfo said they can continue in that range through some loophole for a long long time. Take his valuation and use a 15% tax rate and an 18 exit multiple and add some fcf earned on the cash piling up from the diff between 35 and 15% tax rate and you have a very nice result.

 

Q - Chris Harris

 

And then a quick question on the P&L. You guys have run this fairly low tax rate for some period of time and I'm just trying to think for modeling purposes is it fair to sort of use this sub 10% GAAP tax rate on a go forward basis or is there some benefit that rolls off that we should be thinking about for future quarters?

 

A - Thomas Peterffy

 

Paul?

 

A - Paul Brody

 

Well yes the original benefit embedded in the IPO transaction is a 15 year benefit and our IPO was in 2007, that kind of benefit, though we have nothing planned, that kind of benefit would be increased in renewed with each additional of any secondary offerings where the sale price was in excess of essentially the book value really the tax cost basis but call it the book value that is what generates that tax benefit, so each one of those is a 15 year amortization, so last for quite a well.

 

A - Thomas Peterffy

 

Paul that includes employees selling unregistered shares also, right?

 

A - Paul Brody

 

Yes, each time shares are sold into the public.

 

A - Thomas Peterffy

 

And including bonus shares right?

 

A - Paul Brody

 

Not including bonus shares.

 

A - Thomas Peterffy

 

Not including bonus shares. Okay so the shares that are originally owned shares that become a newly registered, yes?

 

A - Paul Brody

 

Yes, correct.

 

Q - Chris Harris - Wells Fargo Securities

 

 

OK, thanks for clarifying.

[benhacker]

What did you think of the results? I really appreciate your thoughts on IBKR.

 

Hey Kab, I don't have any great insights.  I thought the results were so-so.  As always, I feel quite confident in the investment after hearing the conference call.  They way they think about the business and the long run economics seem still compelling to me, even if the valuation, while better, isn't a screaming statistical bargain.

 

I think results will continue to trend in the right direction and I still think IB has a lot of optimizations in their business, and ways their can accelerate their share grab.  I continue to think the industry is in for a long run of consolidation, and IB seems to have a path to begin monetizing some competitors business and eroding their market position without being forced to buy them which I think is good.  Their market growth in RIAs and HFs is interesting, but I also really like some of the network effect aspects of their model that are falling into place (marketplace, etc).

 

Money quote from the call that made me smile:

 

Rob Koehn

 

Okay, okay. So I guess maybe last question. To what extent, and I probably know the answer to this, but to what extent do you ever – how often do you think about raising prices? I mean, I know for me as a customer –

 

Thomas Peterffy

 

I think about it almost every day and I always say I will never do it.

 

Rob Koehn

 

Okay. I mean, I think there are a lot of people out there that have nowhere else to go, and so they might –

 

Thomas Peterffy

 

I don’t want to be like Oracle.

[kab60]

That one made me smile as well - espescially the next part where the analyst obviously didn't understand the reply. :) Thanks for the comment, I agree with your points but have so far waited for a better entry. Maybe it's silly when you consider their ability to increase prices. They have a long term focus but there is lots of optionality.

[rpadebet]

That one made me smile as well - espescially the next part where the analyst obviously didn't understand the reply. :) Thanks for the comment, I agree with your points but have so far waited for a better entry. Maybe it's silly when you consider their ability to increase prices. They have a long term focus but there is lots of optionality.

 

As long as they have customer accounts to gain, I don't think they need to raise prices. It could be a lot of years before they reach that point.

 

I like how they are licensing their technology and backend to other brokers. They are making themselves indispensable to the system and further strengthening their moat by doing so. This is a much better method than directly trying to compete with them for "less sophisticated" retail accounts.

[kab60]

That one made me smile as well - espescially the next part where the analyst obviously didn't understand the reply. :) Thanks for the comment, I agree with your points but have so far waited for a better entry. Maybe it's silly when you consider their ability to increase prices. They have a long term focus but there is lots of optionality.

 

As long as they have customer accounts to gain, I don't think they need to raise prices. It could be a lot of years before they reach that point.

 

I like how they are licensing their technology and backend to other brokers. They are making themselves indispensable to the system and further strengthening their moat by doing so. This is a much better method than directly trying to compete with them for "less sophisticated" retail accounts.

Agreed. My point was that valuing them on current earnings is silly because they're kept low to gain additional accounts which probably have more long term value. So it's just my own valuation technique that needs to be refined, but I'm really not good at valuing growth. And I agree on the whilelabel/licensing strategy - I think that's brilliant and one of the options I like, but it could take a long time to play out.

[JBTC]

Lots of comparisons have been made from the technical/user standpoint between IB, Fido and SCHW.

 

I am wondering if someone can compare IB and SCHW from an investing point of view. Clearly the model is different and they go after different customers. Both have been owned by value investors. Lou Simpson has a lot of SCHW.

 

Are there any merits SCHW has that IB doesn't?

 

 

[KJP]

Lots of comparisons have been made from the technical/user standpoint between IB, Fido and SCHW.

 

I am wondering if someone can compare IB and SCHW from an investing point of view. Clearly the model is different and they go after different customers. Both have been owned by value investors. Lou Simpson has a lot of SCHW.

 

Are there any merits SCHW has that IB doesn't?

 

To me, Schwab is a different animal than IB.  It's not only that the customer profile is different (though there is overlap), but Schwab is also at least as much a money manager as a broker, and it also operates a bank.  One possible result of that business model is that Schwab could benefit more from higher interest rates:  http://brooklyninvestor.blogspot.com/2015/08/the-charles-schwab-corporation-schw.html