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Shares of FXCM Inc. (FXCM) traded with gains of up to 2.5% in Tuesday's trading session. The online provider of foreign exchange, currency trading and other related services to retail and institutional investors, announced the acquisition of Gain Capital Holdings (GCAP). Shares of Gain Capital rose more than 23% in reaction to the proposed deal.

The Deal

FXCM announced that it has proposed to acquire Gain Capital Holdings. Under terms of the proposed deal, shareholders of Gain Capital would receive 0.3996 shares of FXCM in exchange for each share they currently own.

Based on FXCM's closing price of $13.39 on Monday, the deal values Gain Capital at $5.35 per share, a 25% premium compared to Monday's closing price. The proposed deal values Gain Capital at $192 million.

Combined, the deal would create an industry leader with the potential to achieve significant economies of scale. The combination would also be more resilient to market conditions and regulatory changes.

CEO Drew Niv commented on the deal:

FXCM believes that the substantial potential operating and capital synergies between the two companies would result in an accretive deal with a strong growth profile and improved economies of scale. Additionally, FXCM believes customers of both FXCM and Gain will greatly benefit from the expected improvement of financial strength and stability of the combined entity.

Gain Capital generated annual revenues of $151.8 million for 2012, down 17% on the year before. The company reported net income of merely $2.6 million, down from $15.7 million in the year before.

The $189 million deal includes the net cash position of $37 million which is held by Gain Capital. The deal values the operating assets of the firm at $152 million, or 1.0 times annual revenues and roughly 55 times annual earnings. The company expects that this will be accretive to earnings, and result in incremental EBITDA of $50 to $70 million by 2014. Furthermore, FXCM could reap potential capital synergies between $80 and $100 million as a result of lower regulatory and collateral cash requirements.

The deal is subject to normal closing conditions, including regulatory approval. FXCM expects to close the deal before the end of the year.

Valuation

FXCM ended its fiscal 2012 with $272.3 million in cash and equivalents. The company operates with merely $22.9 million in total debt, for a net cash position of roughly $250 million. The company generated annual revenues of $417.3 million, up 0.4% on the year before. Net income fell by 30% to $9.0 million, or $0.37 per diluted share.

The market currently values FXCM around $475 million, which values operating assets around $225 million. This values the operating assets of the firm at little over 0.5 times annual revenues and 25 times annual earnings. FXCM currently pays a quarterly dividend of $0.06 per share, for an annual dividend yield of 1.7%.

Some Historical Perspective

Shares of FXCM went public at the end of 2012, when the company was sold to the public at $14 per share. Shares have traded in a $9-$15 trading range ever since. Since the start of 2013, shares have risen by more than a third. The heightened European crisis, notably the fact that savers in Cyprus have actually lost money, has resulted in increased demand for forex trading services by retail investors.

Between 2009 and 2012, FXCM has increased its total revenues by some 30% to $423 million. The company's profitability improved from a break-even level in 2009 to earnings of $9 million over the past year.

Investment Thesis

The major upside from a potential deal will be the result of the sizable synergies. Combined, both firms will generate annual revenues of $569 million and hold client assets of $1.6 billion. On a pro-forma basis, the combination will earn approximately $12 million. Yet this does not include sizable capital requirements, compliance, technology and personnel synergies.

The market values the newly proposed FXCM at around $13.75 per share, valuing the new entity at roughly $670 million. This includes the net cash balances of both firm at roughly $290 million, valuing operating assets at just $380 million.

As such, the newly proposed entity is valued at 0.7 times annual revenues and 32 times annual earnings, before considering synergies. The significant synergies will result in adjusted EBITDA between $163 and $183 million, valuing the company at merely 2.2 times annual pro-forma EBITDA.

The market valuation of both firms increased by merely $40 million following the deal, which is rather insignificant given the expected synergies in a possible deal which could create an industry leader in the online FX trading environment.

Overall, the deal creates tremendous value for shareholders in FXCM given the fact that the pro-forma market capitalization increases by just $40 million. Shareholders in FXCM stand to benefit from one-time significant capital synergies of $80 to $100 million, as collateral requirements will be lower. Shareholders will furthermore benefit from $50 to $70 million in incremental EBITDA in 2015.

I think that a possible deal creates long-term value for shareholders, and Tuesday's reaction in FXCM's shares price does not reflect this yet.

Source: FXCM - How An Acquisition Of Gain Capital Will Create Tremendous Shareholder Value