Investment Technology Group: Decent Upside Without the Risk

Jul.16.09 | About: Investment Technology (ITG)

Investment Technology Group [NYSE:ITG] July 16, 2009: $18.85

52-week range: $13.00 (Nov. 21, 2008) - $36.33 (Sep. 19, 2008)

Company description from Morningstar

Investment Technology Group’s primary business is providing electronic trade execution to financial institutions. The company services the whole execution process from pre-trade analytics to post-trade processing. The company has more than 1,000 employees and operations in the United States, Canada, Europe, and Asia-Pacific.

ITG’s flagship POSIT system lets institutional clients trade confidentially amongst themselves through algorithmic matching of buy and sell orders. They also offer trade order management and transaction cost analysis services through their Macgregor and Plexus systems.

Profitability varies with overall trading volumes and ITG’s share of overall transactions. Foreign sales were about 25% of 2008 revenues. 2008 marked the fifth straight year of increasing sales and earnings before the huge market declines of last fall through early March 2009.

Here are the per share numbers from continuing operations as reported by Value Line:

Zacks now carries EPS estimates of $1.51 and $1.90 for 2009 and 2010 respectively.


That makes ITG’s multiples < 12.5x this year’s depressed estimate and just 9.5x next year’s expectations for a partial recovery. Both of those P/Es are below any average annual multiple for ITG all the way back to 1995.

ITG has a nice balance sheet. As of March 31, 2009 they held cash and short-term investments of $296 MM against total debt of just $82.6 MM. Total interest coverage is about 9x. Value Line rates their financial strength as B++. Morningstar assigns ITG a ‘Four-Star’ rating (with Five-Stars being best) and figures ‘Fair Value’ as $28/share.

A return to a still below normal 15 times 2009’s depressed earnings estimate would bring a year-end price of $22.65/share. That same multiple on 2010’s estimate would lead to a target price of $29.85 by late 2010.

Are those achievable goals? A quick glance at the historical chart shows actual peak prices of $40.90 - $59.10 in each year 2005 through 2008 (albeit when markets were stronger than today). In 2007 – 2008 the absolute low trades were $34.40 - $35.40.

If you’re a believer that there’s even moderate upside for ITG here’s a nice six-month play with great upside and moderate risk:

If ITG shares climb by at least 6.1% to $20 or higher by Jan. 15, 2010:

  • The $20 calls will be exercised.
  • You will sell your shares for $20,000.
  • The $20 puts will expire worthless.
  • You will have no further option obligations.
  • You will hold no shares and $20,000.

That’s a best-case scenario net profit of $5,950 / $14,050 = 42.3%

cash-on-cash return. This would be achieved in just six months on shares that only needed to rise by 6.1% from trade inception date.

What’s the risk?

If ITG shares finish below $20 on Jan. 15, 2010:

  • The $20 calls will expire worthless.
  • The $20 puts will be exercised.
  • You will be forced to buy another 1000 ITG shares.
  • You will need to lay out an additional $20,000 cash.
  • You will end up with 2000 ITG shares.
  • You will have no further option obligations.

What’s the break-even on the whole trade?

On the first 1000 shares it’s their $18.85 purchase price less
the $1.85/share call premium = $17.00/share.

On the ‘put’ shares it’s the $20 strike price less
the $2.95/share put premium = $17.05/share.

Your break-even would be the average of those or $17.03/share.

ITG could decline by $1.82/share or (-9.65%) without causing a
loss on this trade.

Summary:

Investment Technology Group appears to offer decent upside without a lot of risk. Last year’s poor market conditions and their effect on this year’s earnings seem to be already reflected in today’s share price.

A rebound to even $20/share by next January would allow for buy/write investors to reap total returns of over 42% on any upside movement above 6.1% from this morning’s quote.

You are protected against loss even if ITG shares fall by almost 10% from current levels.

Disclosure: Author is long ITG shares and short ITG options.