FXCM Inc. (NYSE:FXCM)
2013 Morgan Stanley Financials Conference
June 11, 2013 16:10 pm ET
Drew Niv - Chief Executive Officer
Robert Lande - Chief Financial Officer
Good afternoon everyone. My name is (inaudible). I work with Morgan Stanley. Thank you all for joining us for the Morgan Stanley Financials Conference and for our next presentation by FXCM, a leading retail FX trading venue with a fast growing institutional platform. We have the pleasure of having with us a gentleman who needs no introduction, Mr. Drew Niv, the Chief Executive Officer of FXCM since 1999 and one of the founding partners of the firm. He will shortly be joined by Mr. Robert Lande as well, who is the Chief Financial Officer of the firm and joined the firm in 2010.
Without any further ado, I shall pass the stage to Drew.
For those of you, who are not similar with us, I will give you a little bit of brief overview. FXCM was founded in 1999 by six people and myself and five others. It essentially grew with no external investment until December 2010, when we went public. So the company was on retained earnings only. Primarily, FXCM is a retailer FX business, I think of it like an E*TRADE instead of -- for self-directed investors instead of equities for FX.
A little bit of – for retail FX for those of you who are not familiar, since retail FX is – FX first is $4 trillion a day market is a – its the largest financial services market in the world today. Most people view it as this is the corporate payments or, you know, real money that’s buying foreign stocks or foreign money buying U.S. stocks. Actually between corporate payments, hedging and real money is about 15% of the market, 85% is speculation in FX mostly done by institutions.
The retail business as of today, you know growing, has been growing a lot 10 to 11 to be a descent part of the institutional market is today about 5% to 8%, there is no hard stock of what it is, but just shows you kind of how big of a market it is. This is, as we will get to later, one of the only market that is untouched specially institutional side of it is completely and utterly untouched by Dodd-Frank and all the other regulatory reforms and we believe that it has lots of ways to grow, as we progress we’ll look for the essentially the cheapest place to get leverage and the, lowest place to transact.
The story of FXCM is one where we, if you look at the -- and we go through all of the points, listed here on the presentation and I think the most people don’t appreciate the -- what FXCM is, as they are variably integrated it, it is not just a brokerage firm but also in our space we are the exchange to clearing house – entire stock that the client fees. And this is something that has led to actually a relatively low risk model and a model that is much more stable and much more scalable and mostly perfect.
One of the biggest things, you know, about our business that differentiates us from everybody else sort of makes this into our story very unique is the fact that the retail business, retail FX business mostly like the institutional FX business is primarily a principal business and most of our competitors, our principal market makers and well that is, perfectly fine in the institutional business because for example, in institutional business you get a big hedge fund is long euros with Bank A, he wants to get out of those euros, and he thinks Bank A is going to give him a terrible fight because he knows what position he has, it goes to Bank B, gets the price, gets out and he is able to then -- because the trades are fungible, he is able to neck those out at the end of the day.
The retail client, because retail training is not fungible, whoever he is long Euros with, he is got to get out of those Euros with this as well, the retail broker, because he is the exchange, the market maker, the clearing house and the broker. He essentially gets to see, he has to play poker with his clients while watching their cards at the same time, one of the best analogy to use. Which a lot of people foresee as, you know, obviously highly unfair, environment trading.
What FXCM allows the retail customer to do is essentially to have the same power and functionality of a large macro fund and we essentially take16 large market makers just like a big macro fund would, right? We will be able to line them up against one another, they have to compete for the trade, they are not able to see customer positions or know who their end user customer is, all they do is to use FXCM. And essentially creates -- essentially a private exchange for those retail customers which makes FX trading, you know, a whole of a lot fairer than for the retail customer than it is, you know, in a normal retail environment today.
As I was saying before, the biggest thing about -- unappreciated about us and the part that’s very hard to replicate is that FXCM is not just a broker but it is the clearing house to exchange the back office provider. All of those things that in other exchange trade asset classes are basically outsourced two other things, right? And we have either nationally mandated infrastructure or very large vendors like Sungard, especially in the back of most major brokers firm.
If you look at most major exchange traded brokerage firms, very little of the customer experience is up/down, very little of the customer experience and the stock that he trades through is essentially proprietary. And, therefore, the experiences of the customer are not unique right and the lot of the stuff is very much commoditized.
In FX, every firm essentially because it’s bringing own staff, its differentiating itself against its competitors in 20 different ways instead of in three different ways like most exchange rate brokers, so we would be able to compete on settlement speed and settlement quality on execution speed, execution quality where most retail brokers essentially because they are funneling into the same thing did not have such competitive advantage. A lot of it is competing on commissions on brands, right on things that very hard to compete on and are not very good for pricing powers.
This is also the essence, our technology is also the essence of why half of FXCM’s retail business is not organic clients, half of the FXCM’s retail business is really essentially us what we call the white label business, as we private label our platform and our liquidity for other financial institutions, it’s about 300 of them around the world. And some of the examples we gave in our recent conference calls is E*TRADE uses FXCM, Barclays, which is the largest stock broker in the UK, obviously owned by Barclays, optionsXpress is a division of Charles Schwab and many, many most of our clients are actually in Asia or Middle East and other places as you probably would not recognize the names, but nevertheless, in their home markets pretty, pretty big.
And the reason why they select us is because again, we offered the whole thing for them to hold bill themselves is extraordinarily difficult to do. The system does on a typical day about half a million trade, on very active days or in the flash first day about a million trade.
One of the most prior and the best attribute to FXCM and the best part obviously is pitch to investors is that, if you take the E*TRADE of the world and (inaudible) all those companies, for them to move overseas, they have to localize everything. It is a totally new product, it is essentially a product that for E*TRADE to go to Turkey or Korea or to even to the UK, they have to offer local, connect to the local exchanges, local clearing houses, offer local research, do all of the things that essentially completely to make the service very different than it is here, they are pretty much only to be able to replicate the frontend.
So expanding overseas for exchange rate of broker it’s extraordinarily difficult. The beauty of FXCM and the FX business in general is our customers only -- 10% of our customers in the U.S., 90% overseas and you can see by percentages on this map of our customer dispersion and then the numbers are not presents are in volumes, in billions of dollars traded for the year.
What you’re able to see here is that essentially FX is an identical instrument for every clients around the world whether its Kuwaitis, Chinese or Americans, is essentially trading the identical clients to tell that everyone else is trading. The only localization that we do for people is regulatory reports in a place where they needed and its language, all right? This allows us to with one system essentially scale, the customers in 150 countries, right I guess from everyone about half of our business comes from Asia, half of our business is in the emerging markets, obviously all these places were wealth is growing faster, right?
And most importantly, if you look at the biggest competitors for us is adjacent financial markets for retail participates, futures, equities, options, all of those things. In the U.S., that is a tall order, right because those market have, all the things that we do not because (FDIC is doing) specific protection for funds, there is mandatory national best bid offer you know mandate for best execution, there is all of those infrastructure things that essentially make for the U.S. customer, only for the U.S. customer equities fair, safe, cheap.
That does not apply almost anywhere else. So, even in places in the Western Europe, equity trading is not as fair, it is definitely not a safe and it’s far more expensive. As you go to emerging markets, equities are you know, on the bridge completely and utterly unfair and if you look and you can see for example in place like China, 95% of volume is retail punters doing and out of stocks because no one is crazy enough to actually buy and hold and then consider these things long-term investments. And that is makes FX in those countries much more viable as they are mainstream asset class because of the fact that that the other asset classes are less trustworthy and FX as in euro, dollars, yen are far more trustworthy instruments that their accounting cannot be as manipulated as you know you pick the emerging market company, asserting that example.
In terms of growth potential kind of go through two things that are sort of under our control, two things that are macro things for us. As I said about half of our retail revenue today comes from white label partnerships. This is something that FXCM is a premier white label platform for most of the FX space today primarily because in our space we are the one of the only firms and I know it’s misrepresented by a share count because most of the firms still in analyze. But so only a $1.2 billion market cap which doesn’t sound like a lot for investors here but it is in our space, we have to spec in largest size – growth size of firm.
We are the only of the top ten firms in the business. We are the only agency firm in the business, everyone else is principal and we are one of four only companies in our world in our space that is public and for that are public, one is bigger than us, one is the very small micro caps stock and one is enlisted pink sheet. So as can see from our perspective of the business partner, FXCM is essentially one of the reasons why it’s a very profitable part of partnership we decided to go public is to get a leg up in this business and this is b2b business opportunity allows to expand our brand in a way that FXCM could never as an organic brand expand.
Our institutional business is a business that was started in 2005 as an ancillary add-on and up until last year was about 8% of our business, was it a big acquisition last year? Today its about 25% -- little over 25% of our business is institutional business. The aim over the long run is to – its essentially out 50% of the business, institutional 50%, our retail primarily because institutional business gets rid of our the biggest risk in our retail business is over regulation and not what we have sort of facing the last six, seven years. The institutional business as I said in the first slide is a business that is our utterly unregulated and therefore allows us to sort of edge against the regulatory bid that tied in the regulations the more people seek out, the places that are less regulated and FX is (inaudible) and institutional market is one of them.
Obviously, I don’t need to confuse anyone on retail FX regulation is probably the heaviest in the United States. This is the most expensive financial licenses, probably the most heavily regulated financial entities. And in most developed countries that is the case, but in an institutional business that is not.
On a macro front so as I said before half of our business is emerging market countries liberalization of the emerging market countries most people don’t you know quite follow it as much by in the last 10 to 15 years. The Russia, Israel, Turkey and whole host of countries have floated their currencies and it went from fixed rate regimes to free floating regimes and no capital controls that’s about ten countries or so that have done that in the last 15years.
We believe that the BRICS are essentially going to follow at some stage via China, Brazil and the like in the near future FXCM as we said before for regions we listed as enormous amount of exposure in all of these emerging market countries. So as the big one liberalize, we think that this represents a big opportunity. One of the things that it is important to register map is this our, we get paid in percentage commission so we think of it, if the average trade size for a retail customer in FXCM is about $30,000, we get paid let’s say for the sake of arguments from that is $100 per million that’s what means we make $3 dollars on a trade per side on that size of trade.
The average size account in the western markets are a bit above $10,000, the average size of account in emerging markets because of capital controls people can ship out money only little at a time is about $2000 and therefore as you know, obviously, the average trade sizes are going to be smaller and so the average commissions are smaller as those countries liberalize and lease capital controls and those average accounts kind of meet from the emerging markets meet the developed markets, you will see our average commission size grow and the cost stays the same. So it is again, because being all kind of stock because we don’t have the variable cost outside of the white label cost there is no variable cost to these trades.
The fourth one is probably the most significant macros and for us its interest rates. In 2008, interest rate related income was 20% of revenue, it is in the last two years and so it is about 1% of revenue for obvious reasons everybody knows interest rate drop off face of the earth as those were 100% net margin for us. So obviously when they – when we had interest rate – when those interest rate disappeared that all disappeared off the bottom-line with no offsetting cost when it comes back and they will all re-appear on the bottom line with no offsetting cost.
More importantly than that it’s the primary reason why both institutional customers and retail customer trade FX is for carrying. And if you think about it, what happens today our business is very sort of straight jacket into volatility. When volatility is high, we do really well, volatility is low we don’t. When the carry trade was significant fortune in the market and there was low volatility you know essentially for us just using a terminal, open interest was high and lots of people had carry trades on because you want low volatility when you’re doing carrying. And you know, we had an offsetting balance to it, there was a -- it is a far more successful strategy in chasing volatility. You know all is better when the carry trade was alive, when it comes back it well be a significant force to us.
One of the biggest things that most people under play is that most of the white label relationships especially our biggest ones these days are waiting for the carry trades to come back to introduce it to a larger subset of their customers. If you look at more of the big brokers, we have today’s clients introduce us to a very subset of the active trader sort of a speculative client base as the carry trade comes back it is much more of a mass market. Fixed income product obviously at a lower leverage point but it is something that we would have through a white label partnership, the ability to exponentially grow that reach far beyond what our balance sheet could ever do; far beyond what our brand could ever do and this is something that will be an easy concept to grasp as we have now in the last five years (Japanizing) the entire Western Hemisphere in terms of yield ticking mentality and think that this now not a rocket science to consumers anymore.
Just to give you a little bit about what we have done just in the last few years, as you can see from this chart. FXCM on an FX only basis is the largest IG group which you see is the fourth one is bigger than us only if you include CFT business, it is publicly traded in London is the only firm that actually on a growth size bigger than us. The rest of these are small.
And below this list there is a lots of competitors who are very weak and very small. Because of the over regulations in U.S., Japan, you know Europe. We started about 43 competitors in the United States 5 years ago, last year we had 12, this year was 8 and the number is probably 3 or 4. In Japan, we used to have 100s. We have dozens today and that number is probably going way lower as well and so on and so forth. So, while you have seen in the last three years on the right hand side, as we have bought four different companies. As you can see here the multiples are very cheap anywhere from two to four time EBITDA, primarily except for the last time which is really partnership, the first three were really a company that are essentially their regulatory wires, rose above the ahead and they have to get out. These are businesses that we can acquire very cheap and like in all brokers market, the synergies are very high and these are very accretive acquisitions. We believe that we are going to making a whole bunch more of these in a coming few years as regulations essentially just the water, if you will just keeps on raising, squeezing out all the smaller firms out of the market and at this stage squeezing our relatively big firms out of the market.
Just a bit about – just the FXCM team – the FXCM team as five of its six principals are still active in the business. FXCM principals and management own over 50% of the stock of FXCM. So FXCM management is very vested as a common stockholder very much along side the investors. This is a – we have been founders and management since together for extraordinary lengthy period of time. The average tenure in management FXCM is over 10 years. It’s something that we are very proud of and we are – have one of the – and this is a market if you will there is enormous amount of turnover additional space we are part of the team that we have kept for a very long time.
Opportunities for 2013, wanted to just kind of without going through the whole thing because we are running out of time, a lot of this is, as I said regulations keep coming and there are some pretty serious one. The two that are most important are that CRD IV, which is the minimum cap EU requirements for capital, which is the implementation of Basel III in the EU. The date of implementation is now January 1, 2014. We don’t believe the most of our competitors have the capital to survey that increase.
The other thing that’s happening now is that finally there is a lot of pressure on – especially because of all the reforms in the swaps market on execution. There is lots of pressure on retail, execution in FX to reform for a long very time, obviously, this is for retail, which is more important in protecting institutional customers. We think that our model of agency trading in FX is going to be something that is going to be mandatory in the next year or two. And that’s something that again with 90% of our competitors being principals that is something going to be radically change in the market both short-term and long-term.
I will now turn this over to Robert, our CFO, just to go over little about our financials (inaudible) we’ll give much time there.
Thanks. I’m going to go over our financials relatively quickly. There is a breakout after this if people have more detailed questions.
So you can see here revenues on the left hand side and EBITDA on the right hand side and really the past few years have been the story as Drew said, we in 2008 lost 20% of our revenues were do with interest rate – interest rate differentials disappeared. And as I’m going to show you in the next slide, the volatility of the currency market is in the 45 degree angle down. But, yet we are able to grow revenues and we ping along as kind of $100 million to $120 million in EBITDA. And we are able to do that by just growing the business, the amount of clients that needs deposits with us. And we have done it through some very attractively priced acquisitions.
But what it adds to this thus far as you can see looking at Q1 2013 is after – if these headwinds were to stop, just the sheer earning power of the company and you could see that we did $44 million in EBITDA that was up from $25 million a year before that was up from $27 million in Q4 2012. So, it’s a very scalable business.
And as I said, there in the top left is the VIX in currencies since the beginning of 2009 that has been steadily trending downwards. 2012, it was down 23% from 2011 which ended in itself is not a particularly volatile year. And really how we have done and held our own is, as you can see on the far right. That is a graph of customer equity, the solid blue is plain over organic FXCM. The grey is UK acquisition we made in 2010. And the light blue is two new Japanese acquisitions.
And 2012 despite being a very low volatile year, was still a very good year for us, we grew 14% on balance customers now leave with us over 5 times the amount of client equity that we’ve had in 2008, when we had record results. And as this – this is probably the most important thing for us that we are such a bigger company now if markets were to turn as they have in the first quarter, you can see just how much cash and profitability the company can generate.
I won’t go through this a lot as Drew talked about, we are an agency model. But we are very thoughtful about risk and the company contains risks in a variety of spots in very tangible ways.
Our balance sheet at the end of March we had $273 million of our own cash. And we just recently two weeks ago raised $174 million in a convertible – 5-year convert 2.25% up 50% from our stock price it was a very attractive piece of paper for us. And it really now gives us plenty of ammunition to further consolidate the industry which is purpose of raising money at these levels.
Just a word on our cash generation, 2012 was not a particularly stellar year for us. You can see just how much cash we generate because we don’t have lot of capital expenditures. We generated a $102 million in after-tax cash flows, spent $27 million in CapEx this year. CapEx should be in the low 20s, most people now in the Street have us generating anywhere between $150 million and $180 million of after-tax cash flow.
So, you can see just how the free cash flow generation of this company, how strong it is, and gives us plenty of fire power, we have a share buyback authorization. We pay a dividend and you will see us returning capital pretty significantly to shareholders as Drew mentioned 53% of the company is held by management. And management is very much in the line with shareholders.
So, in sum, we think that the agency model sets us apart from our competition with all the headwinds that we have had over the past five years. We feel that if they were just stop or even become tailwinds that you will be able to see a company that could generate pretty significant profitability. As Drew talked about 20% of our volume single most comes from Mainland China, 15% from Japan, 10% from South Korea, overall 50% from the emerging markets. We are well positioned for growth in the international market. We have pretty strong M&A pipeline which is why we raised the cash that we did. But we will always do it in a disciplined way and at prices that we think are attractive.
We signed up some pretty significant white labels recently with Charles Schwab through optionsXpress launching in July and Vtrade in Barclays last year. And then on our institutional side, we are migrating customers on to our own platform making them a more competitive offering as well as our joint venture with Credit Suisse on the high frequency side.
So in sum, we think we have a lot of drivers which are pretty exciting for us for the next few years. So with that --
Yes, I mean, the thing about FX has been something like 15 years behind equity, right? But the evolution is relatively similar, if you went into equities 20 years ago really banks dominated mostly making – market making activities, the brokering activities all that and that essentially sort of started to dissipate as we had other things.
In FX, that’s not going to be the same because it’s not an exchange traded market, it’s never going to be the exact exchange revolution but that has evolved a lot over the last 10 years. So in the last 10 years, the market has become electronic right and really only became majority electronic probably in the mid-2000, think of how backward that is, right, in comparison to other thing.
And you still have but as the market is evolving, you are having a lot of growth, and actually what you saw, it looks like in equities, margins for trade trend right for all the banks because you have less captive audience that you can charge whatever you wanted of that stuff, but volumes increased by a lot because you had fair market, more democratic market and enormous amount of more participants. And you are starting to see that in FX too. So 5 years ago there was no high frequency trading in FX, today estimates are that’s 40% easy, you know of the market, it’s one of those things that you are starting to see that a lot more.
Fifteen years ago there was no retail FX market, today it is a huge thing, so there is lots of, as the market, evolves, it grows pretty significantly because if you think of how big it was when essentially was done by phone or by chat right like how absurd, was that up until relatively recent. You still have most of the asset managers in FX probably still trade on the phone like a big, they are very large or like(inaudible) mutual funds or buying FX, because they are buying stocks overseas.
And generally speaking during a relatively, still very carefully but if you look at theas what is happening as that’s beginning to change, and it has changed obviously, the more specific customers change first, the people care less about it, those change second, but that’s all happening, and this is sort of, if you will, you are in like the fourth inning of this.
Okay. Can we have a breakout?
Oh, any other last question? If there are no other questions, on behalf of Morgan Stanley, I would like to thank Drew and Robert for your time. Thank you so much.
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