Investment Technology Group: POSIT-tively Cheap

Investment Technology Group's (ITG) 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 operates in the United States, Canada, Europe, and Asia-Pacific. ITG’s flagship POSIT system enables clients to trade confidentially amongst themselves using proprietary algorithms to match buy and sell orders without human intervention.

The frantic pace of trading in 2006 – 2008 pushed ITG’s revenues and earnings to all time highs in each of those years. 2009’s depressed market volumes have contributed to lower sales and earnings for 2009. Zacks now sees 2009 EPS of $1.56 versus 2008’s record level of $2.61. Consensus views for 2010 range around $1.85 - $1.90.

As would be expected, ITG shares tumbled from a 2008 peak of $53.30 to a November 2008 low of $13. The shares climbed steadily to hit a recent high of $28.90 before plunging back to this morning’s quote of $19.60.

Here are ITG’s per share numbers from continuing operations as reported by Value Line:

Year	Sales	C/F	EPS	B/V	Avg. P/E	52- Week Range
2003	7.47	1.38	0.89	8.08	19.0x	10.90-24.70
2004	7.97	1.43	0.95	8.83	15.5x	11.90-20.20
2005	9.47	1.93	1.50	10.72	16.6x	16.60-40.90
2006	13.68	2.59	2.05	13.88	22.6x	34.40-59.10
2007	16.82	3.39	2.48	16.20	16.8x	35.40-48.70
2008	17.61	3.90	2.61	18.17	13.3x	13.00-53.30

At $19.60 /share ITG sells for < 12.6x this year’s depressed earnings and about 10.6x the 2010 expectations. Those are very low valuations compared with all the historical multiples seen in the chart above.

Value Line is using a normalized P/E of 20x in computing their 3 – 5 year target price. I’m going with a more conservative 15.5x multiple in calculating my 12 to 15-month target of about $28 - $29. That would still support a 45% move from the current quote.

Is that a reasonable expectation? I think so and Morningstar concurs. They give ITG a 4-Star (out of 5) rating and assign a ‘fair value’ of $27 /share. S&P gives ITG their highest ranking for ‘fair value’ with a present estimate of $26.50 /share.

It’s worth noting that even at $26.50 - $28.50 these shares would be trading well below the lows during 2006 – 2007 and at less than half the all-time high of $59.10 set in 2006.

Investment Technology’s balance sheet is solid with total debt of less than $60 MM versus treasury cash of over $354 MM.

If you’re interested, but cautious, you could consider selling (writing) some puts that would give you moderate upside with a margin of safety built in to offer some protection against loss.

Here are some five-month options that meet those criteria:

ITG April Expiration	Premium / sh.	Break-Even	Margin of Safety
Sell $17.50 puts	$1.25	$16.25	$3.35/sh. = 17.1%
Sell $20.00 puts	$2.40	$17.60	$2.00/sh. = 10.2%
Sell $22.50 puts	$3.90	$18.60	$1.00/sh. = 5.1%

Summary:

The recent pull-back from $28.90 to Friday’s $19.60 seems to offer upside of 40 – 50% with only moderate risk unless you think the market is going to melt down again.

Writing puts at strikes of $17.50 - $22.50 would allow decent upside over the next 5 months with downside protection of 5 – 17%.

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

Comments

[Paul Price]

My previous buy/write [published here and on beatingbuffett.com last April] worked out quite nicely with a cash-on-cash return of 53% for a six-month holding period that ended Oct. 16th.

2009 Nov 16 07:51 AM

[igggy]

Paul, wouldn't you expect some insider buying if a stock is greatly undervalued? There is none at ITG. It's not like the insiders already one a big chunk of the company (only 1% in fact).

At least there is some buying at NITE, also your recommendation.

2009 Dec 05 03:37 AM

[Paul Price]

The Dec. 14, 2009 edition of Barrons ran a very favorable piece on ITG.

They noted, as I did, that ITG is not too much above its March lows while its prospects look extremely good. They see a $27 price target for ‘fair value’ without assuming any improvement in business fundamentals.

They also noted that ITG holds $295 million in cash - net of all debt- or $6.69 /share. They see little risk and very good upside.

I have continued to add to my ITG position and stick with my original goal of at least a 40 - 50% upside move.

2009 Dec 13 09:42 AM