Interactive Brokers Group at a Cyclical Low Point Should Tempt Buyers

Mar. 5.10 | About: Interactive Brokers (IBKR)

Interactive Brokers Group (NASDAQ:IBKR) is a web-based, global electronic market maker and broker specializing in routing orders and executing and processing trades in securities, futures and foreign exchange instruments on more than 80 electronic exchanges worldwide.

As a market maker, the firm provides bid and offer quotations on approximately 577,000 securities and futures products listed on electronic exchanges. As a direct market access broker, it serves customers of both traditional brokers and prime brokers. They provide customers with state-of-the-art order management, trade execution and portfolio management at consistently rock-bottom commission rates.

Interactive Brokers came public via the same "Dutch Auction" process Google (NASDAQ:GOOG) used when it held its IPO. The April 2007 starting price was set by its bidders at $30.01 per share during the final stages of the last bull market. Shares peaked at $34.25 and $35.93 in 2007 and 2008, respectively, before breaking down with the overall market in late 2008-early 2009.

The shares bottomed at $12.68 a year ago, rebounded to $20.99 last October and then dipped again into the $16 area this January after posting poor fourth-quarter earnings. At this afternoon’s quote of $17.15, IBKR shares offer great potential for investors with a one- to two-year time horizon.

The company earned $1.16 per share in the nine-month stub period from its IPO through year-end 2007, then $2.24 per share for full-year 2008 despite the nasty market environment. Earnings fell to just $0.87 per share in 2009 due to compressed overall volume and almost no ability to earn money on free cash balances due to the near-zero interest rate environment.

Expectations for 2010 range from S&P’s $0.89 to Reuters' view of $1.11 and Value Line’s $1.32. All three services see much improved earnings for 2011, with current estimates in the $1.38-$1.47 range.

With the market averages in solid rebound mode and the assurance that U.S. interest rates eventually will rise again, I am even more bullish for both this year and next. IBKR trades FOREX, futures and options in addition to its basic equities and fixed income businesses and these are all high growth areas.

How do I come to a target valuation here?

Year
Annualized EPS
P/E Range
Book Value
P/BV Range
52-Wk. Range
2007
$1.54
13.7X – 22.3x
$10.17
2.1x – 3.4x
$21.00 - $34.25
2008
$2.24
5.7x – 16.0x
$12.68
1.0x – 3.8x
$12.72 - $35.93
2009
$0.87
14.2x – 24.1x
$13.95
0.9x – 1.5x
$12.68 - $20.99
Click to enlarge
Before the market collapse, Interactive Brokers had never traded below 2.1x book value. When times were good, IBKR hit levels exceeding 3x book value in both 2007 and 2008. Even in the unusually depressed climate of 2009, the stock hit 1.5x book value at its peak even though earnings still finished well below prior-year levels. Book value should reach at least $14.90 by year-end 2010. Even 1.5x that figure would see IBKR shares back at $22.35, or about 30% above today’s quote. This target could be much higher if earnings surpass the very pessimistic projections now on the Street.
Using a 15 multiple as a low-end "normalized" P/E and looking out a year or so brings me to a similar minimum target based on forward earnings for 2011 of at least $1.50 share.
I have no special access to company information, but I have heard rumors that CEO and President Thomas Peterffy might consider taking the company private again while the share price is depressed. It would make sense if he has access to enough capital, considering that he gathered more than $30 a share during the 2007 IPO.
If you’d like to play with IBKR but don’t see a near-term catalyst, you might consider selling some January 2011 puts at very attractive prices. Here are some good ones and today’s prices:
January 21, 2011 Expiration
Premium/Share
Net Cost if Put
Margin of Safety*
$15.00 Puts
$0.85
$14.15 /sh.
17.49%
$17.50 Puts
$2.00
$15.50 /sh.
9.62%
$20.00 Puts
$3.70
$16.30 /sh.
4.95%
Click to enlarge
*Margin of Safety refers to how far the break-even point "if put" is below the current price of $17.15 per share. You give up some safety as you write more aggressively, but the trade-off is for higher potential profits as the premium income is much higher with the $17.50 and $20 strike price puts.
Disclosure: IBKR is one of my largest long positions and I am also short IBKR options.