Interactive Brokers (NASDAQ:IBKR) is an automated 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 100 electronic exchanges and trading venues around the world. Since its inception in 1977, IB has focused on developing proprietary software to automate broker-dealer functions. The advent of electronic exchanges in the last 21 years has provided a huge amount of opportunities to integrate with an increasing number of exchanges and trading venues into one automatically functioning, computerized platform that requires minimal human intervention.
Around 50% of revenues come from Electronic Brokerage. IB offer customers access to all classes of tradable, primarily exchange-listed products, including stocks, bonds, options, futures, forex and mutual funds traded on more than 100 exchanges and market centers and in 19 countries around the world.
The other 50% is driven by market making offering competitively tight bid/offer spreads over a broad base of over 867,000 tradable, exchange-listed products. As principal on the trades, IB commit their own capital and derive revenues or incur losses from the difference between the price paid when securities are bought and the price received when those securities are sold. The company maintains and monitors tight limits over all positions in individual stocks, products and markets.
The company has been through a bit of a roller coaster rid in recent years. Revenues and profits fell off a cliff in 2009. Brokerage volumes increased by around 1% but were offset by a sharp narrowing of bid/offer spreads, particularly in the U.S, due to the increasing level of competition in the listed options market. Much of this competition came from the increasing presence of high frequency traders (HFTs) in the listed options market where they compete with market makers but pay no exchange fees and their orders are given priority over market makers quoting at the same prices.
However the environment began to improve towards the end of 2010 until the earthquake and tsunami in Japan in March 2011 caused a spike in trading and volatility levels. Then, in August, the U.S. government credit rating downgrade by Standard & Poor's, ongoing concerns over European government debt and the threat of credit rating downgrades across the euro zone caused volatility levels to remain elevated for several weeks. This higher volatility boosted market making profits and trading volumes. Additionally, bid/offer spreads in exchange-listed options also widened meaningfully from the historically low levels of the prior year when HFT activity peaked.
However things began to slow down again in 2012 compared to the results posted last year. Exchange-traded stock and options volumes continued to decrease well into the first quarter and stabilized only towards the end of the period. In the market making segment, option volume decreased 13% during the first quarter, driving market share in that segment from 7.1% to 6.2% globally and from 8.7% to 7.7% in the U.S and the profitability of trading was reduced by a drop in the ratio of short term to long term volatility which is a key driver of profitability.
As a result Q1 profits fell from $203mm to $141 million. However, excluding a $54 million currency translation gain in 2011 the drop in earnings if a $54 million currency translation gain in 2011 is excluded.
Trading on $14.72 or 11.7 times historic earnings, IB looks cheap. The recent slowdown is industry wide and could reverse sharply if co-ordinated central bank attempts to boost liquidity and growth take hold. Current consensus forecast point to 2012 full year EPS of $1.22 and five year annual EPS growth estimated at 12.5%.
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