Interactive Brokers Group, Inc. (IBKR) reported earnings in late April and beat analysts' estimates hands down. The company earned 66 cents a share compared to 31 cents for the first quarter last year which is good for an impressive 112.9% increase. Net revenues were $528.4 million which compares to $330.8 million last year.
Despite the fact that the company is a brokerage by name, the majority of the income came through market making activities where traders make the firm money by offering liquidity to the market and taking advantage of the spread (difference between the bid and the ask price for financial instruments.) The term “traders” is used lightly as more often than not, the trades are executed electronically with little or no human intervention. Software is created to keep a tight grip on risk parameters so that there are very few unpleasant surprises that might be associated with a human trader taking too large of a position.
The market environment in the first quarter was extremely beneficial to IBKR as disconnects in the financial area led to increased volume traded and at the same time, the spread on many contracts widened significantly due to the volatility. Interactive Brokers took advantage of this situation and this is accounted for in its attractive earnings numbers. While the positive surprise is certainly encouraging, investors should be cautious not to extrapolate this type of growth out into the next several quarters. While markets still continue to trade with more volatility than was seen over the past year, the second quarter has so far been more sanguine which will likely keep the company from reporting further significant surprises.
In one of the more unique offerings we have seen this year, management formally issued a tender offer for 50 million shares at a minimum of $33.50 per share. On the surface, this does not seem like such an abnormal offer unless you note that at the time, the stock was trading below $28.00 per share. But Interactive Brokers has been consistent in offering its stock in atypical formats.
The decision to come public by using niche underwriters instead of the larger established Wall Street firms has likely played a part in the low amount of coverage received from analysts, which in turn may have a negative effect on the stock price. A careful reading of the IPO documents will uncover a plan to offer 12.5% of the company’s float each year for 7 years. Management recently commented that the offering would hopefully increase the float to a level where more institutions would be able to participate in the stock.
Since the report, the stock has climbed into the low 30’s but still failed to cross the stated minimum price for the tender offer. As such, the company has withdrawn its offer and has stated that it will not register another public offering until April 15, 2009. While this likely increases stockholders confidence that their interest will not be further diluted, the thought of twice the number of shares hitting the market next year could still hang over the price and serve as resistance.
Still, the fundamentals are in place for this firm to grow rapidly over the next several years. Diversification efforts have transformed the firm from one that trades primarily options to an organization that now only receives 40% of its trading gains from US options. As its presence continues to grow in its 3 active continents, (North America, Europe and Asia/Pacific), the geographic diversification should continue to help groom a stable revenue base. Risks appear to be well under control with the debt to equity ratio at a healthy 7.8%, and management noted that its only counterparty risk is with established clearinghouses instead of individual clients.
The stock trades just under 17 times this years expected earnings which is an attractive multiple given the strong profit margins and the expected future growth. Volatility should remain in the market for at least the next several months giving the company a chance to capitalize on the next few quarters' earnings announcements. Since the immediate pressure from the stock offering is now off the table, it appears that this is an attractive time to pick up shares of this well run, growing company.
Disclosure: Author does not have a position in IBKR.