POSITive on Investment Technology Group

Investment Technology Group: (ITG) May 28, close: $40.62

52-week range: $35.36 [Aug. 16, 2007] - $53.35 [May 1, 2008]

ITG provides technology-based trading services and research to institutional investors and other industry professionals. Its flagship POSIT system allows clients to trade securities confidentially using their proprietary algorithm to match buyers and sellers electronically. The also own the Macgregor trade order matching technology and the Plexus (transaction cost analysis) system.

Non-U.S. revenues were about one quarter of 2007 revenues. The company has been absolutely booming since 2003 with major growth in virtually every category. Here are their last five years of per share data as reported by Value Line in their latest full-page report dated April 25, 2008:

Year …... Sales…... Cash Flow ....... EPS …..Book Value …...Avg. P/E

2007 ….. $16.82 …. $3.04 …….. $2.48 …… $16.21 ……… 16.9x

2006 ….. $13.68 …. $2.59 …….. $2.05 …… $13.88 ……… 22.6x

2005 ……$9.47 ….. $1.93 …….. $1.50 …… $10.72 ……… 16.6x

2004 ……$7.97 ….. $1.43 …….. $0.95 ……. $8.83 ………. 15.5x

2003 ……$7.47 ….. $1.38 …….. $0.89 ……. $8.08 ………. 19.0x

Those numbers represent outstanding, steady growth in what is perceived to be a volatile industry.

Consensus estimates for 2008 and 2009 are now at $2.84 and $3.28 respectively. At today's close of $40.62 ITG shares are trading for 14.3x this year's and just 12.4x next year's projections. That's quite cheap for ITG shares based on historical valuation measures. The company first traded as a separate entity in 1994.

In fact, the last time ITG was available at this multiple was in mid-2004 during that year's market doldrums. Buyers of ITG back then saw the shares surge from a low of $11.90 to $59.10 in less than two years as the market heated up again.

Investment Technology has a nice balance sheet. Total debt was just $234 MM at year-end 2007 and was just 16% of capitalization. Long-term interest was covered 15x and total interest coverage was a healthy 8.8x. Net profit margins over the past 10 years have never been lower than 12.3% and have exceeded 20% in three of the ten years.

The past five years saw an average P/E of 18.1x. Even a conservative 16.5 multiple on 2008 expectations of $2.84 lead me to a target price of $46.86. On the 2009 projection I could see the share at more than $54.

Is that a crazy assumption? Not for me. These shares hit their YTD high of $53.35 this month. ITG traded as high as $59.10 in April of 2006 [and at 28.8x forward earnings of $2.05 that year]. In early 2002 ITG hit $54.40 or a trailing P/E of > 34.

As a straight purchase at today's quote you'd see a net gain of about 33% by the end of 2009 using a lower than typical P/E assessment of 16.5x. This is a classic GARP (growth at a reasonable price) play right now.

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For those of you that feel comfortable with options here is another way to play with ITG right now.

…………………………………………….......Cash Outlay …..Cash Inflow

Buy 1000 shares ITG @ $40.62 …………… $40,620

Sell 10 ITG Jan. 2009 $40 Calls @ $5.40 ………………….. $5,400

Sell 10 ITG Jan. 2009 $40 Puts @ $4.60 …………………… $4,600

Net Out-of-Pocket …………………………..... $30,620

On expiration date (Jan. 20, 2009) if the shares remain above $40

and… they are > $40 already:

Your shares willed be called away [sold] for $40,000.

The puts you sold will expire worthless [a good thing for you as a seller].

You will be left with no shares, no option liability and $40,000.

That's a $9,380 profit on a cash outlay of $30,620 for a cash-on-cash return of 30.6% over the eight months of the trade. How does that sound to you?

Consider that this 30.6% maximum profit is achieved...

• If the shares are unchanged.

• If the shares go up.

• If the shares go down to $40 (a drop of 1.52%).

What's the risk?

The break-even on the shares you bought originally is $40.62 less the $5.40 call premium = $35.22 /share.

The break-even on the puts you sold is the $40 strike price less the put premium = $35.40 /share.

Your worst case scenario would have you owning 2000 shares of ITG at an average cost of $35.31 /share. That price is lower than the absolute low price touched in either 2007 or 2008 and very close to the 2006 low of $34.40.

POSITively wonderful in my book.

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