GFI Group: It's Not Your Typical Brokerage

I have followed GFI Group (GFIG) for some time.  The stock is currently well off its highs but at its current levels still represents a rare opportunity for investors to profit from one of the world's most rapidly growing and changing components of the financial market. 

The trading of derivatives has been at the heart of the current credit crunch; this is primarily because the market for individual securities can become illiquid incredibly fast.  Credit derivatives currently account for a little of 30% of GFI Groups revenue.  This slight reliance on derivative trading, which has been disrupted by the credit crisis, has contributed to the decline in price of the company’s stock.  Even with a slow down in the derivative business, the company has still managed to grow its top and bottom lines at a healthy clip. 

I strongly believe that significant upside remains for the company and if you are interested, my detailed analysis of GFI Group it can be found here.  

The primary fear with GFI Group’s credit derivative business is that it will dry up because of the prolonged impasse in the credit market.  GFI Group's derivatives business was built on the idea that the firm could profit from placing trades for clients who were seeking to trade less commoditized derivative products.  Generally speaking, the markets for these products tended to be less liquid.  As a result, with the onset of the credit crunch the division growth slowed considerably.    

Even with the current issues in the credit markets, it is clear that derivatives are here to stay.  The brokerage firms that are best positioned to deal with the market will deliver outstanding returns to their shareholders in the future.  It has always been my opinion that all the industry needed was some type of exchange where derivative products could be traded.  Such an exchange would improve liquidity and allow for more oversight of one of finance's least regulated markets. 

Should such an exchange ever develop, GFI Group, as a market leader is uniquely position.  While per trade revenues would likely decline, the proliferation of trading in derivatives caused by a massive increase in liquidity would dramatically increase GFI Groups total revenue as volume would more then make up for any price declines. 

It would appear that the foundation for some type of derivative exchange is currently being built.  A New York Times article earlier this week outlined a meeting of Wall Street executives that took place on Monday at the behest of the Federal Reserve.  The meeting focused on the need to develop a derivative exchange that would allow for a more transparent and liquid marketplace.  The executives have agreed to move in this direction with the creation of a clearinghouse of sorts for derivatives where investment banks will go to register trades.

If such an exchange were to be developed, I am positive that GFI Group would be the brokerage at the forefront and that it would be best positioned to profit from one of finance’s largest markets.  This new development in the derivatives market, when combined with an already extraordinary low earnings multiple, large cash position and a substantial growth rate, make GFI Group a long term buy.         

For Further Review:

NY Times Article on Derivatives 

Disclosure: Long.

Comments

[tginomorebush:]

TOTALLY agree with your analysis and assumptions.

2008 Jun 11 08:31 AM

[Edward J. R...:]

I agree with your comments. You did not mention the low valuation relative to likely future prospects and the insider buying.

Edward Roche, President Freedom Mountain Investments

2008 Jun 11 06:55 PM

[ergo sum:]

what you fail to mention is that the credit derivatives team LEFT with 50 million in yearly busines...and their credit derivatives slowdown has nothing to do with what you describe. In fact the Credit default swap market is going gangbusters in this default filled world.
It also remians to be seen if the proposed exchanges come to pass, and whether they will have any impact on the predominantly voice brokered market....so what are you smoking exactly?

2008 Jun 12 01:08 AM

[ergo sum:]

Credit derivatives currently account for a little of 30% of GFI Groups revenue. ---basically a meaningless statement....

2008 Jun 12 01:12 AM

[ergo sum:]

dishonesty in the sub prime mortgage markets and greed on wall street which securitized and resold that dishonesty account for the credit crunch not derivatives. And numbskulls like yourself who don't bother to investigate what they right about help too.

2008 Jun 12 01:17 AM

[ergo sum:]

write...

2008 Jun 12 01:19 AM