GFI Group Is Not Your Typical Brokerage

I have followed GFI Group (GFIG) for sometime.  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 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 Group's 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 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 finances least regulated markets.  Should such an exchange ever develop, GFI Group, as a market leader is uniquely positioned.  While per trade revenues would likely decline, the proliferation of trading in derivatives caused by a massive increase in liquidity would dramatically increase GFI Group's 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

[Greg Feirman1:]

A key worry with GFIG also appears to be any exposure they might have on their balance sheet to paying out on any credit default swaps should someone go under. They keep saying they have no exposure on their balance sheet and act only as a broker. But these fears have weighed on their share price, unfairly in my opinion.

What makes you so sure GFIG would be a primary beneficiary of any centralized clearing house? Wouldn't the bigger brokers try to muscle in and take over this lucrative business?

2008 Jun 12 07:46 PM

[ergo sum:]

Utter non-sense. They are a broker so they have no exposure to pay on a default swap unless they are stuffed. And Having lost their whole A Team in credit default swaps its unlikely they are doing as much business, re the lost 50 mil a year.
"Clearing house of sorts" what sorts. What does that mean. Does it mean you have no clue what you are writing about?

2008 Jun 12 11:36 PM

[ergo sum:]

Its nice to see that not only do you have know idea in this article what you are writing about but that you also censor comments correcting the facts as you have mine in the last twenty-four hours.
Brokers don't really have 'balance sheets' like banks do. Brokers interbank brokers have almost no overhead to speak of except computers and rental space.... Clearly the column should be renamed
"Affirming the ignorance of the Ignorant"

2008 Jun 12 11:40 PM

[ergo sum:]

Massive increase in liquidity? Lets see BIS says derivatives are at 576 trillion dollars and rising how much liquidity do you want? Or is it you are confounding your vague notion of the lack of liquidity first IN CP, then SIV , then Subprime mortgages, somehow with the complete other end of the spectrum Credit default swaps? The inability to distinguish one three letter acronym from another starts here apparently.
No, UFOs are not a financial product or derivative.

2008 Jun 12 11:45 PM

[ergo sum:]

By the articles, "line of thinking" if you can call it that...when you lose your cash cow you are a good investment. So we should all be buying AMBAC and MBIA and even LEHMAN and UBS because their business models or practice of their business models have failed. Yup I see your point. I would have preferred to have bought the credit default protection.

2008 Jun 12 11:48 PM

[ergo sum:]

hopefully there are not 'rouge' traders
did you mean 'rogue traders' at their competitors
when you meant 'rogue brokers', and really they are brokers that just left for another interbank broker...not rogues in any sense like a rogue trader.
Do you know the difference between wholesale and retail brokers? Go visit. It should help.

2008 Jun 12 11:58 PM

[wobatus:]

ergo sum, I assume you are short or a rogue broker. :)

2008 Jun 13 08:16 AM