Look For Further Gains Ahead From GAIN Capital Holdings

| About: GAIN Capital (GCAP)
This article is now exclusive for PRO subscribers.

Summary

Strong earnings results look set to continue from the owner of forex.com.

The acquisition of GFT is a game changer and positions GAIN to consolidate a fragmented industry.

Look for top-line growth as the company continues growing its retail and institutional businesses.

Shares remain cheap based on several metrics and look for further share buybacks and a higher dividend payout.

The company remains underfollowed with only 4 sell-side analysts covering the company.

Shares of GAIN Capital Holdings (NYSE:GCAP) got a nice bounce after beating earnings last month. Even still, the stock is set to continue higher, as it is still extremely cheap. Furthermore, its forex.com site remains one of the premier sites for forex trading, which continues to grow in popularity. GAIN continues to grow in terms of attracting both retail and institutional clients. I see shares also rising as GAIN attracts more sell-side coverage, as only four analysts currently cover the company.

chart.png

Fourth quarter earnings came in at $0.13, which beat the consensus by $0.05. Revenues also beat expectations and came in $4.52 million higher at $83 million. EBITDA for the quarter was $13.4 million.

The acquisition of GFT drives Q4 and full year results

The acquisition of GFT has really transformed GAIN Capital. GFT gave GAIN a broader client base and product offerings for its retail OTC business. In Q4, GAIN's retail OTC trading business generated revenue of $61.4 million. This is quite the increase from the $22.9 million the business generated in Q4 of 2012. Total trading volume showed a marked increase as well, rising from $298.8 billion for Q4 of 2012 to $508.0 billion in Q4 2013.

For all of 2013, compared to 2012, the retail OTC trading business generated revenues of $205.1 million versus $127.5 million. Total trading volume rose to $1.8 billion from $1.3 billion.

The commission business offers tremendous potential

GAIN's commission-based businesses also posted phenomenal growth in Q4 and for the full year. The institutional business grew as a result of the merger as well, with traders now serving clients in both forex and futures trading.

In Q4, total revenues for the institutional business came in at $23 million, compared to $8 million in the prior year. Institutional trading volume was $1.1 trillion, up from $538 billion a year earlier. Daily Average Revenue Trades (DARTs) were 15,049 during the fourth quarter, up from 13,049 in the prior year. Total client assets rose 66% to $740 million.

Year-over-year results justify a higher share price and higher multiples

In 2013, revenues rose 76% from 2012 to $266 million. Net income rose to $31.3 million from $2.6 million. EPS went from $0.07 for all of 2012 to $0.79 for 2013. Full-year EBITDA rose 450% to $61 million, from only $11.1 million. Institutional trading volume doubled from $2.0 trillion to $4.0 trillion.

I look for the company to continue achieving its expected combined total cost savings of $35 million to $45 million by Q4 of this year. These cost savings will go straight to the bottom line and margin expansion. The cost savings will come from reduced headcount, office consolidation, and the elimination of GFT's $15 million in annual marketing spend.

Right now, GAIN has a gross margin of 67% and an operating margin of 18%. I look for these margins to continue to expand, particularly the operating margin, which I see growing into the low 20s on a percentage basis.

Look for growth organically and in its partner-related businesses

A strong boost for GAIN is that the forex and futures markets have been active and volatile. This has more customers trading and GAIN should benefit, especially as forex and futures trading becomes more popular.

One area where GAIN excels is in terms of its product offerings. Since the GFT acquisition, GAIN has gone from having a few hundred different products to having over 12,000 today. As the company expands its product offerings, that benefits in attracting more customers and, in particular, institutional and more sophisticated customers that are long-term customers. Customers benefit being able to trade across asset classes.

The other growth area for GAIN is in its partner business. This business now accounts for 60% of total retail trading volume, up from 40% in 2012. I see this business continuing to grow for GAIN, especially as more partners seek access to GAIN's leading product offerings.

Its ECN platform continues to gain more users

GAIN's ECN platform, GTX, continues to gain more participants. This helps build liquidity and allow for higher volume transactions. Quarterly average daily volume has grown at a compounded annual rate of 14% since 2011. By having its own ECN platform, it benefits GAIN's customers that receive better executions and liquidity. I look for GTX continuing to grow with more users and participants, boosting GAIN's businesses across the board.

The addition of futures trading presents an opportunity in a fragmented industry

18 months ago, GAIN added the futures trading division of Charles Schwab to its portfolio. Futures trading remains fragmented, particularly in retail futures trading. This comes as the market has seen the blowups and frauds committed at MF Global, Refco and PFGBest.

I see GAIN being able to consolidate and strengthen the retail futures trading industry, especially with its well-known platform forex.com. Its platform remains well-know among retail traders and with its new product offerings, I see GAIN and forex.com being able to capture more retail customers and grow its market share.

On the company's earnings call, CEO Glenn Stevens laid out his acquisition plans.

"The GFT acquisition was the largest one that Gain has made to date because it does contribute a long string of successes that we've had in terms of being an active acquirer and a consolidator in the space. And it's important to note that's part of our growth strategy going forward. So, we have maintained significant capital levels to fund additional opportunities that arise. We've tapped the capital market for a successful convertible bond offering in the last quarter. We have some dry powder in other sources as well, so it's more importantly even than the resources available, it is the bandwidth and the operational expertise available and we have an internal team that has battled, tested frankly in getting these integrations done successfully. And so the early indication on GFT is that our preparation and our focus on getting the deal done successfully has borne fruit."

I look for GAIN being able to look for acquisitions to complement its institutional business, futures trading, and its retail OTC business. Potential targets are far and wide and I like the strategy GAIN has put in place.

Shares have further upside

Shares of GAIN look attractive from several levels, For one, the company remains an active buyer of its own shares. GAIN repurchased 612,000 during Q4 and has repurchased 100,000 so far this year. The company is also shareholder-friendly with its 2% dividend yield. I see the dividend increasing since it's only a 25% payout of earnings.

In terms of revenues, this year I see the company posting revenues of $340 million. This will be the first full year of operations with GFT in the fold. I see EPS coming in at $1 this year and $1.20 next year. This will come from the full realization of the combined cost savings and organic growth. I don't see a major acquisition this year, but expect GAIN to make another transformative acquisition next year, after it has fully completed the GFT integration.

Diving deeper into valuation, GAIN is trading at only 8.5x next year's earnings. Its PEG ratio is extremely low at 0.61. GAIN also trades at only 1.49x sales and 1.69x book. Its balance sheet is strong for both acquisitions and share buybacks with $39 million in cash and $65 million in debt. Its ROE remains an impressive 15.73%.

Bottom line

I see the acquisition of GFT as a game changer for GAIN and shares look extremely undervalued considering the company's growth potential. In the forex industry, there's no better name to own than forex.com, and that is GAIN's foundation that it continues to build on. I see Mr. Market realizing the potential of GAIN and as its market cap grows, look for more sell-side analysts to jump on the GAIN bandwagon.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.