GAIN Capital: Regulatory Problems Affect Revenue, Margins

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IPOs on tap this week include GAIN Capital Holdings (NYSE:GCAP). Ten others are scheduled for the week of December 13, totaling $2.26 billion.

GAIN Capital Holdings (GCAP) is a $154mm IPO with a market cap of $436 at the price range mid-point of $14. It intends to sell 35% of the company with 96% of proceeds going to selling shareholders. The IPO is scheduled for Wednesday, December 15, 2010.


Focused on retail foreign exchange trading, GCAP is a broker, like OptionsXpress (NASDAQ:OXPS). It’s priced at a 50% discount to OptionsXpress. On an adjusted basis, GCAP’s P/E of 11 is half of OptonsXpress’s P/E of 22, annualizing the nine months ended September 30, 2010 .

GCAP Valuation Metrics

GCAP’s earnings are adjusted for conversion of all preferred stock that had the embedded derivatives. GCAP’s reported results included (non-cash) embedded derivative charges, due to charges in the fair value of convertible preferred stock -- all of which is to be converted on the IPO and is reflected in the valuation metrics

There are issues, however. GCAP has had regulatory problems with China, Japan & Canada (see below). Although GCAP’s nine month revenue through September was up 30% on a comparable basis, revenue for the September quarter was down 7% from the June quarter.

GCAP has a very liquid balance sheet; as of September 30, 2010, GCAP had $264mm in cash, or 60% of the market cap at the price range mid-point. Shareholders intend to sell 96% of the shares in the IPO.


GCAP is an online provider of retail foreign exchange trading and related services. It offers customers 24-hour direct access to the global OTC, foreign exchange markets, where participants trade directly with one another, rather than through a central exchange or clearing house.


The distribution of total customer trading volume sourced through direct, indirect, and institutional channels was 50.4%, 37.3%, and 12.4%, respectively for the nine months ended September 30, 2010. For the year ended December 31, 2009, total customer trading volume sourced through direct and indirect channels was 65.4% and 34.6%, respectively.



For the year ended December 31, 2009, net revenue associated with customers residing in China was immaterial compared to $24.4 million for the year ended December 31, 2008. In May 2008, GCAP became aware of a China Banking and Regulatory Commission prohibition on forex trading firms providing retail forex trading services through direct solicitation to Chinese residents through the internet without a China Banking and Regulatory Commission permit.

As of December 31, 2008, GCAP no longer accepted new customers from China. However, GCAP now believes that it can accept customers from China if the customers come to the company’s website without being solicited by the GCAP or by GCAP’s introducing brokers, agents or white label partners to do so. As a result, the GCAP began accepting customers from China in this manner in June 2010. The GCAP cannot provide any assurance that it will not be subject to fines or penalties, and if so in what amounts, relating to its forex trading services through the Internet to Chinese residents.


A number of GCAP’s customers reside in Singapore. GCAP is not currently licensed to trade forex in Singapore, but has been in contact with the Monetary Authority of Singapore and plans to register for a license after successful completion of the IPO. If GCAP is required by the Monetary Authority of Singapore to cease accepting customers prior to receiving a license, GCAP will direct all existing customers to a white label partner.


  • GCAP has received an inquiry from the Financial Services Agency in Japan concerning which of operating subsidiaries supports customers resident in Japan. Although GCAP only solicit residents of Japan directly from Japan Co., Ltd., GCAP’s registered Japanese broker, GCAP has previously accepted customers resident in Japan in GCAP’s other non-U.S. operating subsidiaries.
  • GCAP is currently responding to the inquiry and has voluntarily ceased accepting customers resident in Japan in any operating subsidiary other than Japan Co., Ltd. If required by the regulator, GCAP will transfer all existing customers resident in Japan to Japan Co., Ltd.


GCAP’s trading services may not have been, and may not currently be, compliant with the regulations of each province and territory. In June 2005, GCAP was advised by the British Columbia Securities Commission, or BCSC, that GCAP was required to register as a dealer to offer trading services directly to residents of that province. GCAP has therefore conducted business in British Columbia through Questrade, Inc, a registered investment dealer in Canada, since August 2005.

Quebec & Ontario

In addition, on October 30, 2009, the Ontario Securities Commission, or OSC, issued interim guidance pursuant to a staff notice which took the position that rolling spot foreign exchange contracts and similar over-the-counter derivative contracts sold using a trading platform similar to ours fall under the definition of securities, which would, absent exemptive relief, require, among other things, GCAP to comply with the dealer registration and prospectus delivery requirements of Ontario securities law.

In November 2010, GCAP received correspondence from the Ontario Securities Commission (OSC) requesting information about customers and business practices in Ontario and asking GCAP to explain why its activities should not be considered in breach of dealer registration and prospectus delivery requirements under Ontario securities law.

  • In its letter, the OSC states that it is acting in conjunction with the BCSC and the Quebec financial industry regulator, the Autorité des marchés financiers, or AMF, in its review of GCAP’s activities.
  • GCAP has also received notices from the AMF asserting violations of derivatives regulations in that province and directing GCAP, in light of the alleged contraventions of regulatory requirements, to cease providing services in Quebec.
  • Effective November 22, 2010, GCAP is directing all new customers resident in Quebec and Ontario to its white label partner, Questrade, Inc. If required by the regulators, GCAP will also transfer all existing customers resident in Quebec and Ontario to Questrade, Inc.


The retail forex trading market is fragmented and highly competitive. Competitors in the retail currency market can be grouped into several broad categories based on size of net capital, technologies, product offerings, target customers and geographic scope of operations:

  • Market Leading Forex Trading Firms: include other firms with similar business models, such as Forex Capital Markets LLC, Global Futures & Forex, LLC and OANDA Corporation. The firms within this category are primary competition for existing forex trading services.
  • Small/Specialized Forex Trading Firms: include firms such as Capital Markets Services, LLC, FXDirectDealer, LLC and InterbankFX, LLC. These firms, to date, have not been core competitors due to their smaller size and technology and marketing limitations.
  • Other Online Trading Firms: include firms such as OptionsXpress Holdings, Inc., E*TRADE Financial Corp., TDAMERITRADE and Scottrade. These firms are generally either niche players focused on a particular product, such as equity options, or traditional online equity brokers, that have expanded into other financial products that may already, or will in the future, include forex trading.
  • Multiproduct Trading Firms: include firms such as Saxo Bank, CMC Group, IG Group Holdings plc, City Index Limited and Interactive Brokers LLC. Among these firms, U.S. firms tend to focus on listed products and provide forex principally as a complementary offering. Other than Saxo Bank, the international firms tend to focus on CFDs.


$5.7 million from a sale of 400,000 shares from the company will be used to cover historical and expected costs from the IPO. Shareholders intend to sell 10.6mm shares, 96% of the IPO.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.