Tiger Broker's IPO Deep Dive: Interactive Brokers Implications?

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Value Vault
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Summary

  • I’ll share learnings from reading the SEC prospectus that Chinese Tiger Brokers filed pre-IPO.
  • My main takeaway is that the money raised in the IPO will be highly beneficial to Interactive Brokers shareholders.
  • Tiger Brokers is the largest and fastest growing introducing broker to Interactive Brokers.
  • I estimate IBKR's profits from TIGR to be almost as large as TIGR's revenues.

Tiger Brokers (TIGR) describes itself as the largest online broker focused on

  • Mandarin speakers
  • offering international brokerage.

Tiger Brokers intends to IPO shortly and filed its F-1 on the SEC website (see here). Tiger Brokers' publicly listed C-Corp goes by the official name of "Up Fintech Holdings".

TIGR boasts famous investors Jim Rogers, Xiaomi and IBKR.

In this analysis, I will lay out how Interactive Brokers (NASDAQ:IBKR) shareholders are highly likely the ones to benefit from the IPO proceeds that TIGR will get. We are long IBKR as a long-term investment.

The first things that pop out are TIGR’s large market share in its self-defined segment (see above); it boasts a 58% market share. Employing a mobile-first corporate philosophy, TIGR’s main product is its app. I believe TIGR’s app is sleek and very responsive. One can register seamlessly on the app itself using selfies and photos of one’s ID card. For Westerners, Tiger Brokers is comparable to fintech Revolut or Robinhood in the US (the latter is known for easy stock brokerage, the former will introduce stock brokerage soon).

This allowed Tiger to grow very fast: In a few years from its founding in Q3 2015, Tiger amassed half a million accounts, 2.4 billion USD in client equity, and a run-rate annual trading volume of 150 billion USD (based on Q4 numbers). To put this in perspective, customer equity, trading activity had CAGR’s of respectively 152% and 217%. See below for the quarter-on-quarter growth evolution of the KPI’s:

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Figure 1 Own calculations based on TIGR's F-1 filing

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Figure 2 From TIGR's F-1 filing

I will first go over the growth drivers before I embark on the implications for IBKR shareholders.

Tiger’s growth drivers are:

  • Private Chinese wealth compounded at 16.5% CAGR in the last 5 years
  • Only 11% of Chinese investable financial assets are in stocks, versus 35% in the US and 17% in Europe
  • 35% of all overseas investment is directed towards online brokers
  • Within the Chinese's stock allocation, global asset allocation (in which TIGR specializes) is only 5% vs 25% for developed countries US and UK
  • Lack of favorable domestic investment opportunities (I believe this is an excellent argument: the Chinese middle class has not many financial rights within China, the stock market is small and inflated, which is what drove the Chinese to inflate residential real estate as well. Domestic Chinese assets )
  • More and more Chinese (typically famous technology) stocks being listed in US

Another driver for customer equity growth is the high-calibre nature of TIGR’s clients:

Young and affluent with high personal wealth growth potential. As of December 31, 2018, 71.5% of our individual customers were under 35 years old, and 86.6% had an annual income of over US$40,000. Such customers have great potential to grow their personal wealth and engage in more investment activities in the future.

Lastly, the management team seems high calibre (emphasis added):

Our founder and CEO, Mr. Tianhua Wu, was one of the most renowned experts in China's Internet field prior to founding our company. As a Tsinghua graduate majoring in computer science and technology, he has over eight years of experience working at NetEase. Our key personnel also comprise of experienced Internet entrepreneurs and talents from top Internet and technology giants in China such as Baidu, NetEase, Tencent and Xiaomi.

The prospectus also notes TIGR is assisted by some former employees from IBKR, major US investment banks.

Implications for IBKR investors

What is less known and not well-explained in the filing is that TIGR’s back-end functions concerning bank accounts, trading execution and clearing, compliance etc. is all done by the US publicly-listed broker Interactive Brokers. Indeed, in the document’s summary, the company says:

That is a bit of a stretch: TIGR is using IBKR’s scaleable platform to fulfil all these (marked) tasks, but that fact is buried in the more arcane sections where TIGR admits 100% of customer money is currently being fully managed by IBKR in the back-end.

What is in it for IBKR? Every time a TIGR client does a trade, IBKR charges its (very low) commissions. TIGR keeps the surplus of its own commission mark-up it chooses to charge. Above a certain threshold, IBKR would share the mark-up economics, but TIGR generally only charges twice the standard IBKR retail charges and this is below the threshold. But it does not stop there. TIGR does not pay the (already minimum) retail commission to IBKR, and it also benefits from IBKR’s volume discounts. I estimate IBKR only charges ~25% of the retail commission to TIGR in general, which for US stocks would be 25 cents per trade.

On IBKR conference calls, founder Thomas Peterffy has been asked multiple times whether IBKR can make money at such low commissions to its introducing brokers like TIGR. Peterffy always confirms they do make money on these commissions because “the IBKR platform is 100% automated” but does not specify how much. My hunch says it's not much: I assume 25% profit margin versus its 60% overall commission margins. Conclusion: Tiger Brokers is the clear beneficiary of its growth? Hold that thought.

The repeated conference call focus of the street on IBKR’s commissions profitability to introducing brokers is a sign the street is confused about IBKR’s real profit driver. While IBKR has better terms for large clients, both for commissions and interest on cash or margin financing, it only views introducing brokers’ clients as a group for the purpose of improving the terms of commissions, not interest and financing.

In what follows I will estimate TIGR's current contribution to IBKR's profits. For this section, I used the IBKR publicly available pricing mechanisms for commissions and financing, as well as the more detailed policy for introducing brokers with respect to marking up IBKR's own pricing.

In short, IBKR views each underlying TIGR client separately to calculate how much interest TIGR should get for their cash (what TIGR passes on to the clients is their choice to make). The same goes for margin loans: TIGR gets charged an interest rate plus a larger mark-up for its small clients’ margin debts.

This is where it gets interesting: the typical account size of TIGR clients is well below IBKR’s threshold to get full interest on customer cash (i.e. 100 000 USD). TIGR’s average account balances are like your typical E-Trade or Ameritrade account. This means IBKR earns large interest spreads on the underlying TIGR clients: it pays little interest to small clients and charges its largest mark-up (US benchmark rate +1.5%) for USD margin loans. Of course, this is still much cheaper than competition.

However, TIGR can charge mark-ups and mark-downs on respectively margin loans and customer cash. IBKR’s terms allow it to share 25% of the mark-up economics in excess of a 1 percentage point mark-up threshold. Gleaning from its translated Mandarin website, TIGR is smart and only charges a 1 percentage point mark-up, allowing it to keep the whole mark-up.

Based on all this, I estimate IBKR earned 27 MUSD net interest margin (pre-tax profit contribution) from TIGR in 2018. Based on my notes on commissions and the fact that TIGR brokers reports its commissions on a net basis (after IBKR withholds its part), we can back now public commission revenues and commission rates into the sharing equation to find what IBKR is earning: I estimate 2 MUSD. Very small indeed, the interest and financing profit is the elephant in the room that the street seems to be ignoring on many IBKR calls.

To wrap up, I estimate IBKR earned about 30 MUSD from TIGR in 2018. This is still small compared to IBKR’s 1.2 billion USD pre-tax profit. However, if customer equity can compound at say 60% p.a., this number would be 200 MUSD in 2022 (that growth would be explained by new accounts, new inflows on existing accounts and customer asset returns).

More importantly, TIGR’s success would reflect well and fintech players in the rest of the world could eye IBKR as their partner, opening a large profit pool for IBKR.

Other learnings for IBKR investors

IBKR invested 20 MUSD in the Series-B-3 round for 7.7% of the current equity. This makes them the largest investor after the founders (together 32%) and Xiaomi (14%). Weirdly, only a week after IBKR’s investment, TIGR’s did another raise at a much higher valuation that would value IBKR’s stake already at 70 MUSD. I believe this is because the participants were – as opposed to IBKR – merely financial investors.

The IPO would raise approximately 200 MUSD. As one can see in the document, most money will be used to grow the platform by heavily investing in marketing and programming personnel. With a 2018 revenue of only 34 MUSD and a net loss of 44 MUSD, TIGR’s main costs are indeed programming personnel and marketing. TIGR already boasts 400 employees; that is already a third of the workforce of its much bigger and profitable partner IBKR.

In summary, according to my estimates, TIGR contributed 30 MUSD to pre-tax profits of its partner while TIGR itself only reported 34 MUSD of revenue and 44 MUSD losses, as it is in high-growth mode. Why is this disparity so large?

  • TIGR reports revenues net of IBKR’s cut of commissions or interest and financing
  • IBKR is a highly scaleable and 100% automated platform with extremely high incremental margins
  • TIGR is heavily investing in growth

Conclusion

My main takeaway is that the Tiger Brokers’ IPO will certainly benefit IBKR shareholders: All IPO proceeds of approximately 200 MUSD will be invested in growth. This growth will be low-risk and highly profitable for IBKR shareholders. IBKR is trading at earnings multiples similar to the average S&P500 stock (somewhat higher when simply using the P/E ratio, but lower when deducting its 6 BUSD of excess capital from the ratio’s nominator).

This article was written by

Value Vault profile picture
335 Followers
Belgian analyst with a long time horizon. Generalist. I prefer fishing in out-of-favor sectors and/or geographies. Not only do those ponds have lower valuations in aggregate, they tend to be less efficient as well. A double advantage for stock pickers.
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Disclosure: I am/we are long IBKR. 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.

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