Author Topic: IBKR - Interactive Brokers  (Read 137765 times)

given2invest

  • Lifetime Member
  • Hero Member
  • *****
  • Posts: 517
IBKR - Interactive Brokers
« on: March 15, 2011, 09:55:56 PM »
I have recently made IBKR a rather large position.   Before I get into the long thesis, I'd like to ask a question:   How many people on this board use Interactive Brokers?   If you don't, who do you use?

The short answer is this:  Any professional investor has no other option except IBKR, especially if they use leverage.   No other broker offers the commissions, direct access, and margin rates that they do. 

Why is IBKR interesting here?   Well, historically, they have made 80+% of their money as an option market maker.  The last 2 years the options market making business has been a disaster and the CEO, who owns 90% of the company and started it, has announced that they might wind it all down and just focus on the broker business.   This sparked my eye.   

The elevator pitch is this:  There are 400 Million shares, dilluted, outstanding - but only ~42 million float.  $2.8 Billion of capital, or $7 a share, is in the market making business.  $1.4 Billion is in the broker, and it's overcapitalized.   Thomas Peterffy (TP, the CEO) has stated that if the market making business doesn't return to making a decent ROI, they will shut the business down and return all this capital to shareholders.  They returned $1 Billion in Q4 to start.  Note:  The market making business once brought in almost $1b in pre tax earnings! It now only does ~150m a year and still shrinking.   It's basically long vol and needs the vix to be in the mid 20's for ideal conditions.   But, let's pretend it doesn't ever go back to earning a decent ROI and TP returns all $7 to shareholders.   What does that leave us?   

We have $8.50 left with a book value of $3 and change.   But it's a pure play brokerage that requires no capital to grow, has tiny cap ex needs, and has 50% pre tax profit margins!   It's all automated, growing new accounts 20% a year, and growing bottom line at 20% a year.  There are no true competitors (take it from me, I wanted to leave them or find a back up account and couldn't) and they currently have 164k accounts and TP estimates the addressable market (savvy financial professionals) to be 2 million globally.   

They will do ~55 cents in 2011 in EPS in the brokerage business, so you are paying 16x for this fantastic business.   It is very likely that in 2013 they do close to a $1 in EPS given growth in new accounts and a small uptick in fed funds rate.   Schwab, Ameritrade, etc, all trade at 20x.   This business has literally no need for capital and should not be valued off of book.   

The reason I really like it is what's your downside?   Todays book = $10.50 + a funky tax attribute that puts it at $12.  The tax situation is very odd and still trying to get to bottom of it but their effective tax rate is only 12% due to the way it was set up.   My numbers above (55 cents in 2011) assumes 35% tax rate and full G&A hit if they shut down market making.   The street expects them to earn 80-90 cents in 2011 combined with market making.   I think downside is extremely limited and upside is mid 20's in 18-24 months or so.

The way I played it is I sold Jan 12 and Jan 13 puts, strike $13.21 (funky cause of the 1 time dividend they paid) at 45 and 85 cents, respectively.   If I am put the stock, I'm put it below book which is highly liquid securities that can be run off in under 3 months.    I then bought Jan 13 18.21/23.21 call spreads for 85 cents which will pay $5 at max return, or almost 6x.   One could just put on the call spread and not sell the puts but I like the combo trade.   I also own the common given how low margin rates are on IBKR and how low the downside is, I have no problem using leverage to own this and have made it a pretty big position in my book, ~25%.     

I can answer questions.  In short, the catalyst is that Market Making, a crappy business, is being shut down/irrelevant, while the brokerage business has finally grown to a level where it's making real money.   It used to be <20% of profits and in 2011 will be >50%.   


Shane

  • Lifetime Member
  • Sr. Member
  • *****
  • Posts: 376
Re: IBKR - Interactive Brokers
« Reply #1 on: March 16, 2011, 07:50:39 AM »
Do they have any proprietary technology that allows them to stay low in costs?  What potential is there that other companies will enter their market and potentially be lower cost producers?  I know you stated a target for 18-24 months... but do you see anything beyond that?

I really like this idea, and every professional I am aware of uses them.

given2invest

  • Lifetime Member
  • Hero Member
  • *****
  • Posts: 517
Re: IBKR - Interactive Brokers
« Reply #2 on: March 16, 2011, 08:10:37 AM »
Good questions.

They have spent absurd amounts on technology.  This is not something that a competitor can just develop.  If you look at the competitors, namely Tradestation, MB  Trading, they can't come close to charging the prices that IB charges and earn a profit.  They don't have the scale and aren't as automated.  I use the term competitor loosely because I could never switch my account to those guys without a HUGE decline in their commissions and margin fees.   I mean huge decline.  Just got to Tradestations website and see.  I pay far less than half a cent a share on IB, more like .25 cents when you factor in rebates.  That's $2.50/1000 shares.  The competitors are leaps and bounds higher.  On margin rates, it's not even remotely close.

IB is also the leader in price improvement/execution which is a hidden cost/fee that other brokerages will cost you.  Of course, most investors don't see this.  They talk about it on their website. 

Basically, I think they have built a huge moat that is nearly impossible for a competitor to overtake.  The other companies are super tiny (TRAD EV is ~100 million vs IBKR's brokerage biz being valued at over 3b today if you use book for market making). 

As a customer, I would not go to a startup competitor that was not extremely well capitalized.   Basically, the only way I'd consider changing is if the commissions/margin were both lower and the company had a huge equity base >$1 billion.  Schwab, Ameritrade, E-Trade, have shown no desire to compete in this manner.   They all have active trader divisions and the fees/commissions are multiples of what IBKR's are.   

I have no reason to believe this is an 18-24 month idea then goes flat.  I think the broker will continue to compound for a decade or more at 20%.  The market opportunity is huge.   Imagine if they released a more intuitive trading platform and went after less sophisticated investors?   

The other edge IBKR has over competition is it's global.  Half their new customers are coming from overseas.    If you think we have no other options, they really don't.  I think they could develop a HUGE overseas market.     

Shane

  • Lifetime Member
  • Sr. Member
  • *****
  • Posts: 376
Re: IBKR - Interactive Brokers
« Reply #3 on: March 16, 2011, 11:36:02 AM »
So would you look at this almost like a commodity business that is the lowest cost producer?  Doesn't sound to me like they have franchise value but they are in a strong market position.

Something I think is very interesting is the lack of tradable shares... maybe they are being missed by analysts because it is difficult to get an sizable investment with them!  I wish I had more time to devote to reading about this, will spend as much time as I can during the week and hopefully be able to take a look further this weekend.  I like this idea!


Eric50

  • Lifetime Member
  • Full Member
  • *****
  • Posts: 216
Re: IBKR - Interactive Brokers
« Reply #4 on: March 16, 2011, 12:08:26 PM »
given2invest -

I looked at this idea about a year ago and I liked it a lot. I passed as I found other businesses at that time that I liked better (no regret; stock price hasn't done anything in the past year). I remember that I liked the CEO a lot - running the show, very entrepreneurial, strong personality, speaks his mind and very honest. I think that he was in his mid-60s or something. I doubt he is the kind of guy who would retire soon but I wonder if you know about any succession plans? Does he have a strong #2? What would happen if he gets hit by a bus tomorrow?

Thanks,
Eric

watsa_is_a_randian_hero

  • Lifetime Member
  • Hero Member
  • *****
  • Posts: 794
Re: IBKR - Interactive Brokers
« Reply #5 on: March 16, 2011, 12:18:21 PM »
I have recently made IBKR a rather large position.   Before I get into the long thesis, I'd like to ask a question:   How many people on this board use Interactive Brokers?   If you don't, who do you use?

The short answer is this:  Any professional investor has no other option except IBKR, especially if they use leverage.   No other broker offers the commissions, direct access, and margin rates that they do. 

Why is IBKR interesting here?   Well, historically, they have made 80+% of their money as an option market maker.  The last 2 years the options market making business has been a disaster and the CEO, who owns 90% of the company and started it, has announced that they might wind it all down and just focus on the broker business.   This sparked my eye.   

The elevator pitch is this:  There are 400 Million shares, dilluted, outstanding - but only ~42 million float.  $2.8 Billion of capital, or $7 a share, is in the market making business.  $1.4 Billion is in the broker, and it's overcapitalized.   Thomas Peterffy (TP, the CEO) has stated that if the market making business doesn't return to making a decent ROI, they will shut the business down and return all this capital to shareholders.  They returned $1 Billion in Q4 to start.  Note:  The market making business once brought in almost $1b in pre tax earnings! It now only does ~150m a year and still shrinking.   It's basically long vol and needs the vix to be in the mid 20's for ideal conditions.   But, let's pretend it doesn't ever go back to earning a decent ROI and TP returns all $7 to shareholders.   What does that leave us?   

We have $8.50 left with a book value of $3 and change.   But it's a pure play brokerage that requires no capital to grow, has tiny cap ex needs, and has 50% pre tax profit margins!   It's all automated, growing new accounts 20% a year, and growing bottom line at 20% a year.  There are no true competitors (take it from me, I wanted to leave them or find a back up account and couldn't) and they currently have 164k accounts and TP estimates the addressable market (savvy financial professionals) to be 2 million globally.   

They will do ~55 cents in 2011 in EPS in the brokerage business, so you are paying 16x for this fantastic business.   It is very likely that in 2013 they do close to a $1 in EPS given growth in new accounts and a small uptick in fed funds rate.   Schwab, Ameritrade, etc, all trade at 20x.   This business has literally no need for capital and should not be valued off of book.   

The reason I really like it is what's your downside?   Todays book = $10.50 + a funky tax attribute that puts it at $12.  The tax situation is very odd and still trying to get to bottom of it but their effective tax rate is only 12% due to the way it was set up.   My numbers above (55 cents in 2011) assumes 35% tax rate and full G&A hit if they shut down market making.   The street expects them to earn 80-90 cents in 2011 combined with market making.   I think downside is extremely limited and upside is mid 20's in 18-24 months or so.

The way I played it is I sold Jan 12 and Jan 13 puts, strike $13.21 (funky cause of the 1 time dividend they paid) at 45 and 85 cents, respectively.   If I am put the stock, I'm put it below book which is highly liquid securities that can be run off in under 3 months.    I then bought Jan 13 18.21/23.21 call spreads for 85 cents which will pay $5 at max return, or almost 6x.   One could just put on the call spread and not sell the puts but I like the combo trade.   I also own the common given how low margin rates are on IBKR and how low the downside is, I have no problem using leverage to own this and have made it a pretty big position in my book, ~25%.     

I can answer questions.  In short, the catalyst is that Market Making, a crappy business, is being shut down/irrelevant, while the brokerage business has finally grown to a level where it's making real money.   It used to be <20% of profits and in 2011 will be >50%.   

I use.  Best value for anyone who doesn't have access to a prime broker.

given2invest

  • Lifetime Member
  • Hero Member
  • *****
  • Posts: 517
Re: IBKR - Interactive Brokers
« Reply #6 on: March 16, 2011, 12:19:33 PM »
given2invest -

I looked at this idea about a year ago and I liked it a lot. I passed as I found other businesses at that time that I liked better (no regret; stock price hasn't done anything in the past year). I remember that I liked the CEO a lot - running the show, very entrepreneurial, strong personality, speaks his mind and very honest. I think that he was in his mid-60s or something. I doubt he is the kind of guy who would retire soon but I wonder if you know about any succession plans? Does he have a strong #2? What would happen if he gets hit by a bus tomorrow?

Thanks,
Eric

Yah, I looked at it a year and two years ago and passed both times cause market making was too big a % of the business and I had no interest investing in that.  

The CEO is extremely smart and well respected.  He gets it.  If he died, there would be no real #2 that could come in, however, he owns 90% of the company.  His heirs would almost certainly sell the company and I believe there would be tremendous demand for the broker asset from both PE and strategic acquirers at prices far north of today's valuation.  I'm not concerned about key man risk.  

One thing that's good is all the senior management team have been there for many years which shows how much they respect the CEO.  Also, most of their comp is in stock and has long vesting periods (as much as 7 years).  I was told the average employee gets over half of their bonus in stock.   The entire company is highly motivated to get the stock price up and to see the shareholders succeed.  

given2invest

  • Lifetime Member
  • Hero Member
  • *****
  • Posts: 517
Re: IBKR - Interactive Brokers
« Reply #7 on: March 16, 2011, 12:23:16 PM »
So would you look at this almost like a commodity business that is the lowest cost producer?  Doesn't sound to me like they have franchise value but they are in a strong market position.

Something I think is very interesting is the lack of tradable shares... maybe they are being missed by analysts because it is difficult to get an sizable investment with them!  I wish I had more time to devote to reading about this, will spend as much time as I can during the week and hopefully be able to take a look further this weekend.  I like this idea!



Yes, there is almost no analyst coverage and the ones that do don't "get it" for the most part.  One of them values it off of book, etc.   The free float is very small compared to the size of the company.   It's more like a small cap than a large mid cap. 

I guess it is a commodity business but how many commodity businesses do you know with 50% pre tax margins with absolutely no competition and extremely low cap ex?  Also, switching costs are mildly high - changing brokers is a pain in the ass, especially from tax perspective. 

given2invest

  • Lifetime Member
  • Hero Member
  • *****
  • Posts: 517

rtgross

  • Newbie
  • *
  • Posts: 16
Re: IBKR - Interactive Brokers
« Reply #9 on: March 21, 2011, 06:04:53 PM »
they currently have 164k accounts and TP estimates the addressable market (savvy financial professionals) to be 2 million globally.   

My numbers above (55 cents in 2011) assumes 35% tax rate and full G&A hit if they shut down market making.   The street expects them to earn 80-90 cents in 2011 combined with market making.   

Do you have any other estimates for the size of the market opportunity?

Along with that, what is the market size for investors that trade these volumes?  Average annual trades are far higher than the competition, if they continue to grow new accounts will profit growth increase at a far slower pace from less frequent trades?

Do you think competition will increase with Schwab's purchase of OptionsExpress?

What do you calculate for an EBIT impact as the result of a 25, 50, 100 bps move in rates?

I established a position in IBKR at the end of February for similar reasons.  The questions above are some of the things I've been working on.