Author Topic: IBKR - Interactive Brokers  (Read 164477 times)

Liberty

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Re: IBKR - Interactive Brokers
« Reply #340 on: March 30, 2017, 08:16:45 AM »
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Even worse, Peterffy plans to take the capital from the market maker and put it in the brokerage. So you can't even add back any value for the MM either.

I haven't followed IBKR closely lately. Did he actually come out and say this about putting the MM capital in the brokerage, or is this more a theory that seems likely based on his actions so far? Thanks.
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KCLarkin

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Re: IBKR - Interactive Brokers
« Reply #341 on: March 30, 2017, 08:29:01 AM »
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Even worse, Peterffy plans to take the capital from the market maker and put it in the brokerage. So you can't even add back any value for the MM either.

I haven't followed IBKR closely lately. Did he actually come out and say this about putting the MM capital in the brokerage, or is this more a theory that seems likely based on his actions so far? Thanks.

Well, I think it is implied from two separate facts:
1. Peterffy has stated that any excess capital would be transferred to broker (Q3 2016 Call):
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Rich Repetto

Got it. And just one last quick thing, would its still the same position, that capital would be transitioned to the broker rather than have any return to the shareholders?

Thomas Peterffy

That is correct. We still we do not only want to be the best and least expensive broker, we also want to be the safest.

2. Since that call, IBKR has announced plans to wind-down many MM activities. So there will be excess capital.

Based on the above, I have reduced my valuation of IBKR.

Liberty

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Re: IBKR - Interactive Brokers
« Reply #342 on: March 30, 2017, 08:55:13 AM »
Thanks. It indeeds sounds like that's what they intend to do. I wonder if they'll also stop the dividend, which has been designed to return MM capital if ROE is under 10%...
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benhacker

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Re: IBKR - Interactive Brokers
« Reply #343 on: March 30, 2017, 10:15:05 AM »
KC, your assumption is they put the $$$ in the market maker but then don't use it to improve growth / returns etc?  Or just that they try but invest poorly in those outcomes?

Thx.
Ben Hacker
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kab60

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Re: IBKR - Interactive Brokers
« Reply #344 on: March 30, 2017, 10:22:09 AM »
KC, your assumption is they put the $$$ in the market maker but then don't use it to improve growth / returns etc?  Or just that they try but invest poorly in those outcomes?

Thx.
The equity from market maker goes to brokerage. And I think the point is that it'll decrease ROE. I also think it means that one might be inclined to double count, ie say you get a 3,5 pct. free cash yield at current prices plus 17 pct. growth, but that 3,5 pct. cash isn't really free since most is needed to fund the growth (although small they do pay a small dividend and returned some 7,2 pct. of the marketcap in 2012, so it's not like Peterffy won't return cash. I figure he just think there's a real use for it).

« Last Edit: March 30, 2017, 10:25:19 AM by kab60 »

KCLarkin

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Re: IBKR - Interactive Brokers
« Reply #345 on: March 30, 2017, 10:34:00 AM »
KC, your assumption is they put the $$$ in the market maker but then don't use it to improve growth / returns etc?

Yes (they take money out of MM and put it into broker). In my model, ROE in the broker has slowly and steadily declined even as revenue has grown strongly and profit margins are steady. This suggests to me that these retained earnings are truly "excess" capital.

Or, to put it another way, Peterffy is emphasizing growth over ROE. There might be a few hedge funds who are slightly more willing to custody a portion of their funds with IBKR due to the balance sheet. But to move the needle, IBKR needs billions of excess capital. The incremental ROE on this excess capital is very low. This is probably the right strategy. And I fully endorse it. But given this strategy, it is wrong to label any of this capital as "excess" capital. If Peterffy ever retires or sells out, then the strategy might change and substantial capital could be released.

Or just that they try but invest poorly in those outcomes?

They won't invest the capital in the traditional sense. It will be added to the balance sheet to make IBKR a "safer" custodian. But will it really matter if they have $5B in excess capital instead of $4B? Maybe on the margins. Frankly, it would be much cheaper for them to invest in better marketing and user experience, but this seems to be a blindspot for TP.

Edit to add: For an investor, there is also a counter force. The stronger the balance sheet, the safer IBKR is as an investment. So the cost of capital should fall (higher multiple). But I don't think $1 in retained earnings adds $1 in market value with the current balance sheet.
« Last Edit: March 30, 2017, 10:39:49 AM by KCLarkin »

KCLarkin

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Re: IBKR - Interactive Brokers
« Reply #346 on: March 30, 2017, 11:26:03 AM »
Another way to look at this:

The current balance sheet is rock solid. Not only is there a lot of excess capital. But the capital is conservatively invested in 2 year treasuries. Margin requirements and auto-margin calls also make it very difficult for IBKR to sustain large losses. There would need to be a sudden, unprecedented event to imagine any sizeable hit to the balance sheet.

Let's say that IBKR is currently 99% safe. There is a 1% chance that a black swan event (say a nuclear attack on a major U.S. city) could wipe out the balance sheet. This is not great. Many hedge funds might find this too risky (of course it is questionable whether GS or MS are any safer).

So to make IBKR even safer, Peterffy doubles the amount of excess capital. It still takes a cataclysmic event to kill IBKR. But the odds of survival increase slightly. Let's say that IBKR is now 99.1% safe.

How many hedge funds would really switch for such a modest improvement in safety?

--
Now imagine an alternative universe where IBKR invested $1B of retained earnings to design a great SMA/RIA reporting interface? How many more RIAs would choose IBKR if it wasn't such an embarrassment to clients?

GregS

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Re: IBKR - Interactive Brokers
« Reply #347 on: March 30, 2017, 02:26:39 PM »
I found this quote from the Q3 call to be revealing:

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Our third group of customers are the hedge funds, which represent under 1% of our accounts and 9% of equity and commissions, which are also 9%, and they are our fastest growing commission generating groups. The big banks appear to be consolidating their prime brokerage operations and are happy to see their smaller and less profitable hedge fund clients leave. But this begs the question, if these clients find that they are happier on our more automated and less expensive platform, as they in fact do, will they be followed by their larger peers? We certainly hope so. As I have said many times before, our challenge is overcoming the perception of the end customer level that the larger banks are safer custodians.

Seems like the excess capital is being used to bolster that perception of safety, which they hope will bring more of the highly profitable hedge fund business.  In a way, you can consider the additional capital on the balance sheet to be growth investment.  I think that's how they perceive it.

Perhaps as KCLarkin suggested they should reinvest more on their client-facing end to bolster the RIA business.  Of course I don't see these efforts as mutually exclusive.

flesh

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Re: IBKR - Interactive Brokers
« Reply #348 on: March 30, 2017, 05:37:59 PM »
Perhaps some of our hedge fund operators could elucidate/quantify why they do/don't use IB, generally. Additionally, why and how much excess capital would it take to make this a no brainer. Is someone informed enough to quantify these issues from a front line business perspective? I'm not sure I understand the math behind this low probability disastrous outcome? Where's the tipping point/threshold regarding these issues?

Any worthwhile info is appreciated.


KCLarkin

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Re: IBKR - Interactive Brokers
« Reply #349 on: March 30, 2017, 06:18:48 PM »
Is someone informed enough to quantify these issues from a front line business perspective? I'm not sure I understand the math behind this low probability disastrous outcome? Where's the tipping point/threshold regarding these issues?

This isn't a quantitative thing. It is reputational. Hedge funds trust GS or MS as their prime broker. Peterffy believes, and he is probably correct, that IBKR is already safer than the big primes. But until IBKR earns that reputation some funds will not feel comfortable with IBKR as their custodian. More importantly, many clients wouldn't allow it. It's one thing for IBKR to convince a hedge fund manager that they are a safe custodian. It is quite another to convince a college endowment that has never even heard of IBKR.

It is a real issue. Just not one that can be solved quickly or cheaply.