Interactive Brokers: There's Still Money in Financials

You can still make money on longs in the financial sector these days.

Interactive Brokers (IBKR) is an online broker offering some of the lowest transaction costs and access to more international markets than any of the larger brokers, but most of its profits actually come from being a market maker in stock derivatives through a wholly owned subsidiary, Timber Hill. The company uses sophisticated proprietary trading and risk management models, and sees itself as a technology company.

Last May, JC Flowers invested $300 million in MF Global (MF), a derivatives broker and trader who follows a similar model, which in my view provides some validation on the sector and business model; however, this week, MF Global  announced lower earnings guidance and the need to raise $300 million of very dillutive capital. The stock was hammered more than 40 pct. (it had also fall off a cliff two or three months ago, before JC Flowers came in). This further strengthens my conviction on IBKR's excellent execution. The stock is up 4% for the ytd (June 20, 2008) and 25% for the last 12 months.

Why did I bet on IBKR? I like the space (stock derivatives have been growing at a very fast pace and, unlike their over the counter cousins, listed derivatives do not present the same counterparty risks) and the business model (very technology intensive and with a distinct value proposition offering a single platform for global trading and very low costs trying to lead through volume); but the most important reason was its Founder and Chief Executive.

Tom Peterffy, an Hungarian emigre, is a very independent unconventional thinker who has been a leader in innovation in the sector (he has been ahead of the curve in electronic trading) and is relentless in the pursuit of excellence for his company. A logging company surveyor before he fled communism at 21, he literally started with nothing and has built a multibillion-dollar enterprise. An example of his non conventional thinking was the fact when he IPOed the company ,he used WR Hambrecht and the same Dutch auction model that Google (GOOG) used and which the street was so upset about (this model is most tranparent and efficient way to offer shares to the public).

It is much better to have a guy like Tom in your foxhole during turbulent times than your average Wall Street CEO (I will open an exception for Goldman Sachs (GS) here) who has been molded in an environment where lemming behavior is the rule.

I'm holding on to my shares and will continue to accumulate on weakness. I think that this company, which is shooting for the stars, is "gonna" go far.

Disclosure: Author has a long position in IBKR

Comments

[peaktrade]

IBKR is a wonderful firm that is absolutely head and shoulders above the cyber-trading crowd in the sophistication of their trading platform and worldwide products available to trade. However their customer service is abysmal and they need intensive work on that area. Execution costs are much lower also then conventional firms such as E-trade, Schwab and TD Ameritrade. I give them a big thumbs up on being a customer and a stockholder.

[purline]

I agree, peaktrade. Love the interface and pricing; I've been a customer for many years. It's a good thing that IB thinks of themselves as a tech company because that is exactly the level of customer service that they offer - contradictory answers and stubborn representatives.

[customer]

I disagree completely - I think IBKR's leadership has reached their pinnacle. They are tech savvy options traders that are only good at raping retail orderflow when regs allow (which is changing soon in the States). They have no experience or risk tolerance for dealing with institutional clients, nor have I ever seen profiteering options traders ever learn how to market and sell successfully to any customer segment.

[James Davis]

"customer" sounds like the one or two professional IB bashers who pop up everywhere. Nothing he said makes a whit of sense,

[customer]

OK? I guess Mr. Davis only wants positive IBKR comments on this thread. Why doesn't IBKR have any institutional clients? They said that they would secure this segment in the IPO filing. Their clients today consist of daytraders and micro-hedge funds (most of whom will go out of business). I owned this stock from the IPO and now occasionally trade it as a vol bet, so I am not a "basher", whatever that means. Mr. Davis, does this question have a "whit of sense"?

[Frank Rizzo]

Any idea how IBKR has weathered the huge daily drops in FRE, FNM, and LEH? Options market makers try to be delta neutral, but delta neutrality doesn't protect against huge price gaps.

[JWG460]

"Tom Peterffy ... is relentless in the pursuit of excellence for his company."

I use IBKR as my online broker. I'm a software engineer with a lot of experience in writing apps like their trading platform, TWS.

It's just not a quality job. It is buggy, quirky, defies normal conventions for UI design, and doesn't agree with its documentation. Many of these defects are quite typical of a bunch of enthusiastic coders with no professional IT management to establish proper processes for Q/A, priorites, standards, and so on.

Checking their careers page it became clear that their software staff are mostly russians (i.e. cheap) and living all over the place. Again, it doesn't look like a professional IT organization.

Overall I think their software is only just useable. It may be, of course, that they don't care, because TWS is not central to their business model. Perhaps they mainly expect people to use third-party add-ons like Ninja Trader. Or perhaps, as other posters suggest, executing trades for the commission revenue is not where they make their money. So if you are an investor, you might argue that the quality of TWS does not matter. Nevertheless, it sure doesn't look like relentless pursuit of excellence to me.

So I'd like to ask Charlie Bottle why he wrote that.

Thanks