IBKR - Interactive Brokers: A Lot To Like Except The Price

2023-07-19 05:35:24 ET

Summary

• Interactive Brokers has achieved impressive growth in the last few years.
• The company has been the go-to broker for many individuals, due to its high automation platforms as well as low costs.
• The current macro environment has a positive effect on IBKR’s business as net interest income expands.
• However, in terms of valuation, the IBKR doesn’t offer a lot of upside.

During the past three years, there's been an extraordinary influx of retail investors to financial markets. This trend is facilitated by the technological era that we live in, where access to information is a few clicks away. Social media also adds fuel to the trend as millions of people could follow allegedly successful traders and investors. Brokerage firms are also using the power of technology and have digitalized the entire process from opening an account to executing trades, making it as convenient as possible for their customers. One of the brokerage firms that is especially popular amongst retail investors is Interactive Brokers ( IBKR ). Looking at the company's business model, there's a lot to like. However, it's important to differentiate a great business from an attractive investment. While the company is trading at a considerable premium to peers, it's slightly below its own 5-year average. However, when high interest rates environment and the potential for insider sales is taken into account, IBKR doesn't seem to offer a lot of upside.

Company overview

Incorporated in 1993, Interactive Brokers leveraged the experience its founder Thomas Peterffy gained in financial markets throughout the 1980s and the technologies, developed by his company - Timber Hill. Nowadays, IBKR is a leading electronic broker with 2.29m (+19% YoY) client accounts and US$365B (+24% YoY) of client equity as of 30 June 2023. It offers access to a wide variety of markets and instruments at a relatively low cost, making it an excellent option for the retail investor/trader, who seeks to manage his own money.

Ownership structure and implications

One of the things that makes IBKR stand out from other peers in the financial sector is the unusually high insider ownership. Through a complex ownership structure, the founder Thomas Peterffy controls more than three quarters of the company.

It's important to note, that the publicly listed company - Interactive Brokers Group, Inc. has just 24.5% economic interest in Interactive Brokers Group LLC, which is the actual entity that provides millions of clients with brokerage services. Understanding this relationship is key in reading IBKR's income statement, which always shows significant non-controlling interest.

Usually, such extremely high insider ownership is considered an advantage as it aligns the interest of minority shareholders with management. However, in the case of IBKR there's a caveat. Such concentration of wealth in a single asset is not desirable, from purely portfolio management standpoint. As someone who has made a fortune through his understanding of financial markets Mr. Peterffy is well aware of this and has adopted a trading plan to sell up to 20k shares of IBRK daily. And he has been doing just that in large part of the last three years. It has to be noted that since Jan'23 there has been no insider selling. But still, this remains a risk as a possible return of Mr. Peterffy to the market will lead to additional selling pressure.

Great business model

Going back to IBKR's business model, the figures speak for themselves - the company has been able to benefit on the influx of newcomers to financial markets. Client accounts have more than quadrupled, while client equity is more than 2.5x higher for the last 5 years. Behind these numbers, there's the operational excellence and lean cost structure that IBKR provides to its clients. The company has been awarded the best online brokers by Barron's for six years in a row. It offers much lower margin loan rates than its peers, while at the same time offering very attractive interest on available cash balances in client's account.

As far as the client base goes, it's comprised mostly of individual investors, especially when considering that client equity to introducing brokers are de-facto also mostly individuals. Still, IBKR is used also by institutional investors like hedge funds and mutual funds. In terms of geographical breakdown , a little more than half of commissions come from Americas based clients, followed by Asia-Pacific (30%) and Europe (18%).

Another reason why IBKR is so liked by retail clients is its heavy reliance on automation on both mobile and desktop trading platforms. As of the time of this writing, IBKR has 3.8/5 stars on trustpilot, which although may not seem a lot, is way better than Robinhood's ( HOOD ) 1.3/5 or Schwab's ( SCHW ) 1.6/5.

Strong financials

The result of IBKR's great business model could be best seen in the company's financials. Revenue has been growing, while margins have been expanding.

Another important point is that the current raising interest rates environment is actually positive for IBKR. The company could earn higher interest on margin loans, while its LT debt-free profile limits interest expenses. As such, in Q1'23, IBKR realized net interest income of US$637M, compared to US$282M a year ago. In fact, net interest income was the biggest contributor to net revenues for the quarter with a share of 60.3%, compared to 43.7% in Q1'22.

Q2 reveals a slowdown

The Q2'23 report shows some signs that the amazing growth from the last few years may be flattening. Commissions revenue was flat YoY at US$322M, but was down 9.8% QoQ. The element of income that jumped significantly was net interest income (US$694M; +99.4% YoY), on the back of higher interest rates. However, on a quarterly basis, the growth in net interest income was only 8.9% QoQ.

It has to be mentioned that IBKR marked US$63M in other losses, mainly on FX effects. The slowdown could also be observed in the dynamic of DARTs (Daily average revenue trades), which fell 14% YoY to 1.87m on a total basis.

Valuation

No matter how great a business is, its attractiveness regarding potential returns is a question on its own. In the case of IBKR, it appears to be trading quite above its peers. When comparing the company to its own 5-year average, it's trading a bit below it. But it has to be remembered that the macro environment has radically changed. Nowadays, an investor may earn approximately 5% on money-market securities annually, while such number was unheard of not that long ago. So it's somewhat justified for equities to be trading below their historical multiples from the times of low interest rates.

For that reason and the threat of Mr. Peterffy renewing his daily dispositions of shares, I don't think the stocks offers much upside in the short to mid-term.

Conclusion

IBKR has achieved remarkable growth during the past few years. Its operational excellence, high-quality trading platforms and attractive terms are drawing in a lot of clients to IBKR as their go-to broker. While the high insider ownership ensures that the interests of management and shareholders are aligned, the desire of Mr. Peterffy to diversity his wealth may result in selling pressure as he partially unloads his massive position in the company. In terms of valuation, IBKR is trading at higher multiples than its peers, but a bit below its own average. However, the latter is normal when put into the context of the current high interest rates environment. In essence, IBKR is a great business, but the current price doesn't justify considerable upside.

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