I’ve received a lot of great comments and questions regarding my valuation of IBG. I think it will be best if I expand on my thinking here.
- How the hell did you come up with a value today of $10B? The market capitalization is only $1.4B!!!
Here is my calculation. Note that prices have moved since I wrote my post.
|A||Shares Outstanding – Basic||57,099,052||3Q14 10-Q|
|B||Price Per Share||28.43||12/10/14 Close|
|D||% of Shares Publicly Traded||14.1%||p.8 3Q14 10-Q|
|E||Total Value of Equity||11,512,950,698||C/D|
2. Why did you use DARTs as a principal revenue driver? DART volume is very unpredictable. It makes more sense to use Account Growth.
First, I question the basic premise. I am not at all sure that account growth is more predictable than DART growth. IBG’s customers are far more active than the other E-Broker customers. Further, IBG DART volume seems to have de-coupled from total US trading volume (see 3Q14 earnings call transcript).
In any case, I can take a look at the impact if any this change in assumptions has on value. For IBG, the growth rates over the past 8 years are 18% for accounts and 14% for DARTs. Revenue per account has been flat at $3600. If we assume 15% account growth over 10 years, this gives us 967,000 accounts in 2023. If we then assume $3600 of net revenue per account, this gives us revenue of $3.5B in 2023 which is pretty close to the $3B of revenue in our original calculation. So the impact is not very dramatic.
3. Why are you assuming margins stay flat at 50%? Your whole presentation is based on economies of scale, Dummy. Shouldn’t margins increase over time as volume of transactions goes up?
This is a very good point. I kept margins flat at 50% but I could have assumed margin expansion. I was simply trying to be conservative and not make any heroic assumptions.
|2023 Revenue||Margin||Earnings||Value at 15 P/E||Increase in Value|
Thus, if you want to assume 600 basis points of margin expansion over 2013, you can get a 50% return over 10 years. By the way, I know that Peterffy says they can get to 70% margins and maybe he is right. He certainly knows more about the business than I do. But that is simply too big of an increase for me to go with.
4. Why didn’t you assume any cash returned to shareholders? After all, this is not an asset intensive business.
This is another very reasonable question. I did not assume any free cash being returned to shareholders via dividends or buyback for two reasons. First, because I had assume very dramatic increase in the loan receivable, I anticipated that every dollar of earnings retained would have to be loaned right back out again. Second, ROE for the overall business was only 8% in 2013. I could not calculate ROE on a separate basis for just the Brokerage business so I don’t know to what extent MM was dragging down the overall result. Therefore, I could not get comfortable assuming how much capital is required to run the business.
If any one has a different way of looking at this, I would love to hear it.