Interactive Brokers

Business

IBKR is a fast growing international stockbroker.  They make most of their money from interest (2/3rds of revenue in 2019), and the rest from executing trades (1/3rd).  Trading commissions were only 7% of PBT in 2019 - that was an exceptionally bad year for trading - the average from 2015 to 2018 was 23%.  They also do some market making, which is negligible.

Institutional customers make up half their accounts and 65% of their total customer equity.   Over 60% of their accounts are form outside the Americas.

Competitive Position

I don't know who the players are for institutional investors, but assume its competitive.  For US retail investors, a market share estimate does not even include IBKR as its such a small player.  So numbers wise, they have a small share in a highly competitive market.

Their main product, IBKR pro, is for sophisticated traders/investors.  The user interface is complex and hard to use.  But they are one of the few retail brokers that allows you to trade a wide range of markets, currencies and instruments around the world.  IMO, they are not really a direct competitor to the other US brokers, but more occupy a high performance niche.

Despite being low cost, operating margins are amazing:

With these margins, they must have some competitive advantage.

Balance Sheet

Looks good.  Debt and operating lease liabilities almost zero.  2.8bn of cash acts as a buffer around 27bn of cash and securities in client accounts (Financial instruments are not included in cash, as they are mostly options - p86).

Risks

Like a bank or finance company, lending money is inherently a risky business.  One where the risks often don't appear on the balance sheet or cashflow statements.

Stockbroking risk is shorter term, as you mark-to-market every day.  But you have to deal with wild price swings:

• In 2015, when the Swiss unpegged their currency, IBKR lost 137m (down to 115m in 2019 after some debt collection).
• In 2019, there is an unusual loss of 42m (possibly up to 50m) for margin to "a small number of brokerage" customers who positioned in a US stock that had a drastic change in price (TSLA, maybe?)

These losses look OK in light of their cash and profit numbers.  A normal part of doing business.

However, financing businesses are a black box.  In every crisis a few go bust, and its hard to tell from the financials which ones.  If I buy, size this position accordingly.

Growth

Main growth driver is new accounts, which has been in the teens (number of accounts), or twenties (customer equity):

Source: 2019 Goldman Sachs Conference

IBKR is also a platform used by other stockbrokers ("introducing brokers").  The new Chinese broker Tiger, which they own a stake in, performs its trades through IBKR.

Profitability

Most profits are from interest:

Short term profitability is affected by:

• Interest Rates.  Lower rates mean "lower net interest income from customer deposits due to interest rate spread compression".  Management stated that 2019 profits would be 22m lower with a 0.25% decrease in rates.  I guess that with rates at zero, interest will be 130m to 200m lower.
• Market volatility.  "Historically, our profits have been principally a function of transaction volume and price volatility... rather than the direction of price movement."  More volatility means more trades.  2019 was a bad year due to low volatility.  Now the VIX is over 60....yeah, they probably didn't want that much volatility...but lets assume trading revenue goes up to 2018 levels, which is around 200m higher.

Conclusion

This may be a Buffet buy-and-hold company.  No debt, minimum capital required, may have a sustainable competitive advantage.  What price would I pay for it?

• For a company growing 15-20%, I'd catch a falling knife at 12X earnings. Thats $25.
• In a more normal market, maybe 12-15X earnings would be fair.  Thats up to $31.

Alternatively, since the majority of earnings are from interest, wait till we see signs of interest rates rising.  Right now, we probably get a recession, then one or two quarters of growth (off a low base)... then we start to expect interest rates to rise.

Misc

Glowing report on IBKR from SumZero.

IBKR used to have a larger market making operation, but have reduced it due to HFT.