Interactive Downgraded to Neutral - Analyst Blog

By Zacks Equity Research,

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We have downgraded our long-term recommendation on Interactive Brokers Group Inc. ( IBKR ) to Neutral from Outperform based on colossally increasing expenses. Despite the decent performance by the company in the fourth quarter, we remain apprehensive about the steady generation of adequate returns by its Market Making segment to subsidize dividend payment.

However, Interactive's healthy liquidity position, sturdy capital base and technological excellence continue to be the positive contributors. In addition, robust performances by its Electronic Brokerage and Market Making segments, along with high barriers to entry further reinforce its position.

Interactive's fourth-quarter 2011 earnings outpaced the Zacks Consensus Estimate substantially. Results were facilitated by higher revenue and net income attributable to non-controlling interests. However, these were partially mitigated by elevated interest and non-interest expenses.

A solid capital base as well as a highly liquid balance sheet with low leverage, grants Interactive a better-than-peer positioning. The company was able to actively manage its excess liquidity and uphold hefty borrowing facilities through the securities lending markets and banks. Additionally, the company maintains over $2 billion of excess regulatory capital in its broker-dealer companies worldwide.

Also, Interactive has become the largest electronic broker with regards to daily average revenue trades (DARTs). Lower commissions and financing rates as well as superior trading tools offered by the company helped in attaining this noteworthy feat. In 2011, cleared DARTs increased 19% to 409,000 compared with 2010.

Interactive has positioned itself at the crossroads of globalization, adoption of technology, spreading of equity culture and optimization of resource allocation on global electronic networks by processing trades in stocks, futures, options and forex on more than 90 exchanges across 27 countries and in 17 currencies. Moreover, adoption of technology has led to higher profit margins. Also, owing to the company's technological excellence, its compensation expense is minimal relative to the net revenues, unlike many of its peers.

On the other hand, Interactive's dependence on IBG LLC remains an area of concern. The primary asset of the company is its 11.5% equity interest in IBG LLC. In addition, its controlling interest and related rights as the lone managing member of IBG LLC makes it dependent on revenue generation.

The company incurs taxes on its proportionate share of the net taxable income of IBG LLC as well as expenses on its self operations. Inability of IBG LLC in providing ample funds to Interactive for tax payment or any other purpose will affect the company's financial condition adversely.

As per the recent dividend strategy of Interactive, the regular quarterly dividend will be paid from its Market Making segment. Due to this, the segment's capital base could get eroded over a period of time and in case of the segment's failure to produce adequate return to pay dividend, the company will be forced to deploy its capital through dividend, which will reduce its financial flexibility.

Currently, Interactive retains a Zacks #3 Rank, which translates into a short-term Hold rating. However, one of its peers, Knight Capital Group Inc. ( KCG ) retains a Zacks #4 Rank (short-term Sell rating).

INTERACTIVE BRK ( IBKR ): Free Stock Analysis Report
KNIGHT CAP GP ( KCG ): Free Stock Analysis Report
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Zacks Investment Research

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Business , Stocks
Referenced Stocks: IBKR , KCG

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