Business Breakdowns
· Freddie Lait
[00:00:00] S1: Yeah, sure. No, it's great to be back on the show. Thanks for having us. Interactive is a really interesting business. It's one we've owned for about 18 months, been following for a number of years. It's a digital broker, so you can trade stock and bonds and currencies and options, pretty much anything you like through it. And it started out 50 years ago as, by far and away, the most technologically-led business in the space. And there's lots of history we can get into. But what they've done through investing in technology and investing in automation and a couple of other strategic advantages is developed by far and away the lowest cost model, the lowest cost to serve with the highest quality output. And this is what's driving the flywheel effect. They're making the highest profitability at the lowest costs, driving huge growth in their customer base. And that compounding is coming without advertising, without marketing. Individual investors are increasingly choosing Interactive over all of the competitors. But what's most exciting in this business model in the last five or 10 years has been the doubling up of that compounding effect through the growth in other channels. So they're growing from other brokers introducing business. They're growing from hedge funds, they're growing through RIAs, or what we call IFAs in the UK, and they're really growing internationally. They're a truly global business with a huge market potential and a lot of exciting things to talk about today.
· Zack Fuss
[00:00:00] S0: I guess a nice place to start when talking about brokerage businesses. Just take us through the key revenue streams and how these businesses fundamentally make money?
· Freddie Lait
[00:00:00] S1: It's relatively simple. There's a lot of complexity when you really dig into it, but at a headline level, they make money in two ways. They make money through charging commissions on trading and they make margin through net interest margin. So a spread on cash held on account or margin loans that they make. And it's reasonably straightforward to model this through. They have three and a half million accounts. The average account does about 200 trades per year, and the average commission is about $3. And when you times that through, you get to the sort of roughly $600 per account in trading commissions per year, or around $2 billion a year on the net interest margin. They pay very good rates on cash. It's a real strategic advantage. They own quite a narrow spread on their funding, but effectively their securities, lending and margin business, which is about 11% of client assets, is financed with customer deposits. And the spread between what they pay on those two equates to a net interest margin of about $800 per account, or about $3 billion. And those are relatively stable per account numbers. And so the real driver for this business over time has been and will be account growth. And when we started looking at the business, it had around a million accounts. It's got around three and a half million now, five years later. And they have various different targets to get to 10, 20 or maybe 80 million accounts as time goes by.
· Zack Fuss
[00:00:00] S0: And so then when I consider Interactive brokers and the broader landscape, you've got Charles Schwab, Fidelity, obviously, Robinhood. What are the key differentiating factors about this particular business as opposed to its peer set?
· Jacopo Di Nardo
[00:00:00] S2: When you look at Interactive, it was born out of a person who is first and foremost an engineer and a technologist. And that type of culture has reverberated throughout the firm. Day one. So when you look at Interactive, it's by far the most automated of all brokers. So when you go onto the app, most of the functions you'll hit on it, including actually eliminating accounts because they exceeded the margin loan, is done automatically by a bot. This doesn't tend to be the case for the competitors. And this has also morphed the broker into being really one that is liked and used first and foremost by experienced traders. In the first days, the business was really only used by individuals and what today we call prop traders. These are individuals with account balances that tend to vary between, let's say, 200,000 up to a couple million dollars per account of client equity. And this compares, broadly speaking, quite favorably versus other online brokerages. So you'd think someone like Robinhood or Etoro would have account balances averaging maybe 5 to 10,000. So it would be the first brokerage you go to when you learn about trading. And places like Schwab would have higher account balances, but they would be used in a much less frenetic way. As Freddie mentioned, you make about 200 trades a year per account on an Interactive, and that number might be tens of times even lower if you're using your Fidelity or Schwab account, which tend to be used for slightly different purposes. So obviously 401(k)s being one of those in the US.
· Zack Fuss
[00:00:00] S0: So I think it's impossible to really appreciate how differentiated IBKR Interactive Brokers is without spending some time discussing its founder, Thomas Peterffy came here with effectively nothing, I believe, in the 1960s and is now one of the wealthiest and relatively unknown Americans. Can you just tell a little bit about his story, how this business came to be, how it's evolved over time, and then how much of the business and how involved Thomas is today?