Business Breakdowns
· Jacopo Di Nardo
[00:00:00] S2: From a NIM perspective, Zack, what's also pretty interesting is obviously margin loans tend to be higher yielding products maybe pay 100 basis points more than what they get on cash on the asset side. And these tend to be cyclical, but move in the opposite way of interest rates. So for example, if interest rates were to go back down to levels that we observed in 2019 or 2020 or 2021, the amount of leverage that investors are usually willing to take slightly higher. So the margin loan per account was materially higher back then. And so in the mix as interest rates fall, we would also expect margin loans to pick back up, helping a little bit with a NIM fall. If you go back in time, 2019, 2020 were pretty difficult years for whoever was exposed to rising interest rates and the company was still making maybe 30 basis points less than today net interest income, they have proven themselves in a way through cycle to be able to earn fair, attractive spread on assets and liabilities.
· Zack Fuss
[00:00:00] S0: And so you guys had mentioned the international opportunity here and where some of the growth is coming from. Obviously we've seen through the COVID backdrop, participation in capital markets and investing exploding, perhaps the advent of Robinhood as an on-ramp for that, but also just the financialization of western economies. What are the growth opportunities for this business? And I ask that in the context of on their earnings calls, they're very often asked if there's any M&A opportunities. And because they operate such low costs and they provide such attractive margin loans to customers, the pro forma earnings of acquisitions make the math very difficult for them. And so I guess weighing organic versus acquisitive growth, where they're going to see their business continue to expand?
· Freddie Lait
[00:00:00] S1: Interesting, you picked up on that comment too because it's one we've discussed in the past, which is this idea that if we buy a business but then we take it to our spreads and our offering, the underlying revenue and profits would collapse in that business. So they're not able to pay what the owner thinks they can pay. Because if they give back to customers as much as they give back in their main business, it would be a very different profit level. And so that to us is incredibly telling. They are open to acquisitions. They have done them in the past, but there's nothing out there which would make sense. And so they're going to grow organically. They have one of the lowest advertising budgets of all of the online brokers. And despite that, have outgrown anyone we look at. They're growing organically. They're growing because their rates are just better than everybody else's. And if you are trading any meaningful amount of capital, I'm not here to sell it. But I'm sure some people listening to this will be trading their own shares. And it's worth a look because it's a meaningful saving to go to a business like this. And I think at the moment what they're getting asked more about is this sort of potential for growth in the more B2B channels that we've discussed, the RIAs, the hedge funds and the introducing brokers. But notwithstanding that, individual accounts are growing very rapidly too. So the mix isn't changing very quickly. And when we think about growth potential, I mentioned earlier a few different sort of big, hairy, audacious goals for the management team. Schwab have I think 25 million accounts principally in the US. I think fidelity is something around that level. They are smaller on average, so there's a tail of those accounts which would be less profitable for this business. But three and a half or four million accounts that we have today is still a fraction of that domestically. And they talk about 20 million globally as a sort of first stop in their growth story. And then at a sort of later stage they talk about this 80 million number because in a couple of countries where they operate, they are already at sort of 1% of the population. And that would be that sort of level of penetration. And the key thing to that potential is people will still continue to trade a lot.
· Freddie Lait, Jacopo Di Nardo
Whatever happens with markets becoming more digital and outsourcing within the B2B channel will probably continue for the next 5, 10 and 20 years. Big question is, can someone compete with this? Can someone come away to stop them organically growing share? Given the counter positioning and that first comment about acquisitions and the competitors to reinvest, to try to build the direct market access and to invest in prices and cost and automation like this business has, everyone's folding and using this business instead of trying to compete with it. [00:00:00] S2: To your comment of more participation into financial markets by all sorts of individuals, especially after Covid, we believe that to be a pretty good tailwind too because as we said at the beginning, someone who is inexperienced and might have a smaller account balance, he might start a Robinhood account or eToro or whatever else he can get his hands off depending on the jurisdiction. But after a certain period of time, after becoming more accustomed to trading and honestly after having increased his own disposable income, we do believe the proposition of joining Interactive, especially as an active trader, is so much better than anything that's around there. But we do see a lot of his customers eventually dropping to Interactive over time as soon as the account balances reach $100,000 or $200,000.
· Freddie Lait, Zack Fuss
[00:00:00] S1: And if I can just add one more thing you mentioned earlier, some people are upset with the customer service. We see a lot of analogies between this business and other low-cost businesses that we look at. One would be sort of Ryanair. And I think it's really compelling to see that business, another business we like, where Michael O'Leary said, "I didn't realize looking after customers would make me so much profit." And he started making the customer experience more pleasant. I think they're doing that at Interactive too. They've had this obsessive focus on costs and automation for 50 years, including in their prime brokerage business. But they've just rolled out what they call the sort of white-glove service, which is a very manual, independent director looking after your account as a hedge fund. And I expect a bit more of that over time coming back into the business on the customer service too, which slightly opens up their market. One final thing they're doing as well is really relaunching their app, which will come in and help that customer acquisition that Jacopo said of those who are out there learning the ropes in apps like eToro and Robinhood, but may want to grow up into Interactive later. [00:00:00] S0: And so we touched upon it in relation to M&A. But clearly a business that's generating as much excess free cash flow as this one, capital allocation becomes increasingly important. What is their demonstrated strategy as it relates to redeploying the cash that they're generating on an ongoing basis if M&A is not available to them?
· Jacopo Di Nardo
[00:00:00] S2: This is a very important question, especially as the business will eventually mature. And in fact, at the moment the only capital return we are receiving is a dividend yield that's usually targeted to be about 0.5 to 1% of the total market capitalization. And there's a couple of things though to keep in mind. I think the company wants to keep a balance sheet that's as strong as it can be, mostly to develop the prime brokerage and hedge funds business. And one of the reasons being that the companies they do compete against, behemoths like Goldman, Morgan Stanley, UBS and Bank of America, are materially larger financial institutions. So to win over customers and hedge funds that manage 1 to 5 billion dollars of assets, they do need potentially stronger balance sheet than what we actually could imagine ourselves. The second point comes actually with the company structure. It is a publicly listed company, but still today, insiders own roughly 80% of the stock, of which most of it, 75%, is still Thomas. But the CEO and CFO also have a significant stake in the business. And therefore launching extremely big special dividends or share repurchase programs is not necessarily doable until the float of a business is increased. So we, like many other external investors, we are looking at the topic. We do believe over time, as Thomas, as he rightly says, is not immortal and he's approaching or above 80 years of age, we will see how that evolves. But it is something that we do like to an extent, because if you think about ways of maturing as a business, the final phase when growth slows down and is not what it used to be 20 years ago. Any business has a choice to make which can be growing again through M&A whenever it is possible, or returning excess cash to shareholders. And we are not even close to there. As Freddie has discussed, there's a potential over time to probably 20x the number of customers on the platform. But once that is done, having excess capital to return to shareholders, as the structure has probably changed by then is an option. But as investors, we do like to have—there's other businesses that are in that situation, I guess Berkshire Hathaway being an enormous one, which is in a similar position with an incredible amount of cash and Treasuries sitting on the balance sheet.