By Geoffrey Smith
Investing.com -- IG Group (OTC:IGGHY) is paying up heavily for a piece of the action in the fast-growing market for retail derivatives trading in the U.S.
It’s paying $1 billion for tastytrade, a 10 year-old startup that combines a popular online brokerage service with educational content for the swelling hordes of ‘self-driven’ traders. It’s betting that the trend toward increased democratization of stock markets will outlive the current perfect conditions created by loose monetary policy, high market volatility and the enforced semi-idleness of millions of people locked down at the pandemic.
The strategic rationale looks sound enough, bringing clear diversification benefits. Regulatory crackdowns on the legacy business of contracts for differences in its home European market are still a fresh memory, and there is no arguing with increasing its footprint in the world’s biggest and deepest financial market, which accounted for only 4% of revenue in the first 11 months of last year.
The target also looks, well, tasty. Tastytrade’s core market of U.S. options grew at a compound rate of over 24% in the last four years, and growth accelerated sharply in 2020. With EBITDA margins of 47% last year and a highly-scalable technology base, there are no obvious red flags about the underlying health of the business. Adjusted underlying earnings rose just under 50% last year on a 44% increase in revenue.
Even so, the market’s reaction on Thursday was to baulk at the price being paid. By mid-morning in London, IG Group (LON:IGG) stock was down 1.4%.
The $1 billion price tag is around 30% of IG’s market value as of Wednesday’s close, and the company will have to borrow over $200 million and issue 61 million new shares at a valuation of $700 million. That values IG stock at only 843 pence, a 7% discount.
The discount, however, is a modest one, considering that Wednesday’s close was a 27-month high that comes at the end of a big rally: the shares have almost doubled from their lows of early 2019, when the threat from European regulation was at its most severe.
There may be some concern among investors that the ideal current conditions for retail traders may not last forever, and that the willingness of tastytrade’s owners to sell out now may reflect a desire to get out at the top. But its owners will exchange largely IG shares for their own, and will be locked up for five years. Key staff will be retained through a four-year share-related scheme.
Most of all, IG is surely right when it says that the secular trend embodied by the likes of tastytrade is likely to endure. As the company noted, retail participation has increased to nearly 25% of the entire U.S. equity market in 2020 from a range of 10% to 15% over the previous four years, driven by improvements in technology and trader education, as well as greater market accessibility. The underlying structural shift is real, even if things do slow down a bit when the 'stimmies' are all spent.