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  • Financial Institutions Group Team

IG Group to spend $1 billion to acquire tastytrade

By: Rachel Tang, Solomon Wong, Mohammad Memon, Diego Zuloaga Prado

Deal overview

On the 21st of January 2021, IG Group Holdings Plcannounced the acquisition of Tastytrade, Inc for $ 1 billion. The deal consists of $300 million in cash and 61 million IG Group shares roughly worth $700 million and reflects a valuation for Tastytrade, Inc of about 18 times 2020 earnings before interest, tax, depreciation, and amortisation. This deal, which is scheduled to be completed in the summer of 2021, is the largest-ever acquisition for IG Group.

Company Details: IG Group Holdings

Established in 1974 as one of the world's first providers of financial derivatives to retail traders, IG Group Holding continued leading the way by launching the world’s first online and iPhone trading services. IG is a multi-product trading company providing retail, professional and institutional clients with access to trading in over 17,000 financial markets. Operating globally under the IG brand, it is the trusted platform provider for nearly 340,000 active clients. Its business model is based on generating a return from services through transaction fees (spread, commission, and funding charges) charged to clients. The level of revenue in any period is predominantly driven by the number of active clients it serves in that period and the level of trading activity undertaken by each client. IG does not seek to generate returns from actively taking market risks - it does not take proprietary trading positions, and revenue is not dependent on the direction of market movements.

Moreover, it is the world’s number one provider of contracts for difference (CFDs)* and a global leader in the forex exchange market. IG’s core markets include the UK, EU, Australia, and Singapore. Beyond its Core Markets, IG’s strategy is focused on its Significant Opportunities portfolio, comprising the US, Japan, Emerging Markets, and Greater China geographies. Additionally, IG has a range of affordable, fully managed investment portfolios that provide a comprehensive offering to investors and active traders.

*A contract for differences (CFD) is a financial contract that pays the differences in the settlement price between the open and closing trades. CFDs essentially allow investors to trade the direction of securities over the very short-term and are especially popular in FX and commodities products.

Founded in 1974, headquartered in London, UK

CEO: June Yee Felix

Number of employees: 1,921 employees

LTM Revenue: $649.2 Million

P/E Ratio: 8.42

EPS: 65.3p

Market cap: 2.899B

Total Equity: $935.90 Million

Total Assets: $1,299.70 Million

ROE: 25.69%

Company Details: Tastytrade, Inc

Tastytrade is a fast-growing platform that provides differentiated financial content and trader education as well as a sophisticated options and futures brokerage. It operates through two primary entities: Tastytrade, an online financial network that provides trading content to knowledgeable retail traders, and Tastyworks, a leading online brokerage platform allowing self-directed retail traders to trade US options and futures platform enabling self-directed retail traders to trade US options and futures (84% options; 9% futures; 7% equities). Focusing on trader education and original content, alongside its sophisticated brokerage offering, enables Tastytrade to have a clear competitive advantage over its peers. In addition, Tastytrade produces 8 hours of live, original programming each weekday to provide financial information, investment strategies related to options trading and the stock market. Tastyworks, a subsidiary of Tastytrade, has built a strong and fast-growing client base, which today comprises over 105,000 active accounts and represents c.1.3% of the entire US equity options market (institutional and retail) by volume traded while being ranked by Barron’s as the second best online brokerage platform for active traders.

Founded in 2011, headquartered in Chicago, US

Co-CEOs: Tom Sosnoff (founder) and Kristi Ross

Number of employees: 145 employees

LTM Revenue: $116.2 million ( at 31st of December 2020)

Gross Assets: $200.5 million

Adjusted EBITDA: $54.1 million

Profit before tax: $49.0 million

Deal rationale

The acquisition of Tastytrade establishes IG’s position in the fast-growing retail trading market. Retail participation has increased to almost 25% of the US equities market in 2020, from a range of 10-15% over the last four years, driven by improvements in technology and access to both markets and education. IG expects increased interest in derivatives as retail traders seek to take more control over their financial outcomes and financial wealth.

IG is a market leader in the leverage OTC space, and its original core offerings – CFDs and spread betting – still generate the majority of its revenue. The acquisition complements IG’s existing organic growth strategy by including Tastytrade’s highly complementary expertise in exchange-traded options and futures, while Tastytrade will be able to use IG’s global infrastructure to expand its services internationally. This extension of IG’s product capabilities diversifies IG’s regulatory risk profile beyond its historical focus in risky OTC trading, into US exchange-traded derivatives. Furthermore, the acquisition provides lucrative growth opportunities as it expands IG’s presence in the US. With an estimated 1.5 million retail traders, the US options and futures market is larger than the CFD/FX and European Turbo markets combined in the rest of the world.

Tastytrade’s revenues grew at a CAGR of 49% between 2018 and 2020, and active accounts grew at a CAGR of c.64% during the same period, reflecting its robust and differentiated proposition within the expanding US options and futures market, and represents clear financial benefits to IG shareholders. The acquisition is expected to be low single-digit accretive to IG’s adjusted earnings per share in the first full year post-completion. Besides, Tastytrade’s strong profitability and cash flow positions IG to drive additional earnings growth in the longer term.

Finally, both IG and Tastytrade share the same client demographic of self-directed retail traders. In the long term, the combined company’s larger set of derivative product offerings is expected to increase retention rates and revenue per client.

Competintion landscape and industry trends

In recent years, while IG group’s business has grown significantly, the brokerage sector in which it operates has also become more competitive than ever. The most prominent competitor firms of IG group include: Schwab, Citadel Securities, Jane Street Capital, E-trade, etc.

As the pandemic hit the financial market in 2020, there have been a few important trends occurring in this period:

1. A boom in retail investor trading volume

As governments around the globe have been adopting expansionary economic policies, the stock market has risen considerably since March, thereby attracting many new retail investors and driving up the trading volume in the market. Brokerage firms have greatly benefited from this trend, as they receive more revenue from providing market-making services. For instance, in 2020, Citadel securities, one of the largest market makers, has seen an increase in its net income by more than double the previous year’s.

2. An uptick in M&A activities within the sector

2020 has seen a significant boost in deal activity, driven by a low-interest rate environment and firms seeking to increase efficiency with more economies of scale. For example, We have seen Charles Schwab acquiring TD-Ameritrade in October and Interactive Investor's acquisition of Folio Investment in December, etc.

3. Shrinking margins as firms compete on zero transaction fees

Price competition between different brokers is fierce. With more firms offering free commission fee services to investors, the broker firms’ profit margins are under pressure. Therefore, firms are increasingly innovating to capture customer segments and launch new products, to boost profitability.

4.Digitalisation amid Covid-19

Throughout the pandemic, firms had to adjust to the new normal and engage customers through online platforms, hence highlighting the importance of firms being digitally adept. Moreover, facing new market entrants such as non-traditional FinTech firms, market incumbents need to up their game to fend off competition. Due to these two reasons, we have seen firms in the brokerage industry increase their capital expenditure in R&D (Research & Development) in 2020.

Risks and uncertainties

Lastly, as with regards to risks and uncertainties that could challenge this deal, they are very limited.

Firstly, it is very unlikely that there will be a struggle for regulatory approval.

Secondly, integration risks are also quite low. On the one hand, no significant integration will be required, so associated costs are minimum. And on the other hand, managerial risks are also unlikely. Both firms present experienced senior management teams with a proven track record. The deal would enhance cooperation between the firms and provide significant synergies to both companies, without supposing a threat to shareholders. On the one hand, a five-year lock-up period on IG shares grants an alignment of interests for Tastytrade shareholders. And, on the other, the announced four-year retention program for employees will ensure management continuity. And, with an alignment of interests, the probability of this deal failing is almost non-existing.

Finally, risks of client attrition, once again, are also limited. Both firms currently tackle the same type of client and this deal will allow them to reduce costs and join forces in this matter. Additionally, client attrition will also be unlikely because the acquisition will still enable Tastytrade to continue its operations as a standalone division under IG’s existing brands. In that regard, Tastytrade will enjoy a certain degree of independence which once again, contributes towards minimising obstacles to realising synergies.

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