Description

IG Group Investment Thesis

We believe that IG is a great business with significant upside and a large margin of safety due to 2 key factors. Firstly, although IG’s core business benefited from the COVID environment (higher trading volumes and volatility), the market is wrongly perceiving this benefit to wholly reverse out. We strongly believe that IG’s business has taken a permanent step upwards with a now significantly larger client base and customer churn that is in line with previous years. Secondly, we think IG’s transformative acquisition of TastyTrade (TT) in the US is a game changer for the business. TT is a unique asset in the US. They are disrupting traditional options and futures brokers by undercutting peers on price, whilst also providing unique insights and education to clients through new channels such as Youtube. The company benefits from a structurally growing options and futures market that has compounded at 20%+ over the medium term and has significant potential to continue taking market share from peers that are busy dealing with consolidation (Schwab and TD Ameritrade). Since the closing of the TT acquisition in July 2021, IG set out a new business plan to grow its core at 5-7% a year and its ‘High potential Markets’ which includes TT at 25-30% per annum with TT growing at the top end of that range. The new plan implies IG could grow total revenues by 8.5-11.5% a year which would result in low teens to high teens earnings growth. CEO June Felix has a history of delivering on her targets, with her last business plan that was set out in 2018 achieved 1 year early and significant returns for shareholders over the period. 

Depressed Valuation with implied significant earnings reversal

In FY2021 (Ending May 31st 2021) IG produced £862m of revenue (+32% yoy) and £1.06 (+56% yoy) of earnings per share. At today’s price of 913p, IG trades on 8.4x LTM pe with a significant net cash balance. The stock has not seen these levels of valuation since it faced regulation headwinds in Europe in 2018 and the business was seen to be in a dire situation. This is in stark contrast to the very high valuations given to companies that equally benefited from pandemic tailwinds such as Robinhood and E-Toro. Pre 2018 European regulation changes, IG traded at 16-18x earnings. Our view is that the market will eventually realise that IG’s growth is sustainable, as the new business plan is executed. Assuming a slightly lower base in FY22, we think IG can compound earnings at 12% CAGR for the medium term. Conservatively bringing the business back to its previous multiple range of 16-18x pe on our FY2023 eps estimate of £0.922, IG could be worth 1475-1660p in 12-18 months giving us 65%-86% upside. At these levels of valuation, our downside protection is clear. Even if our estimate of IG’s earnings in FY2023 is wrong by 40% the stock will have no downside if you assume the historical 16-18x pe range. In order to start seeing downside on the stock you have to assume that IG’s depressed valuation continues, and the earnings take a steep hit.

Business History 

IG group is a leading global provider of leveraged OTC products. The business is in structural growth due to the growing wealth of the middle class and the increasing percentage of the population taking control of their own portfolios. Furthermore, due to its long history of trading and its dominance in the UK, IG has a very strong brand and is highly regarded, in particular with high-net-worth individuals looking to trade.  Since its IPO in 2005, IG has grown revenues (and earnings) over 10x from £60m to £700m in 2020.

Due to its compounding revenue growth, high margins (50% EBITDA margins) and high cash conversion, IG stock was an incredible outperformer in the UK with annual returns including dividends of 20.5% CAGR from 2005-2016.

However, since 2016 the performance has been poor due to low volatility in the forex market from 2017-2019 and new regulations in the ESMA regions that was implemented in late 2018. The combination of these 2 factors led to IG revenue being flat from 2016-2019 and the stock de rating from a high of 19x forward earnings to the low teens.

TastyTrade Acquisition and the potential for IG in the future 

In January 2021 IG announced the acquisition of TastyTrade in the US for $1bn, $300m in cash and $700m of IG stock. This was the first significant acquisition IG has made in several years as the past strategy focused more on organically growing the business in the US. Due to this sudden departure from the previously communicated strategy, the market initially took the TastyTrade acquisition quite badly and IG stock suffered a 20% correction. We think the acquisition is a massive win for IG for several reasons. First, IG’s existing US business was niche (binary options and OTC FX) and subscale. There was very little chance the company was ever going to be able to organically grow its way out of these core issues. Furthermore, the acquisition made strategic sense as IG is still over concentrated in mature markets such as the UK and underrepresented in growth markets such as the US. On top of the geographic diversification, IG’s product mix will also benefit as TT sells purely listed derivatives, compared to IG’s concentration in OTC derivative products such as CFD’s and spread betting.

Second, our own due diligence on the TastyTrade asset post the announcement led us to believe that this combination had the potential to transform IG from a low growth OTC player to a faster growing global trading business. We think TT is a fantastic business with a significant edge over its peers. The company has been highly disruptive by growing its presence and share of voice through non traditional media channels such a YouTube. The TT Youtube channel has 100m hours viewed and 255k subscribers. It provides important educational content to people trying to learn basic and more sophisticated options strategies. The Youtube Channel and the TastyTrade website provide a funnel of growth for TastyTrade’s brokerage business TastyWorks (where TT makes all their money). The combination of its unique content and disruptive pricing model, has allowed TT to gain market share every year of its operations and it now holds 5% of the retail portion of the options market and 1.4% share in the whole US options market. We think the business can continue taking share from peers and benefitting from the structural growth in the US options market. Thus, we think that management guidance for TT to grow 30% annually is very much achievable.

Finally, there are revenue synergies between IG and TastyTrade. IG has expertise in SEO and marketing on a global scale. They have been optimising the cost of acquiring users vs user lifetime value over several years and can apply their expertise to help TT accelerate its user acquisition strategy. IG will also help TT with its international expansion. For example, TT has a small presence in Australia where IG demands a leading position. IG has also identified potential in countries such as Singapore where there are a significant number of options and futures traders, and IG holds the number 1 position in the CFD market.

Conclusion

We think IG can grow earnings sustainably at 12% CAGR from a 2022 base of 82p (2021 pro forma eps of 98p) reflective of our assumption that the new business plan is very achievable. The market is putting too much emphasis on the tough comps IG faces next year leading to a valuation we haven’t seen since European regulation issues. The acquisition of TastyTrade is a true game changer for IG, diversifying its revenue into a higher growth geography and potentially launching IG into a new era as a global fintech service provider. IG has an excellent management team with a history of achieving their targets earlier than expected and a robust balance sheet with a net cash position. For all of the above reasons we think IG has significant upside of 65%-85% in the next 12-18 months with very limited downside. 

Catalyst

Quarterly results showing IG revenue not falling off a cliff post COVID benefit