thinkorswim group SWIM
January 05, 2009 - 5:20pm EST by
zach721
2009 2010
Price: 5.90 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 405 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Description

SWIM has a significant competitive advantage in the brokerage business which has played out over the last 27 months as the business has grown organically from 15,600 to 94,450 fully funded accounts (Nov 2008) while revenues have grown from $65mn in 2006A to $210mn in 2008E. Brokerage has attractive underlying economics where the customer acquisition cost ranges from $400-600, with annual EBITDA per customer of $1,100, with only 6.5% annual account churn leading to an industry best 6 month payback period. Usually high growth, high margin businesses trade at a significantly higher multiple than 5.5x '08E and 3.5x '09E EV/EBITDA, however given the current state of the market combined with a number misperceptions have left SWIM trading at 35-40% of what we think the business is worth today.  A worst case scenario has played out on the education side, yet the barriers to entry and value of the education business has been transferred to the brokerage business which gives the company a significant competitive advantage. The value of Investools Education business as a stand alone profit center has been successfully transferred to a powerful marketing engine for the highly profitable brokerage business as evidenced by an industry leading pay back period of only 6 months (this calculation includes all losses from education) combined with brokerage revenue growth that is 5-10x that of its peer group. SWIM has one of the best business models that we can find as the business requires virtually no capital to grow at high rates and margins given the mix of deferred revenue model in education and the high margins in brokerage. The CEO, Lee Barba commented on November 2008 metrics:

 “The volume in our brokerage business held up extremely well in November despite the severe volatility of the market, reinforcing our confidence in the thinkorswim model. We achieved our second highest levels for new accounts opened (at 10,925) and retail DARTs (64,500) - exceeded only by our record October results. New funded accounts continued at a strong pace, total funded accounts reached a record 94,450, and account attrition declined further to the lowest level in two years. Contrary to some expectations that the electronic brokerage industry's results might not be sustainable, our performance has been characterized by strength and stability." 

Quick definitons: TOS=ThinkorSwim (brokerage) and Investools= Education

 

Loads of intangible assets and deferred revenue clouds true economics: Brokerage on the balance sheet shows identifiable assets of $423mn of which $329mn is goodwill/intangible assets. On the liability side the balance sheet has $120mn in deferred revenue, where the vast majority of the costs have already been expensed. In reality what appears to be at first glance a to be a capital intensive business model is really a business that requires close to no capital to run and while sustaining high growth rates. (Working Cap: -$40mn, Intangible assets $329mn, Deferred revenue $120mn, CFO $60mn with $7mn in CAPEX, Tangible Equity -$120mn). As education continues with new front end price points we expect EBIT Margins and Operating Cash Flow to grow substantially driven by the brokerage business with 45% EBIT margins.

Sell Side analysts estimates show no growth for 2009: Due to education revenue plummeting, brokerage revenue growth slowing and the reduced tax shield. We think SWIM should generate $60mn in CFO in 2008 and $98mn in 2009 with annual CAPEX in the $7-8mn range.

Education was confusing, which can be easily simplified in looking at the overall business by taking loses from education and adding marketing spend from brokerage to see what the customer acquisition cost is for brokerage which runs $400-600 per brokerage customer. Approximately 50% of education students open a TOS brokerage account. Investools education allows the company to spend approximately $70mn a year to acquire students. Education has over 380,000 paid grads and approximately 100,000 subscribers to their proprietary Investools toolbox which pay $600 a year to subscribe. Education model while complex has proven its value in extremely strong brokerage account growth over the last 27 months (+566%). Education is an attractive business with very high barriers to entry and very low barriers to exit, which has played out in Investools slamming on the brakes and reducing events by 70% in 2008 yet adjusted EBITDA margins were actually up 50 bps yr/yr. Education has very low fixed costs and high variable costs. The tools and information are largely web based with a very good value proposition (i have been a toolbox subscriber for several years and think it is a valuable service: you can build literally any kind of stock screener, shows weekly money flows into sectors/industries, ranks stocks on 13 point scale on 5 year cash flow growth, sound balance sheet, ROE, Insider buying, etc, there are literally hundreds of other good features). Investools invested over $30mn in building out this platform over the last 10 years. It is essentially a simplified Bloomberg for retail investors, which costs $50 per month.Education revenue will decline sharply with the change in pricing to $299 from $999 while unit volumes should remain flat or decline slightly.

The hair: Education has a formal SEC investigation on how several intructors sold the service on several occasions. The instructors in question were promptly fired. We are comfortable that this will be a minor issue. Our comfort stems from immediately after this occurred Investools hired Pete Santori from FINRA/NASD, who was for 13 years Chief Counsel of market regulation, second Investools went to great lengths to ensure compliance before this happend whereby they would record every word from start to finish of every event, finally this happened with Russ Whitney (a competitor) and the total fines thus far have been minimal around $500K for far more egregious violations.  We estimate to be wildly conservative that this SEC issue is costing investors about $1 a share or $68mn. Finally, Investools has the most generous policy in the industry offering a 100% money back guarantee no questions asked (which is usually 10-14 days) in which a user can use the toolbox and read materials.   

 

Why this mispricing should not last: Growth should continue given user satisfaction is very high, unique customer acquisition channels with Investools, combined with very heavy marketing spend.

Users love the products and the company is rapidly gaining market share through referrals. Some quick examples:

Barrons annual ranking of 25+ brokers has rated TOS #1 or #2 last three years running

TOS is getting 14 to 1 accounts from other brokers http://library.corporate-ir.net/library/10/104/104432/items/296908/SON-060508%20Final.pdf (In October they saw as much as 25 to 1 inflow of new ACTS to out)

Shows 90% of users rate TOS favorably vs. 72% for OXPS and 60% for TRAD but compares close to 100 brokers http://www.elitetrader.com/br/index.cfm?action=view&R_FirmID=146

2008 results: 54,000 fully funded accounts 12/07 to 98,000 fully funded accounts 12/08 or 81% growth.

Marketing Spend of approximately $70mn a year for both TOS and Investools

Investools should graduate their 400,000th student in Feb-Mar 2009.... this is literally 100,000's higher than the next competitor and these are paid graduates.

Net Net: the company has unique customer acquistion channelsbetween education and brokerage, outstanding products that show up in high user satisfaction, and significant marketing dollars to continue to take share in online brokerage.

Unit Economics:

Each account generates ~$1,100 of EBIT (recently has been more in the $1,200-1,300 range).  With 8% churn (LTM churn is 7%), fully taxed and after acquisition costs of ~$500, each account is valued at ~$4,000 (it comes to about 4x EBIT on each account, using a 10% discount rate)

The key is can SWIM keep adding 3K+ accounts per month worth $4K each for a CAC of $500?  We definitely think so and believe that is part of their competitive moat.  The reason they have been consistently adding 3K+ net accounts per month and will continue doing so is: not only is SWIM taking accounts from other brokerages but they are also creating new accounts from scratch thanks to their strong educational offerings.  So they are not only increasing market share but also increasing the size of the pie.  Other brokers mostly just try to steal accounts from each other with various offers or high marketing spend (CAC is anywhere between $500 and $1,500).  SWIM’s educational offerings, including the content itself but also the technology around the content, develop the best customers in the business (highest trades per account, high average account balance, etc.) and makes for a very sticky customer (recent churn in the 4-6% range).

That means that the current 95k accounts are worth ~$380mm (or $5.7/share) and each quarter SWIM adds ~$0.60/sh of value in new accounts or $2.50 per year. If you give a 4 multiple of $2.50 in value creation from the new annual account additions that gives you $10 in value, so we think that current value plus future growth SWIM is worth at least $15/share.

Comps:

                    EBIT/Acct         CAC     Payback Period (mos)    Net Acct adds per qtr     Marketing ($)p/s    Broker Rev Gro (YTD)

OXPS               $570                 $450                 10                       11K                         $0.33                              6%

TRAD                $1,350              $900                 8                        1-2K                        $0.15                              7%

SWIM               $1,275              $640*                6                       10K+                        $1.00                             85%

*SWIM CAC should be $400-600 +/-  going forward

It is important to show that SWIM dramatically outspends its competition due to the Education business, which is an extremely effective customer acquisiton tool based on the payback period.

Market cap (68.5*$5.90)=  $405mn

 

Cash of $72mn + Debt of $96.9mn = Net Debt= $24.9mn

EV = $430mn

'08E EBITDA= $85mn '09E EBITDA= $120mn

EV/EBITDA= 5.0x '08E and 3.6x '09E


Management team is excellent: (cliff note verison)
Lee Barba: has been CEO since the company was 0.15 cents, has made one good decision after the next over the last 6 years.

Anslie Simmonds: Head of Marketing, formerly worked at a Molson/Coors JV and Campbells Soup.

Tom Sosnoff: Head of Brokerage very sharp guy was a former floor trader on CBOE for 20 years and co-founder of TOS

Pete Santori: Chief Legal Counsel, formerly 13 years (1994-2007) at FINRA/NASD as Chief Counsel of Market Regulation. 

 

Whats attractive about the business

Returns on Invested Capital: For 2008E CFO should be $60mn with $7mn in CAPEX with invested capital base of -$7mn.  

DSO's: 23, Fixed Asset Turnover: 51, No Inventory, CFO: $60mn with of CAPEX: 7mn

Brokerage Revenue: $65mn '06A, $120mn '07A, $210mn,

Brokerage EBIT Margin: 45% 

Net net we see a brokerage business business that is being powered off an efficient marketing engine that is spending nearly $70mn a year with attractive underlying economics shown in a 6 month customer pay period with high brokerage growth rates.

 We think SWIM is worth between $13-15 per share due to industry leading brokerage growth (+85%), high user satisfaction (14 to 1 ACAT in to out), aggressive marketing spend of over $1 a share a year which is 6x TRAD and 3x OXPS on a per share basis, and the best payback period in the brokerage (6 months). This aggressive marketing spend should allow TOS to continue to take market share going forward and the company should get credit for the value in TOS.SWIM bought back 160K shares @ $9.57 last quarter. Finally, SWIM business model allows the company to adjust rapidly to changes in the macro environment due to having very little fixed costs in education and a highly profitable and recurring brokerage business.

  

 Disclaimer: This does not constitute a recommendation to buy or sell this stock.  We own shares of the company, and we may buy shares or sell shares at any time without updating the board.

 

Catalysts:

Playing for growth: SWIM Marketing dollars per share slightly over $1 in 2008 compared to OXPS .33 per share and TRAD .15 per share. Not only is SWIM the most aggressive in the industry they have the best customer pay back period which led to 81% fully funded account growth in 2008.

 SWIM EBITDA $1.25 '08E and $1.75 '09E (assumptions finish '08 w/ 98K fully funded brokerage accounts and '09 with 138K) (2008 will show fully funded account growth growing from 58K to 98K in 2008, all organic growth) and cheap at 5.5x and 3.5x 08/09E EV/EBITDA  

Best customer payback period in the industry at 6 months ($400-600 CAC vs. EBITDA $1100) with one of the lowest churn rates in the industry at 6.5% annualized

 High Growth and low capital intensity: Brokerage business $65mn, $110mn, $210mn last 3 years with 45% EBIT margins and DSO's of 20's

Cheap 3.5x EV/EBITDA combined with attractive economics: extremely high ROIC, 24% EBITDA margins

 High barrier to entry business: education + top ranked online brokerage with high user satisfaction and rapid growth.

 Sharp management: Tom Sosnoff (Brokerage), Lee Barba (CEO), Pete Santori (Legal), Anislee Simmonds (Marketing)

Catalyst

see above
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