“Don’t get involved in partial problems, but always take flight to where there is a free view over the whole single great problem, even if this view is not a clear one.” – Ludwig Wittgenstein
For once, there might not be much more to say after a title like this one – and I’m not getting paid to offer strategic advice to the players on this rink – so I will be brief.
First and foremost, my hometown Red Wings have recently been replaced in the sub-basement of the NHL’s Atlantic Division by the Panthers, so hopefully some things have changed for the better for the boys in the D. Just sayin’.
Second, we did a little work to update our Virtu + GETCO + Knight Capital + ITG pro forma modeling, and – uh – how about the good news first? Picking up from where we left off in the most recent post, Virtu, ITG: Much More Than Meets The Eye, which focused mainly on Virtu’s Q3 print of updates to our ongoing suite of charts, we have now turned our attention more specifically to what ITG brings to the story.
In the chart below, Alphacution has modeled ITG’s commission and fee revenue for the 19 quarters beginning Q1-2014 and then segmented that stream by US and non-US components. The upshot here is that ITG has been keeping its largest source of revenue on a relatively even keel by counteracting ongoing US weakness with combined strength in Europe, APAC and Canada. These are definitely areas where Virtu would like some additional diversification given its latest concentration in the Americas and US equities, in particular.
The problem, however, is – ummm – where do I begin?
Even without severe commission and fee pressures – which are prevalent throughout the entire financial ecosystem – ITG’s core franchise has been in decline for the past 10 years purely on an absolute volume basis (see below).
Both total shares traded and POSIT shares traded at ITG have been under pressure for a while (see next two charts).
Now, sorry to say, but what may be worse than these pictures is the fact that ITG does not appear to have diluted its dependence upon its top 10 clients, which means it is either not attracting newer clients that get bigger, or are losing out to other players. Likely, both (see below).
And, even the potential for diversified revenue from ITG’s workflow technology and analytics segments are, at minimum, not moving fast enough in the right direction to make much of a dent anytime soon (see below).
All of which comes together to cause some head-scratching as to how this deal is going to influence Virtu’s fortunes anytime soon (see next two charts below).
If past is prologue, we should expect plenty of consolidation and rationalization fireworks just after deal closing on the earnings front given that ITG finished 2017 with 934 employees. On the top line, however, revenue surprises are likely to be more challenged without a parallel surprise in US market volatility. Except…
While this last piece of our analysis is still in the oven, we are not sure that Virtu is still set up to benefit from volatility spikes (in the same way) as they may have been if they had adopted the entire KCG strategy. Of course, Virtu’s strong revenue response to the Q1-18 volatility spike gives us pause to leap to any conclusions, but our new fascination with 13F analysis – launched in the neighboring post, Goldman Sachs’ Book: Hiding In Plain Sight, has provided some intriguing evidence worth exploring further – and, likely, a dedicated post.
At minimum, you might enjoy a high-level view of that picture (see below).
Bottom line: This deal between Virtu and ITG is likely to provide some needed non-US diversification, incrementally boost upstream flows for downstream US market making, and opportunities for a quarter or two of earnings boost from cost center consolidations. Longer term, this neck of the woods – what we call the “structural alpha zone” – is becoming quite barren of additional consolidation plays as long as you believe – as I do – that Virtu will not go into the proprietary realm, or even the non-US realm, for its next meal.
Frankly, Virtu’s next major play will likely be to offer itself up as a meal to a much bigger fish that needs the technical trading boost and won’t have sticker shock for a deal in this valuation arena. Perhaps a bank like Citi or BAML.
So much for brevity…
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