ITG’s third quarter results illustrate the challenges facing research providers. Despite the environment, ITG seems committed to its transition from an execution broker to a research broker. With its acquisition of Majestic Research and subsequent purchase of Ross Smith Energy Group, ITG is a publicly traded example of an agency broker seeking to profit from higher commissions generated through research. The good news: ITG’s revenue per share traded is improving, in large part because of its research product. However, ITG has so far been mum on the profitability side, which may cast a different light on its research investment.
Third Quarter Results
For the third quarter, ITG generated consolidated revenues of $127.6 million, 8% lower than the second quarter of 2013, but 7% higher than the third quarter of 2012. It posted GAAP net income of $0.20 per share in the third quarter of 2013, compared to GAAP net income of $0.13 per share in the second quarter of 2013 and GAAP net income of $0.01 a share in the third quarter of 2012. However, excluding non-operating expenses generated in the second quarter, partly related to restructuring, third quarter earnings were down 25% from adjusted net income of $0.27 per share in the second quarter of 2013.
ITG partly offset declines in U.S. commission volumes with increased international market share. For the third quarter, average daily volume of combined New York Stock Exchange and NASDAQ listed volumes was down 20% from the first quarter of 2013, and 6% below the already low levels in the third quarter of 2012.
Despite the lower commission volumes, ITG was able to increase its average revenue per share to 49 mils, in large part thanks to its research product. In the earnings call, CEO Bob Gasser said that the increase in average revenue per share is thanks to more clients paying for research through bundled trading, as well as increased use of ITG’s block crossing platform.
Gasser’s summary for the third quarter: “Even as U.S. cash equity volumes dropped to their lowest level in more than six years, we remain profitable in the U.S., while our European operations reported strong revenues and profitability for the quarter.”
Third quarter research revenues were down 5% from the second quarter and up 3% from the previous year. During the earnings call, ITG said the decline in research revenues were primarily due to declines in Canada and Asia Pacific while research revenues in the US and Europe were stable.
ITG’s evolution from an execution broker to a bundled research provider is not an easy transition. It is not just a matter of research product, but also building the sales and trading to wrap around it.
During the third quarter, ITG hired high-touch traders and research salespeople. From Gasser’s prepared remarks: “[We] expanded our high-touch sales trading team, bringing on experienced portfolio traders, as well as sector specialists in our consumer and technology, media and telecom sectors. These sector specialists are helping us to expand the distribution of our differentiated research products by deepening our client relationships, amplifying our research calls into buy-side clients and collecting on research obligations at commission rates that are multiples of the U.S average.”
Because of the expense of the sales and trading infrastructure associated with research, ITG will be focusing its research on three primary sectors: Energy, Consumer and TMT.
During the earnings call, Gasser estimated that ITG was in the third or fourth inning in terms of its transition from execution broker to research broker, but was quick to point out that he didn’t mean that in terms of future investment. He indicated that the expense associated with research sales and trading was largely reflected in the current results.
ITG deserves credit for executing on its strategy despite strong headwinds. Its increase in revenue per share traded seems to vindicate the strategy. However, we don’t yet know the profitability side of the equation. The profitability of ITG’s research will be unveiled next quarter, when ITG reports full year results.
As we have noted in the past, product profitability is notoriously difficult and typically not flattering to research. We’ll see how ITG tackles the challenge.
Most likely, the increased revenue per share has come at a higher cost per share in terms of research analysts, salespeople and high-touch traders. If ITG is in the third or fourth inning (in other words about half way) in its transition from an execution broker to research broker, and if its research infrastructure is largely in place, it can expect improving profitability from its research. Stay tuned.