FXCM and Gain Capital (Forex.com) each announced their Q1 results yesterday. Wall Street was clearly unimpressed with both firms, as the shares of both traded down sharply – FXCM by 17%(!!!) and Gain by 6%. (FXCM is now down 29% from its December IPO price, Gain is off 30% – for more details on publicly traded and M&A multiples and valuation comps in the Forex sector see our Online Forex Industry Report). However we at LeapRate saw the Q1 announcements of both firms mainly positively, with both making nice volume and client assets gains (following similar decent results of early reporters Swissquote and IG Group), and serious inroads in Asia, positioning both firms for strong results down the road.
Our key takeaways from the results announcements and analyst calls?
- The growing importance of Asia. Asia now represents the largest retail market for both FXCM (42% of volume in Q1) and Gain (48%!!!) – and for Gain especially this is a huge shift, as it until now did more than half its retail volume in the US. Clearly, these (and other) firms are making a huge push in emerging markets generally and in Asia specifically, as “traditional” markets in the US and Europe mature. Longer term, aside from the nice near-term results these firms are seeing in Asia, firms are beginning to jockey for position in China, which remains the “holy grail” of the retail Forex world and potentially its largest market. However, we believe that the Chinese – despite some signs of opening such as allowing Yuan options trading (but not spot), allowing firms such as Gain to open representative offices and engage in certain activities with institutional and bank clients (but not retail), and licensing foreign banks (most recently BMO) to make markets in Yuan options – are still far away from allowing foreign firms to take Chinese retail client money, or from allowing margined spot Forex trading.
- Customer Equity growth. The key (and most impressive) number for both FXCM and Gain? Customer Equity. At FXCM it is now $775 million – up by more than 100% from year-end 2009 ($354 million), and at Gain it is $283 million (or $307 million, adjusted for the post-quarter dbFX and TradeStation transactions), up from $197 million at year-end 2009. Long-term, the ability to keep attracting new clients and new client funds is, in our view, the best predictor of long-term success in the Forex business. Some of that growth at both firms has been via acquisitions – most notably FXCM, where GCI Capital Japan has added $114 million and ODL $163 million to client assets – but much of the growth has also been organic.
- Increased costs of being a public company. FXCM’s and Gain’s earnings have fallen despite increased volumes (see below), seemingly disappointing Wall Street, as both firms are seeing increased expense levels across the board. Much of the increased costs relate directly and indirectly to being public companies – increased reporting and accounting costs, legal expenses, etc., as well as increased regulatory and admin costs as both firms continue to expand, and as regulators worldwide are making life more difficult (and expensive) for the Forex firms.
- Volumes are looking great. While we already knew FXCM’s Q1 volumes via its monthly reports, the added information FXCM now gives breaking out institutional volumes ($73 billion per month average in Q1), as well as their April retail volume number of $293 billion, point to a nice recovery in FXCM’s base business after a somewhat lackluster second half of 2010. And Gain saw record volumes averaging $171 billion monthly in Q1, of which 21% represented institutional trading. While FXCM’s greater volumes did translate into higher revenues, Gain’s did not, staying right around the same level as Q4-2010 and down 4% from Q1-2010. Clearly Gain is seeing significantly lower revenues-per-volume the past few months, mainly attributable to a rise in institutional trading, which is typically a steadier but less lucrative business on a per-volume basis.
- Overall? Despite FXCM’s and Gain’s inability to make a lot of money in the near-term, we believe that both firms are well positioned for growth down the road. Both firms have shown us that they continue to grow in several key markets (most notably Asia), have the ability to integrate acquisitions without too much trouble, and continue to solidify their customer base and (most importantly!) attract client deposits, positioning for strong growth over the long haul.
A few other interesting observations / notes / numbers:
- Now that FXCM breaks out retail vs. institutional revenues and volume, we can see that FXCM earns just about 1.9 pips per round-trip trade on its retail volume, and about 0.7 pips on institutional trades – or about 1.6 pips overall. Gain Capital earns about 1.6 pips overall (no breakout possible between retail and institutional).
- Gain Capital announced an up-to-$10 million share buyback plan. Typically, companies announce share buybacks (whether intending to actually repurchase shares from the market or not) to help “goose” the stock price – just the thought of the company repurchasing its own shares can create the illusion of increased demand for the stock. We would be very surprised if Gain does carry through with the entire buyback, as one of the key problems Gain has is lack of liquidity in its stock, which trades only about 100,000 shares per day. Even if an institutional investor were to like Gain, it would have a hard time getting its hands on enough shares to make it worthwhile. And it would also need to be concerned with eventually getting out of its position in an orderly manner. The last thing which Gain needs is to remove more float from the market by buying back stock.
- Interestingly, Gain spends a lot more on marketing ($10.2 million in Q1) than does FXCM ($7.0 million). Gain’s ad budget represents more than 25% of its revenues, while FXCM’s only 7%.