FXCM is doing great… and is in big trouble

Retail forex broker FXCM Inc (NYSE:FXCM) continues to report some of the highest FX trading volumes in the industry month by month, with May 2016 coming in at $280 billion.

After narrowly avoiding bankruptcy early last year in the immediate aftermath of the January 15, 2015 surprise Swiss Franc spike by securing (over the course of a hectic 38 hour period) a $300 million rescue loan from Leucadia National Corp (NYSE:LUK), FXCM has amazingly been able to maintain its top-of-the-heap position in Retail Forex trading. It has done that despite FXCM having to jettison some divisions and businesses in order to start paying down that loan, such as FXCM Japan and FXCM Hong Kong.

The company has been able to start regrowing its business, with FXCM Q1-2016 Revenues up 9% QoQ to $71.5 million.

And FXCM is in big trouble.

We’ll explain.

As we described in the rosy picture painted above, it is hard to envision FXCM doing all that much better operationally than it is. In Q1 this year FXCM generated $71.5 million in Revenue and EBITDA earnings of $10.3 million – numbers which many other brokers would love to have.

So what’s the problem?

The aforementioned loan which FXCM took from Leucadia came with two key conditions: 1) Leucadia gets most of the ‘upside’ should FXCM be sold down the road, and 2) FXCM pays Leucadia a very high punitive rate of interest on the loan as long as it remains outstanding. The loan interest rate started off at 10% (per annum), and increases by 1.5% each quarter for as long as it is outstanding up to a maximum of 20.5% per annum.

The Leucadia loan stood at $193 million owing as at the end of Q1. And at the current interest rate of 17.5% (it will reach the max 20.5% rate later this year), that means that FXCM is paying interest to Leucadia of about $8.4 million each quarter. If the loan principal stays at its current level those quarterly interest payments will hit $9.9 million later this year. Which is basically FXCM’s entire EBITDA.

And FXCM has other debt to service, including $172 million of senior convertible notes paying interest of 2.25%.

So what this all means is that FXCM is caught between a rock and a hard loan. The company still has a sterling reputation as one of the big and safe brokers in the FX sector, doing business with both retail and institutional clients. But as far as we can see, for the foreseeable future FXCM will be pouring its entire cash flow (and more) into servicing its debt.

Drew Niv, FXCM

FXCM CEO Drew Niv commented on the situation to LeapRate:

FXCM together with discontinued operations, had $236 million in operating cash as of 3/31/16. We currently believe in the strategy we have laid out regarding asset sales to pay off our debt. Customers of FXCM are safe and should know that we are financially secure and remain a market leader with some of the best execution and technology in our industry.  We generate enough cash to make our interest payments and all client money is secure. As we have stated publicly before it will take years for shareholders to see any returns. Our priority is to repay our debt.

Companies in FXCM’s situation often try to raise more equity capital to pay down some of the debt and re-balance the equity/debt equation. However condition # 1) in the Leucadia loan listed above makes that all but near impossible. Unless the money comes from Leucadia itself, or unless Leucadia agrees to convert some or all of its loan to FXCM into equity, who would buy new shares in a company where most of the upside (if things go well) goes to another party?

It seems to us that the stock market has caught on to this whole FXCM conundrum thing. FXCM shares were down 9% two consecutive trading days at the end of last week, and began this week by trading down another 1%. While FXCM’s business still obviously has a lot of value, the value to shareholders is quite another issue.

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