As many investors are aware, last quarter's stock market was extremely volatile. That should theoretically benefit online brokers, which make money from trading activity. Nevertheless, discount broker Interactive Brokers (NYSEMKT:IBKR) missed expectations for both revenue and earnings per share on its recent earnings release, sending shares down roughly 4% the next day.
Still, I think investors should stick with Interactive Brokers, the lowest-cost operator in the brokerage business. Last quarter's miss appears to have more to do with the idiosyncrasies of the quarter, not Interactive Brokers' competitive advantages. Let's dig in to see what happened.
Misleading headline numbers
At first, it may seem as though Interactive Brokers is a declining business. Revenue declined 4% year over year -- not what one expects from a disruptive growth company, which is what Interactive Brokers purports to be.
However, that headline number doesn't reflect the true story. Interactive Brokers' core operating businesses actually grew revenue 17%, from $425 million in the fourth quarter of 2017 to $496 million in Q4 2018.
Offsetting that was a $12 million loss from Interactive Brokers' "GLOBAL" currency strategy. Because Interactive Brokers is a worldwide operation with significant overseas segments, management has decided to hold the company's cash reserves in different currencies reflecting its end markets. Unfortunately, those currencies took a hit versus the U.S. dollar last quarter.
In addition, Interactive Brokers got a $93 million boost from the U.S. Tax Act in the year-ago quarter. That combination, along with some smaller accounting factors, led to a huge $115 million swing in inter-company revenue.
Over time, these one-time items will even out, so investors should focus on the core electronic-brokerage business, which continued to grow accounts by 24% year over year.
China restrictions affected Asia growth
Like virtually all companies with global businesses, Interactive Brokers was a victim of the Chinese growth slowdown and the U.S.-China trade war. Management said of capital controls: "Starting early in the fourth quarter, we noticed that some of our accounts in Asia, particularly Mainland China, have taken longer to fund, if they can fund at all, due to constraints on their local banks regarding capital outflows."
Mainland China had been one of Interactive Brokers' strongest growth regions, but the company's China growth fell 70% off its prior pace in Q4. That means even the company's 17% core revenue growth may be undershooting Interactive Brokers''s true potential.
Thomas Peterffy isn't selling (much) despite retirement
Another concern surrounding Interactive Brokers is the recent retirement of founder and CEO Thomas Peterffy. Peterffy actually still owns over 80% of Interactive Brokers' shares, and on the conference call with analysts, he acknowledged some investor concerns surrounding his holdings. Namely, that he might sell shares in large quantities for his "retirement" (even though he'll continue to act as chairman), or that his heirs may dump stock to pay estate taxes upon his death.
In response, Peterffy came up with a gradual, automatic selling plan, in which he will sell 20,000 shares per business day starting in July, and which will run for the next 60 years. If that seems like a lot of money...it is. At today's prices, 20,000 shares per day equals about $1 million. Over 60 years, that comes to roughly $15 billion.
Peterffy elaborated: "This program demonstrates my long-term commitment to the company. It would also generate sufficient cash to deal with the tax issues, and will also gradually increase the public float, which will be good for the liquidity of the issue."
Check out all our earnings call transcripts.
The younger generation makes me bullish
Despite currency headwinds, China issues, and succession concerns, I remain bullish on Interactive Brokers. Its software-driven automation is a key cost advantage, allowing the company to undercut competitors on both commission and margin loan rates.
What might hold up customer growth? Well, due to its automated nature, Interactive Brokers' user interface isn't the easiest to use, and older investors may find it daunting. On the call, management pointed to the relatively young age -- 46 -- of its average customer. The upside of a younger clientele is that it points to a long runway for client equity growth, just from the existing customer base. As the younger generation gets more and more tech-savvy, the global investor base should become less intimidated by Interactive Brokers' tools, and its cost advantages should become more apparent, attracting even more customers.
A young, tech-savvy customer base and a low-cost advantage still put Interactive Brokers in a great position, even if its last quarter was challenging. In short, I remain a happy Interactive Brokers customer and shareholder.