Virtu Financial (VIRT)

[Doubledown22]

Virtu Financial's Stock Market Revolution Spells Big Payoff
Apr. 14, 2015 1:31 PM ET | About: Virtu Financial (VIRT)

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
http://seekingalpha.com/article/3069676-virtu-financials-stock-market-revolution-spells-big-payoff

Summary
•Virtu Financial is a high-speed trading company that operates as a market-maker between bid and ask prices.
•The company has been extremely profitable over the past 5 years, recording only one day of trading losses.
•The current IPO price presents a favorable valuation to investors.
•The company is well positioned for future long-term growth.
•Significant risks could be highly detrimental to the company's profitability and operations.

Overview

The week of April 13 is shaping up to be a busy one for initial public offerings. Notable companies like Virtu Financial (Pending:VIRT), Etsy (Pending:ETSY), and Party City (Pending:PRTY) all plan to make their IPOs. Currently, eight companies plan to list, which could raise funds in excess of $1.1 billion given current filing information. One of the most publicized will be Virtu Financial, a high-speed, high-profit, electronic trading market maker. The publicity will be the result of much controversy. In 2014, the company announced that it had only posted one day of loses in the past five years, which, in light of Michael Lewis's book "Flash Boys," the company was criticized for unfair advantages in high-speed trading. The company actually postponed its initial attempt at an IPO until the controversy settled. Virtu is destined for a large IPO pop, and individual investors should wait until the valuation stabilizes.

Valuation

Given current pricing, the company could be valued as high as $2.6 billion given all four classes of common stock at a price of $19 per share. Only 30 million shares will have economic rights at issuance, assuming voting rights-only Class C and Class D shares are not converted. The following schedule lays out the pro forma income statement for the publicly traded corporation:

Source: Virtu S-1

The resulting company would have produced $0.81 in earnings per share. The resulting price-to-earnings ratio would be 23.5. This is in line with current comparable peers of similar size and growth trends.

The S-1 also lays out a dividend policy to pay 70-100% of earnings as quarterly dividends. The first dividend of $0.24 is slated for September 30, 2015. At $0.81 EPS, the dividend yield would be 4.2% at $19 share price. An annualized dividend of $0.24 for four quarters, or $0.96, would yield 5.1%. Virtu is well underpriced using the peer group yield. In order to yield the same dividend rate as the peer group, the stock would have to be priced just over $73 a share.

Growth

For fiscal-year 2014, Virtu posted almost 9% revenue growth year over year. Most of the growth came from net trading income from a diverse set of markets.

Source: Virtu S-1

One of Virtu's keys to future growth will not only be reaching new markets, but more importantly expanding depth across a large variety of markets.

Source: Virtu S-1

Increasing exposure and utilization in already existing markets can offer significant future growth prospects, especially as emerging markets mature.

Too good to be true?

When Virtu announced that it had only posted one day of trading losses since 2009, it expected a positive response to exceptional performance. The response was more tempered and critical of the ethics behind its high-speed trading model. Regardless, if you agree or disagree with the platform, investors should still be critical of future results.

Source: Virtu S-1

The company makes its profit by matching buy and sell orders at high speeds and profiting the spread between the orders. These proceeds create two key risks. At anytime the company can be holding a ton of assets as it is self-clearing or dependent upon clearing houses to meet its obligations. Any disruption or abrupt fault in a market could be disastrous. The second risk revolves around rules and regulations behind high-speed trading. Virtu stands to be harmed if this competitive advantage is regulated in any market it currently operates in.

Summary

Virtu looks like a great investment given the current valuation and yield, historic trading performance, and future growth outlooks. A steady 5% yield coupled with potential for almost double-digit annual growth is always very attractive. However, the risk of eminent doom exists. In a flash, the company could suffer dramatic loses or its business model could be ruled completely useless. I fear most investors will undervalue these risks and drive Virtu's trading price up following the IPO. However, if Wall Street uses more caution, individual investors might be able to pick up a good value.

DD22