Shares of GAIN Capital were on the defensive yesterday as they fell to $9.5 after previously closing at $10.33. The decline was in reaction to yesterday’s Q1 2015 financial report from the broker where earnings of $0.18 were well below analyst expectations of $0.39 a share. As first reported yesterday, the broker was beset by contracting revenue capture from retail traders. Today we take a deeper look at GAIN Capital’s performance and conference call analysis.
Falling Revenue Capture
The highlight, or perhaps better termed the low-light of GAIN Capital’s report, was retail revenue per million (RPM) dollars traded falling to $83 from well above $110 the previous quarter. The fall in RPM wiped out what could have been a record breaking month for retail revenues as the division hit an all-time quarterly high in retail volumes traded. GAIN blamed the RPM decline on customers taking one-sided positions on the euro. In the conference call, GAIN Capital Glenn Stevens explained that customers were highly uniform in their consensus for the euro. The result was few volumes being crossed among traders as he stated, “You see how customers were actively trading, so you see our active customer numbers go up, but you don't see that ability as a market maker to have customers trading amongst themselves, which ultimately is our best-case scenario."
Interestingly, Stevens explained that although historically higher volatility did in fact increase revenue capture, it didn't always show up in quarter by quarter figures. As a result, despite rising volatility, RPM plunged.
On the bright side, Stevens did state that through synergies and cost savings, the broker’s RPM breakeven point has declined to the mid-$70 range from above $80. Therefore, even assuming volumes retreat by 10-15%, GAIN Capital could be well set to have a bottom case scenario of at least $.10 to $.15 a share in earnings.
City Index Impact: More CFDs, Less Referral Fees
With their acquisition of City Index being completed on April 1, results of the combined firms are set to be reported going forward for both GAIN’s quarterly reports and monthly metrics. For GAIN Capital, beyond just a boost in volumes, the City Index deal will lower the firm’s reliance on the Forex markets with the split between FX/CFD volumes dropping from around a 70/30 ratio to 60/40. City Index also has a much smaller base of accounts from partners and introducing brokers. Therefore, after combining, referral fees are expected to drop from around 30% to 20-22% of retail revenues.
In terms of revenue capture, Stevens explained that CFDs typically provided about 1.2 to 1.3x higher RPM than Forex Trading , with the exception of equity index CFDs which were lower. As such, with a higher ratio of CFDs, the broker expects RPM to also get a boost over the longer term with a completion of the deal.
City Index valuation
Final figures for the deal amounted to $148 million, composed of $96 million in cash and 5.3 million shares of GAIN Capital stock. Netting out the $71 million in cash held by City Index, the net purchase price was $77 million. Coincidentally, City Index monthly volumes averaged $77 billion in 2014. Overall, the net purchase price was 4.5X City Index’s EBITDA of $12.7 million for 2014.
At 4.5X EBITDA, the valuation was below that 5.5 to 6X valuation GAIN Capital had traded at for much of Q1 2015. However, like GAIN, City Index revenues were also under pressure during Q1 2015, with EBITDA reported at $2 million even as volumes grew.
