What's Instinet Worth to You?

The pioneer electronic stock-trading network is a survivor, and its IPO will allow investors to name the price they are willing to pay

Before Archipelago, before Island ECN, before even Nasdaq, there was Instinet. Since 1969, this pioneering electronic stock-trading network has given institutional investors the power to swap shares directly. Without having to send their orders on circuitous routes past toll takers on Wall Street's exchange floors and trading desks, Instinet's clients often can save money and time. Demand for the service keeps running high: Revenues last year leaped 48%, to more than $1.4 billion (table).

Now, even small investors are noticing Instinet. With clever TV ads on CNBC and CNN featuring a matador and live market updates from its Manhattan headquarters, it's taking a higher profile. Next step: an initial public offering. Reuters Group (RTRSY ), Instinet's owner since 1987, aims by June 30 to sell 12.5% of Instinet for an estimated $12.50 a share, or $369 million.

Good deal? Could be, but as usual it will depend on the price. Happily, with this IPO, prospective investors have two circumstances working in their favor. The IPO market remains sickly, limiting the price that Reuters, which stands to take $150 million of the deal's proceeds, can win for Instinet. Better yet, because of Instinet's link to an unusual new underwriter, small investors can specify the price they're willing to pay. More on that in a minute--first, let's look at some risks in Instinet.

NEW RIVALS. While its revenues have been growing smartly, other trends are worrisome. The biggest is that annoying little thing called competition. Rivals have been multiplying with the new wave of "ECNs," or electronic communications networks, such as Island. In January, 2000, Instinet led this pack, handling 10.6% of volume in Nasdaq companies, more than the other ECNs combined. A year later, Instinet's share had grown to 12.2%, but its ECN rivals claimed 15.5%.

All of this had the usual ugly effect on prices and profits. Instinet's average revenue on each trade last year sank 19%. Its average pretax profit fell even faster, by 38%. It threatens to get worse as Nasdaq prepares next year's launch of its own revamped trading system, "SuperMontage." Instinet CEO Douglas Atkin is keeping quiet ahead of the IPO, but the company's securities filing says: "We believe that the downward pressure on prices will continue."

So why am I not a stone bear? Instinet has survived such threats before, notably in 1975 with the end of fixed brokerage commissions. My bet is it will survive again--and thrive. It boasts a long list of blue-chip clients. It's financially strong. It's growing in multiple ways, abroad and via such new services as bond trading. It also has hedged itself with small stakes in Archipelago and Nasdaq, and owns about 8% of that unusual new underwriter, W.R. Hambrecht.

Because of that tie, up to 17.5% of the IPO shares will be sold via Hambrecht's "OpenIPO" online auction. In a typical IPO, underwriters give their biggest clients first dibs on shares and a large say in the offering price. Little investors get scraps. In Hambrecht's auctions--details at www.wrhambrecht.com--anyone with $2,000 to open an account can bid for shares equally. The higher you bid, the more likely you will get them. Yet you also can bid low. Instinet's estimated IPO price is 20 times last year's net. That's no wild e-multiple; neither is it a bargain. Suppose, though, that you decide it's worth, say, 14 times earnings, or $9 a share. Through OpenIPO, you have the power to bid $9. If the IPO ends up being priced below your bid at, say, $7, you pay $7. The risk you take is that the deal is priced higher and you get no stock. As IPO risks go, that's one worth running.

Questions? Comments? Send an e-mail to barkerportfolio@businessweek.com or fax (321) 728-1711

By Robert Barker

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