ICAP Thrives Amid Financial Volatility

The London interdealer broker's position handling nonstock trades means it's poised to profit whether the market gains or falls

In a brutal year for financial services, one British company is flying higher than ever. London-based ICAP (IAP.L), the world's leading interdealer broker, makes money from handling a wide range of nonstock trades for banks, dealers, and fund managers—whether the market is going up or down. The volatility and anxiety gripping markets since last summer have only sweetened ICAP's bottom line, as asset sales and hedging have lifted trading volumes.

On May 20, ICAP announced record pretax profits for the year ended Mar. 31, of $648 million, up 31%, on a revenue increase of 18%, to $2.56 billion. Little known outside financial circles, the company says it now handles nearly one-third of the world's interdealer brokerage transactions, which run the gamut from trades in corporate and government bonds to foreign exchange and energy contracts.

Thanks to its central role—and surging fortunes—ICAP has been the best-performing financial-services company on Britain's FTSE 100 stock index in the past 12 months, up 15%. That compares with a 6% decline for the market as a whole and a near 50% drop for some financial-services giants such as Barclays (BCS) and Merrill Lynch (MER).

A Broader Product Offering

Partly as a result, ICAP has been a frequent subject of takeover speculation. But with its $6 billion market capitalization and minimal debt, the company is more likely to be the buyer. Its stock trades at nearly 19 times expected 2008 earnings, compared with ratios of around 14 for New York-based rivals BGC Partners (BGCP) and GFI Group (GFIG). And analysts at Citibank (C) figure ICAP could tap an acquisition war chest of around $1 billion to snap up smaller firms—something it has done in previous years to expand beyond its original bond-trading business into a wide range of services.

"The [market] volatility has been helpful, but ICAP's core underlying business remains strong," says James Hamilton, a financial analyst at stockbroker Numis Securities in London. "The company has a broader [product] offering than it used to, and there are many areas of growth still out there."

Originally known as Intercapital, ICAP has come a long way since it was founded in 1986 by Chief Executive Officer Michael Spencer. A colorful character known for his red suspenders and criticism of the European Union, Spencer has built the company from its roots in fixed-income trades into a one-stop shop for financial institutions looking to trade assets ranging from equity derivatives to shipping contracts.

Further Acquisitions Are Likely

One key to ICAP's success has been its aggressive use of acquisitions to enter new markets. In 2006, the company paid $775 million for EBS, the world's largest currency and commodities trader, a move that also boosted its presence in the U.S. More acquisitions have followed: Last October, ICAP spent $247 million for New York-based Triana, a provider of post-trade processing services to financial institutions, and in April, it bought London-based Link Asset and Securities, an equity derivatives broker, for $498 million.

Further acquisitions likely are in the works. Spencer told analysts on May 20, "There are an increasing number of expansion opportunities…as the world's financial markets grow." The top priority is emerging markets: ICAP now gets only 12.8% of its revenues from the Asia Pacific region, compared with 40.5% from the Americas and 46.7% from Europe, the Middle East, and Africa. A push into emerging markets, especially China, would lessen ICAP's dependence on London and New York.

Trading Volume Falls in April

Acquisitions may become even more important if the current financial turmoil calms over the next 18 months. ICAP thrives on volatility, so if investment banks start to hold on to their positions in fixed-income securities and money-market products instead of selling them, ICAP could see a decline in its transaction fees. "The market is definitely concerned with [ICAP's] medium-term prospects," says Mark Durling, divisional director at stockbroker Brewin Dolphin in London.

Worries that ICAP's profits could drop if banks trade less were highlighted earlier this month when the company revealed that its average trading volumes in April had fallen 12% from a record high established the month before. It was the first month-to-month decline reported since September, 2007, though April's volume was still 21% higher than the level recorded a year earlier.

Figures like that help explain why ICAP has weathered the recent financial-services downturn so much better than many firms. Investors naturally wonder how long the good times will last, but for now, ICAP is well placed to make money no matter which way the market goes.

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