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0:59 This is Business
1:01 Breakdowns. Business Breakdowns is a
1:04 series of conversations with investors
1:06 and operators diving deep into a single
1:09 business. For each business, we explore
1:11 its history, its business model, its
1:13 competitive advantages, and what makes
1:16 it tick.
1:18 We believe every business has lessons
1:20 and secrets that investors and operators
1:23 can learn from and we are here to bring
1:25 them to you. To find more episodes of
1:28 breakdowns, check out join colossus.com.
1:31 All opinions expressed by hosts and
1:33 podcast guests are solely their own
1:34 opinions. Hosts, podcast guests, their
1:36 employers, or affiliates may maintain
1:38 positions in the securities discussed in
1:40 this podcast. This podcast is
1:41 forformational purposes only and should
1:43 not be relied upon as a basis for
1:45 investment decisions.
1:48 I'm Zach Fuss and today we are breaking
1:50 down Interactive Brokers, widely
1:52 recognized as
1:54 IBKR. Founded in 1978, Interactive
1:57 Brokers evolved from a market maker on
1:59 the American Stock Exchange to a global
2:02 cuttingedge electronic brokerage firm.
2:05 Its founder, Thomas Pedrey, remains far
2:08 and away its largest shareholder and has
2:10 earned his place as one of the
2:12 wealthiest people in the world. Pedifrey
2:14 came to the US from Hungary as an
2:16 immigrant who spoke no English and
2:19 taught himself computer programming in
2:20 the 70s. Eventually, he pioneered
2:23 automated trading and played a crucial
2:25 role in the digitization of financial
2:27 markets. Today, we'll explore the
2:30 journey of IBKR from its early days as
2:32 Timber Hill to its current status as a
2:34 publicly traded company with a market
2:36 cap of nearly $80 billion. We'll dig
2:39 into how Interactive Brokers makes money
2:41 beyond just commissions, including their
2:43 net interest income and other market
2:45 making activities. And we'll explore
2:47 their reputation for offering lowcost
2:49 access to a vast variety of global
2:51 markets and sophisticated trading tools,
2:54 which has made them a favorite amongst
2:56 traders and institutional investors.
2:59 Additionally, we'll discuss their
3:00 differentiated tech stack, their global
3:02 reach, and again, their famously low
3:05 fees. We'll explore their competitive
3:07 landscape, the risks they face, and what
3:09 the future may hold for this brokerage
3:11 giant. To break down IBKR, I am joined
3:14 by Freddy Le and Yakobo Dinardo of
3:16 Latitude Investment. We hope you enjoy
3:19 this breakdown of
3:22 IBKR. So today we got a two for one
3:25 special. We're joined again for the
3:27 third time by Freddy Le and his partner
3:31 Ayakapo to discuss interactive brokers
3:35 which has been quietly covered business
3:38 despite the fact that its growth has
3:40 been so pronounced and it's integral in
3:44 kind of the way that we interact with
3:46 the markets today and its growing
3:48 presence. I think Freddy Yakapo just to
3:51 set the stage about the brokerage
3:53 business, discount brokerages and the
3:54 broader landscape. Maybe we kick it off
3:56 there and then we can dive deeper into
3:58 this particular business and why it's so
4:00 special. Yeah, sure. No, it's great to
4:02 be back on the show. Thanks for having
4:04 us. Interactive is a really interesting
4:06 business. It's one we've owned for about
4:07 18 months, but been following for a
4:09 number of years. It's a digital broker,
4:11 so you can trade stocks and bonds and
4:12 currencies and options, pretty much
4:14 anything you like through it. And it
4:15 started out 50 years ago as a by far and
4:17 a way the most technologically led
4:19 business in the space. And there's lots
4:21 of history we can get into. But what
4:22 they've done through investing in
4:24 technology and investing in automation
4:25 and a couple of other strategic
4:27 advantages is develop by far and away
4:29 the lowest cost model, the lowest cost
4:31 to serve with the highest quality
4:32 output. And this is what's driving the
4:34 flywheel effect. They're making the
4:36 highest profitability at the lowest
4:38 costs, driving huge growth in their
4:40 customer base. And that compounding is
4:42 coming without advertising, without
4:43 marketing. And individual investors are
4:45 increasingly choosing interactive over
4:47 all of their competitors. But what's
4:49 most exciting in this business model in
4:51 the last 5 or 10 years has been the
4:53 doubling up of that compounding effect
4:55 through the growth in other channels. So
4:57 they're growing from other brokers
4:58 introducing business. They're growing
5:00 from hedge funds. They're growing
5:01 through RAAS or what we call IFAS in the
5:04 UK. And they're really growing
5:05 internationally. They're a truly global
5:07 business with a huge market potential.
5:10 and a lot of exciting things to talk
5:12 about today. I guess a nice place to
5:14 start when talking about brokerage
5:15 businesses. Just take us through the key
5:18 revenue streams and how these businesses
5:20 fundamentally make money. It's
5:22 relatively simple. There's a lot of
5:24 complexity when you really dig into it,
5:26 but at a headline level, they make money
5:27 in two ways. They make money through
5:30 charging commissions on trading, and
5:32 they make margin through net interest
5:34 margin. So, a spread on cash held on
5:36 account or margin loans that they make.
5:38 And it's reasonably straightforward to
5:40 model this through. They have three and
5:42 a half million accounts. The average
5:43 account does about 200 trades per year
5:46 and the average commission is about $3.
5:48 When you times that through, you get to
5:49 the sort of roughly $600 per account in
5:51 trading commissions per year or around
5:53 $2 billion a year. On the net interest
5:56 margin, they pay very good rates on
5:59 cash. It's a real strategic advantage.
6:00 They own quite a narrow spread on their
6:03 funding, but effectively their sort of
6:05 securities lending and margin business,
6:07 which is about 11% of client assets, is
6:09 financed with customer deposits. And the
6:11 spread between what they pay on those
6:13 two equates to a net interest margin of
6:15 about $800 per account or about $3
6:17 billion. And those are relatively stable
6:20 per account numbers. And so the real
6:22 driver for this business over time has
6:25 been and will be account growth. And
6:27 when we started looking at the business,
6:28 it had around a million accounts. It's
6:30 got around three and a half million now
6:31 5 years later and they have various
6:33 different targets to get to 10 20 or
6:35 maybe 80 million accounts as time goes
6:37 by. And so then when I consider
6:39 Interactive Brokers and the broader
6:42 landscape, you've got Charles Schwab,
6:44 Fidelity, obviously Robin Hood, what are
6:47 the key differentiating factors about
6:49 this particular business as opposed to
6:51 its peer set? When you look at
6:53 interactive, it was born out of a person
6:57 who is first and foremost an engineer
7:00 and a technologist. And that type of
7:02 culture has reverberated throughout the
7:05 firm day one. So when you look at
7:07 interactive, it's by far the most
7:09 automated of all brokers. So when you go
7:12 on to the app, most of the functions
7:15 you'll hit on it, including actually
7:17 eliminating accounts because they
7:19 exceeded the margin loan is done
7:21 automatically by a bot. This doesn't
7:24 tend to be the case for the competitors.
7:27 And this has also morphed the broker
7:30 into being really one that is liked and
7:33 used first and foremost by experienced
7:35 traders. The first days uh the business
7:38 was really only used by individuals and
7:41 what today we call prop traders. These
7:43 are individuals with account balances
7:45 that tend to vary between let's say
7:47 200,000 up to a couple million dollars
7:50 per account of client equity. And this
7:53 compares broadly speaking quite
7:55 favorably versus other online
7:57 brokerages. So you'd think someone like
8:01 Robin Hood or E Toro would have account
8:04 balances averaging maybe 5 to 10,000. So
8:07 it would be the first brokerage you go
8:09 to when you learn about trading. And
8:12 places like Schwab would have higher
8:14 account balances, but they would be used
8:17 in a much less frenetic way. As Freddy
8:19 mentioned, you make about 200 trades a
8:23 year per account on an interactive and
8:27 that number might be tens of times even
8:30 lower if you're using your Fidelity or
8:32 Schwab account which tend to be used for
8:35 slightly different purposes. So
8:37 obviously 401ks being one of those in
8:40 the US. So I think it's impossible to
8:43 really appreciate how
8:45 differentiated IBKR Interactive Brokers
8:48 is without spending some time discussing
8:50 its founder. Thomas Pedy came here with
8:53 effectively nothing I believe in the
8:56 1960s and is now one of the wealthiest
8:59 and relatively unknown Americans. Can
9:01 you just tell a little bit about his
9:03 story, how this business came to be, how
9:05 it's evolved over time, and then how
9:07 much of the business and how involved
9:09 Thomas is today? As you said, he was
9:12 born in Hungary during basically the
9:15 periods of war in Europe and he migrated
9:17 with nothing to the US pursuing the
9:21 classic American dream. And the business
9:24 started out actually as a market making
9:27 business for options when Thomas bought
9:30 a seat on the Chicago Merkantile or
9:33 Board of Option Exchange. And initially
9:37 his broad idea was that of pioneering a
9:41 way of pricing options. It was at the
9:43 time when the formulas were coming out
9:46 from black and shores and when option
9:49 trading was nothing compared to today
9:51 and the company was called Timber Hill
9:54 and it was really an option market
9:57 maker. But if you think about that, the
10:00 way Thomas approached the business was
10:02 completely different in the sense that
10:05 he wanted to automatize everything that
10:07 could be automatized. And this still
10:09 permeates the culture of a business
10:11 today. Interactive doesn't want to be in
10:13 businesses that eventually cannot be
10:15 automatized in the future. On top of it,
10:18 if you think about the role of the
10:19 option maker, risk management is at the
10:23 center of everything you have to do. So
10:25 you're taking obviously both sides of a
10:27 trade most of the times and you're just
10:28 creating a market for participants. So
10:32 up to these days obviously risk
10:34 management is one of the most important
10:36 point that differentiates interactive
10:38 compared to other brokerages. There's
10:40 couple of examples, but the only time
10:43 they really actually lost some money in
10:46 a significant way, which is not
10:47 significant compared to the total amount
10:49 of equity they have, was when the Swiss
10:51 central bank let the Swiss Frank
10:53 appreciate freely and the company lost
10:56 about 1% of their capital at the time.
10:59 And recent examples include when
11:02 interest rates were zero in 2021 and a
11:04 lot of other online brokers decided that
11:07 it was the time to take some duration
11:10 risk to make some more money on net
11:11 interest income the company refrained
11:13 from doing that. So I think when one
11:16 thinks about the two vectors on why this
11:18 business is so well managed and managed
11:20 to succeed but I think his starts as
11:24 someone who is fundamentally an engineer
11:28 and focused on risk management are two
11:30 very important aspects of the business
11:33 and it's worth saying that he's also
11:35 very hard-nosed and smart businessman.
11:37 So whenever he saw that the option
11:40 market making business due to changes in
11:42 regulation and the market environment
11:44 after the great financial crisis was not
11:46 a business that would earn excess roe
11:49 anymore he decided actually to close
11:51 that down to focus entirely on the
11:53 online brokerage and so when you
11:55 consider the business of online
11:57 brokerage there was a pretty big
11:59 evolution I'd say over the course of the
12:01 last decade primarily focused on payment
12:04 for order flow or poff and so what you
12:07 went from is a world where commissions
12:09 were 510 $25 per trade to a competitive
12:13 landscape where many of their peers
12:15 offered zero commissions and so I'm
12:18 curious despite that IBKR while still
12:21 being a business that charges
12:23 commissions has seen its growth explode
12:26 what is going on what is the debate
12:28 around PIFO which I believe is actually
12:29 not even a legal business proposition
12:32 outside of the US how do you think about
12:34 that backdrop as it relates to
12:36 Interactive Brokers ability to continue
12:38 to take share. We think this is one of
12:40 their key competitive advantages that
12:43 since day one they've always chosen to
12:45 have direct market access. So imagine
12:48 like a kind of Costco model. They're
12:49 cutting out the wholesaler. They don't
12:51 have someone else. They don't have to go
12:52 to a broker. And so when they have
12:54 linked their system up to every exchange
12:56 in the world, give or take directly. And
12:58 so they execute directly at the best
12:59 price on your behalf. Whereas payment
13:01 for order flow, which is pretty much
13:03 just a US phenomenon, these businesses
13:05 who buy that order flow clearly make a
13:07 large amount of profit. And so that has
13:09 to come out of someone's wallet and
13:10 implicitly that has to come out of the
13:12 customer's execution price. And so you
13:14 can listen to the CEO Thomas Pepy
13:17 talking quite viciferously about this
13:19 practice and other banking practices
13:20 that have yet to be regulated, but it's
13:22 something that they've always avoided.
13:23 And it does save them a huge amount and
13:26 allow them to move much faster than a
13:28 lot of competitors as well. So, it's no
13:30 higher cost. They don't get the payment
13:32 for order flow into their revenues like
13:33 some other businesses do, but they don't
13:35 need it because they can prove best
13:36 execution. They still have lower
13:38 commissions across the marketplace. They
13:40 charge far less than others in most
13:42 cases. And their other draws are their
13:45 much cheaper margin loans and their much
13:47 more generous payment for cash on
13:49 deposit. They basically pay 50 basis
13:51 points less the local base rate on any
13:54 cash deposits over a certain threshold.
13:56 So they're seen correctly as giving back
13:59 everything they can to customers with a
14:01 small margin and then it's just that's
14:03 their principal competitive advantage.
14:05 The second as Yakapo's already touched
14:06 on is the automation of the trading
14:08 itself of the risk management and of the
14:11 management of the business and all the
14:12 opex which means that their cost base is
14:15 just so much thinner than the others. So
14:17 they're able to continuously reinvest in
14:18 price. I think one of the things that's
14:20 interesting is if you look at the
14:22 headcount of IBKR relative to its peers,
14:25 it obviously speaks to their interest in
14:27 making sure that everything is tech
14:29 enabled. I will say amongst some
14:31 investors who use the platform, they do
14:33 complain about the lack of customer
14:35 service at times, but it's what allows
14:37 them to offer such incredible lowcost
14:40 execution. And then the other aspects of
14:43 it being really your ability to use
14:45 leverage at a very low cost of capital.
14:48 Can we just talk about how they use
14:50 their balance sheet in a way that
14:52 provides such a structural cost
14:54 advantage relative to their peer set?
14:56 Fundamentally, there's a couple of
14:58 points here to be made. The first one is
15:01 a bit like Jamie Diamond at JP Morgan
15:04 talks about having a fortress balance
15:06 sheet in financials is of paramount
15:09 importance to succeed over time. It
15:11 allows to obviously survive crisises if
15:14 they happen. Interactive has a similar
15:16 approach. If you look at the balance
15:19 sheet today at the end of 2025, there's
15:22 probably going to be about $18 billion
15:24 of excess capital, which is about 95% of
15:28 the total capital they have. That allows
15:31 them obviously to grow the business in a
15:33 fairly serene way without necessarily
15:36 participating in the ups and downs of
15:38 the market. And the second point being
15:40 when offering lowcost margin loans, it
15:43 stems partly from that and partly from
15:46 again going back to the automation
15:48 point. The big risk when offering margin
15:50 loans is that eventually those accounts
15:53 will need to be basically closed because
15:55 with a market draw down the fall in
15:57 value is superior to that of a margin
15:59 loan. And there's plenty of examples
16:01 around the latest one actually coming
16:04 from Archigos where even at investment
16:06 banks which one would think are fairly
16:08 well invested in technology still
16:10 require quite a lot of human involvement
16:13 and personal calls in order to make that
16:16 decisions. That never happens at
16:18 interactive because everything is
16:20 automatized and the account if it
16:23 doesn't post the required collateral
16:26 within a very short period of time is
16:28 automatically liquidated and eliminated.
16:31 And if you think about that dynamic,
16:32 that is exactly what allows interactive
16:34 two things. One is to underpric
16:37 competition in terms of cost for the
16:39 margin loan. It's about half the cost of
16:41 Fidelity or Schwab or whoever else
16:44 competes in the US. And it also allows
16:46 them to offer slightly more leverage
16:48 than competition without really
16:50 affecting the total risk if you're able
16:52 to cancel that account or to close down
16:55 that account fairly quickly and you're
16:57 also able to mitigate the risk of loss
17:00 from that account in a better way than
17:02 competitors. That allows again to foster
17:05 that competitive advantage coming from
17:08 lower cost and obviously higher
17:11 automation.
17:13 And so I think it would be helpful to
17:15 illustrate how this manifests by
17:17 demonstrating what an account looks like
17:21 and how a customer uses the business.
17:25 For example, let's say you have someone
17:27 that's a professional trader that has a
17:29 million-doll account and maybe is
17:31 running at$2 or $3 million of gross long
17:34 and short. They're obviously borrowing
17:37 and lending securities. What does it
17:39 look like? And then how does that
17:41 translate into the different revenue
17:44 line items? So the commission revenue,
17:45 the net interest income, the fees and
17:47 services that they provide just to
17:49 really drive home how people interact
17:52 with this business and its ability to be
17:54 differentiated on every service that it
17:56 provides to its key customers. The
17:59 difficulty here is that one does need to
18:00 disagregate a little bit. We've been
18:02 discussing this as an online broker,
18:04 which makes it feel very much like it's
18:06 aimed entirely at individuals logging
18:08 onto a website or an app. The truth is
18:10 more than 50% of the business and a
18:12 large portion of the growth in the
18:13 business although individuals are still
18:15 growing very nicely is the other three
18:17 main cohorts which are white labeling
18:20 the platform and service for raas
18:22 advisers around the world prop traders
18:24 and hedge funds. They're now the fifth
18:26 largest prime broker in the world. So
18:28 they're larger than many of the big
18:29 banks you could name from a standing
18:31 start about 10 years ago. They're
18:33 growing far faster than the market for
18:35 prime because they are seen as more
18:36 attractive to the hedge fund groups in
18:38 general. And then the final one which is
18:40 just worth touching on is what they call
18:42 introducing brokers. And you can think
18:43 about this as another bank or another
18:45 brokerage business who is outsourcing
18:47 and cancelling their own internal
18:49 technology investments. As an example,
18:51 they just brought on HSBC globally and
18:53 then they're going to plug in the
18:55 underlying trading capability of
18:57 Interactives. And I would think about
18:58 this in the same way that a lot of
19:00 people have become comfortable with
19:01 outsourcing admin or custody to JP
19:04 Morgan or these large custody banks like
19:06 Northern Trust. A large number of these
19:09 huge global institutions as opposed to
19:11 investing in the technology are renting
19:13 it implicitly from interactive and that
19:16 is where a lot of the growth's coming
19:17 from. So what we see at an account level
19:20 is slightly averages of those things. We
19:22 can make some assumptions about where
19:24 the margin skews towards the hedge funds
19:26 and the prop traders and obviously away
19:28 from a lot of the RAIA business. But
19:29 what you see is an average account
19:31 balance that even when it was
19:32 individualled was much higher than most
19:36 other firms and very normal typical to
19:38 have 100 $150 $200,000 as the average
19:42 account balance. Against that there are
19:44 two other interesting assets which are
19:46 the margin loans which we've discussed
19:48 which used to be far higher actually and
19:50 have come down as a percentage of equity
19:53 over the last sort of 10 years but are
19:55 ticking up again at the moment in the
19:56 short term at about 10 to 12% of assets.
19:58 So, if you've got a $200,000 account,
20:02 you might have $20 of margin loans
20:04 against some securities in there on
20:06 leverage. What's also been very popular
20:08 with all of the brokerage platforms,
20:10 including Interactive, has been
20:12 securities lending. And again, as we've
20:14 probably become boring saying, this is
20:17 fully automated. So, you can sign in if
20:19 you want to. Your securities, your
20:21 stocks can be lent out to people who
20:22 wish to borrow them and to short them.
20:24 They're still fully tradable. They're
20:26 fully collateralized from our
20:27 perspective as shareholders by cash and
20:30 the client earns most of that lending
20:32 fee and again there's a small but very
20:34 honest spread which is all transparent.
20:36 So they have a similar amount of
20:38 securities lending about that sort of
20:40 for a $200,000 account about $20,000 of
20:43 lending so 10% of the base. So that's
20:45 the kind of average, but we do believe
20:47 it skews a lot. A lot of the introducing
20:49 business and a lot of the RAAS we think
20:52 are probably using less, probably
20:54 trading less as well under that sort of
20:56 200 trades per year. And then really the
20:59 majority of this stock lending, margin
21:02 loan, and even the turnover, the number
21:04 of trades or darts as they call them,
21:06 daily average revenue trades, if
21:08 anyone's reading the annual report after
21:10 this, that skews towards the hedge fund
21:12 business. So, it's a variety of
21:14 different clients all benefiting from
21:16 the same lowcost platform, but they're
21:18 using it in different ways. When you
21:20 look at this business's P&L, and I'm
21:23 looking at 2024 as a reference, you have
21:26 about $1.7 billion in commissions, which
21:29 results in around $2 billion of
21:32 non-interest related income. And then
21:34 the rest, $3 billion is that net
21:37 interest income, that NIM, resulting in
21:40 about $5 billion of revenue. How do you
21:42 think about how that should evolve over
21:45 time, the mix in quality as it relates
21:48 to the evolution of their customer base,
21:50 which you just mentioned? And then a
21:52 second question related to that, when
21:53 you see a business that's as significant
21:56 an earner on net interest margin, you
21:58 beg the question as it relates to
22:00 interest rates and how they impact the
22:01 business and what would happen in an
22:03 environment where rates were going down
22:05 versus going up. Just curious on those
22:07 two items really revenue mix and nim as
22:11 the business evolves over time. There's
22:13 quite a few ways to cut it. This is
22:15 clearly a cyclical business. It grows
22:17 very rapidly and account growth that had
22:19 been around 25% per year is inflecting
22:22 up towards 30 and 35% per year at the
22:24 moment as the flywheel gathers ahead of
22:26 steam. The most important thing that I
22:28 want to compel you to understand from
22:30 our perspective is that it's account
22:32 growths that matter. And if you need to
22:34 believe account growths are what matter
22:35 then one needs to believe the sort of
22:37 stability in the other things like the
22:39 amount of trading and the revenue per
22:41 account. And so when we've interrogated
22:43 the sort of the number of trades that's
22:45 been going on as the mix has changed and
22:48 the accounts have been growing the
22:50 trades per year have been falling and
22:52 again one would expect hedge funds are
22:54 trading many times a day but ra
22:56 introducing brokers in particular are
22:58 probably trading less than the 200
23:00 average trades per year. And so we
23:03 expect and we've observed over the last
23:05 5 or 10 years a kind of 5 to 10% decline
23:08 in trades per year. So if the growth is
23:11 similarly skewed between the different
23:13 cohorts over the next few years
23:15 obviously in periods of volatility one
23:16 trades more in periods of low volatility
23:18 one trades less but as a trend we put a
23:21 deflation if you like in the number of
23:23 trades per year and I think there's
23:24 probably a small amount of potential
23:27 deflation to come through from
23:28 commissions but the management team have
23:30 talked about flat average commission
23:32 levels from here and it really does
23:33 depend on mix again a crypto trade is a
23:37 very different commission level or an
23:38 option compared to trading Google
23:41 shares. The way it's worked is you have
23:44 that kind of average $500 $600 per
23:46 account of commission. It'll probably
23:48 trade a little bit lower, maybe 5% down
23:51 per year on an average basis and then be
23:54 cyclical with client equity. But if
23:56 account growth is 35% or anything along
23:58 those lines, that will dwarf any
24:00 reinvestment backing price. That's the
24:02 easier one is the commissions. And
24:03 obviously, you can take your own view on
24:05 average client equity and average equity
24:07 market performance over the long term.
24:09 When you factor those things in too,
24:11 they offset that reduction normally on
24:13 the NIM. And I think this is probably
24:15 one of the greatest misunderstandings in
24:17 the business and it was certainly what
24:19 gave us the opportunity to invest in it
24:21 18 months ago is the actual sensitivity.
24:24 If you think about the alternative, if
24:25 you think about a business like Schwab,
24:27 which only a couple of years ago almost
24:29 needed effectively a wholesale rights
24:30 issue because it had what was
24:32 effectively a run on its funding source
24:34 because they weren't paying anything on
24:36 their customers cash and customers when
24:37 interest rates went up started saying
24:39 we'd better go to a bank or we better go
24:40 to a money market fund and they robbed
24:42 Schwab of that source of cash and
24:45 funding. The arrangement between
24:46 Interactive Brokers and their customers
24:48 is just far more honest and it's very
24:50 transparent and it's as I said on any
24:52 large balance more than $10,000 which is
24:54 about 2/3 of their entire customer cash.
24:56 They just pay the local market base rate
24:59 less 50 basis points. That results in a
25:01 far lower risk firstly to the point
25:05 about Thomas Pepy's risk conservation.
25:07 Clients are probably not going to leave
25:09 because they get 50 bits more elsewhere
25:10 even if they could. But secondarily,
25:12 it's actually less interest rate
25:13 sensitive than you think because if
25:15 rates go down by 50 basis points, they
25:16 still just take 50 basis points on a
25:18 spread. And so they do disclose that
25:21 overall interest rate sensitivity. And
25:22 for a 100 basis point move down in
25:25 interest rates around the globe, and
25:26 again this is a global business,
25:28 probably 40% US. Yakapo is nodding at
25:31 me, but it's global in nature. If global
25:33 interest rates fell 100 basis points,
25:34 NIM would fall by 10%. And again, that's
25:37 NIM per account. So if you're growing
25:40 your accounts at 30 35% it will more
25:43 than offset a multiple of times that a
25:45 net interest sensitivity. So that's why
25:46 we focus so obsessively on the business
25:48 model and the potential for account
25:50 growth. From a NIM perspective, Zach,
25:53 what's also pretty interesting is
25:55 obviously margin loans tend to be higher
25:58 yielding products, maybe pay 100 basis
26:00 points more than what they get on cash
26:02 on the asset side. And these tend to be
26:06 cyclical but move in the opposite way of
26:09 interest rates. So for example, if
26:11 interest rates were to go back down to
26:13 levels that we observed in 2019 or 2020
26:16 or 2021, the amount of leverage that
26:19 investors are usually willing to take on
26:21 is slightly higher. So the margin loan
26:24 per account was materially higher back
26:26 then. And so in the mix as interest
26:29 rates fall, we would also expect margin
26:32 loans to pick back up. helping a little
26:35 bit with a nimfall. If you go back in
26:37 time, 2019, 2020 were pretty difficult
26:40 years for whoever was exposed to rising
26:43 interest rates and the company was still
26:45 making maybe 30 basis points less than
26:48 today net interest income. They have
26:50 proven themselves in a way through cycle
26:52 to be able to earn a fairly attractive
26:54 spread on assets and liabilities. And so
26:57 you guys had mentioned the international
26:59 opportunity here and where some of the
27:01 growth is coming from. Obviously we've
27:04 seen through the co backdrop
27:06 participation in capital markets and
27:09 investing exploding perhaps the advent
27:12 of Robin Hood as an on-ramp for that but
27:14 also just the financialization of
27:16 western economies. What are the growth
27:19 opportunities for this business? And I
27:21 asked that in the context of on their
27:23 earnings calls, they're very often asked
27:25 if there's any M&A opportunities. And
27:27 because they operate at such low costs
27:30 and they provide such attractive margin
27:33 loans to customers, the pro-former
27:36 earnings of acquisitions make the math
27:38 very difficult for them. And so I guess
27:40 weighing organic versus acquisitive
27:43 growth where they're going to see their
27:45 business continue to expand. interested
27:47 you picked up on that comment too
27:48 because it's one we've discussed in the
27:49 past which is this idea that if we buy a
27:52 business but then we take it to our
27:54 spreads and our offering the underlying
27:56 revenue and profits would collapse in
27:58 that business. So they're not able to
27:59 pay what the owner thinks they can pay
28:01 because if they give back to customers
28:03 as much as they give back in their main
28:04 business it would be a very different
28:06 profit level. And so that to us is
28:08 incredibly telling. They are open to
28:10 acquisitions. They have done them in the
28:11 past but there's nothing out there which
28:14 would make sense. And so they're going
28:15 to grow organically. They have one of
28:17 the lowest advertising budgets of all of
28:20 the online brokers and despite that have
28:22 outgrown anyone we look at. They're
28:24 growing organically. They're growing
28:26 because their rates are just better than
28:28 everybody else's. And if you are trading
28:30 any meaningful amount of capital, I'm
28:32 not here to sell it, but I'm sure some
28:33 people listening to this will be trading
28:36 their own shares. And it's worth a look
28:37 because it's a meaningful saving to go
28:39 to a business like this. And I think at
28:41 the moment what they're getting asked
28:43 more about is this sort of potential for
28:45 growth in the more B2B channels that
28:47 we've discussed the RAAS the hedge funds
28:50 and the introducing brokers. But
28:52 notwithstanding that individual accounts
28:53 are growing very rapidly too. So the mix
28:56 isn't changing very quickly. And when we
28:59 think about growth potential I mentioned
29:01 earlier a few different sort of big
29:03 hairy audacious sort of goals for the
29:05 management team. Schwab have I think 25
29:07 million accounts principally in the US.
29:10 I think Fidelity is something around
29:11 that level. They are smaller on average.
29:13 So there's a tale of those accounts
29:14 which would be less profitable for this
29:16 business but 3 12 or 4 million accounts
29:19 that we have today is still a fraction
29:21 of that domestically. And they talk
29:23 about 20 million globally as a sort of
29:25 first stop in their growth story. And
29:27 then at a sort of later stage they talk
29:29 about this 80 million number because in
29:31 a couple of countries where they operate
29:32 they are already at sort of 1% of the
29:34 population. And that would be that sort
29:36 of level of penetration. And the key
29:39 thing to that potential is people will
29:41 still continue to trade a lot. Whatever
29:43 happens with markets becoming more
29:45 digital and outsourcing within the B2B
29:47 channel will probably continue for the
29:49 next 5, 10 and 20 years. Big question is
29:52 can someone compete with this? Can
29:54 someone come away to stop them
29:56 organically growing share? And given the
29:58 counterpositioning and that first
29:59 comment about acquisitions and the
30:01 competitors to reinvest to try to build
30:04 the direct market access and to invest
30:06 in prices and costs and automation like
30:08 this business has, everyone's folding
30:10 and using this business instead of
30:11 trying to compete with it. to your
30:13 comment of more participation into
30:16 financial markets by all sorts of
30:18 individuals especially after COVID. We
30:21 believe that to be a pretty good
30:22 tailwind, too, because as we said at the
30:25 beginning, someone who is inexperienced
30:28 and might have a smaller account
30:30 balance, he might start a Robin Hood
30:32 account or E Toro or whatever else he
30:37 can get his hands off depending on the
30:38 jurisdiction. But after a certain period
30:42 of time, after becoming more accustomed
30:44 to trading and honestly after having
30:47 increased his own disposable income, we
30:50 do believe the proposition of joining
30:53 interactive, especially as an active
30:55 trader is so much better than anything
30:58 that's around there that we do see a lot
31:01 of these customers eventually dropping
31:03 to interactive over time as soon as the
31:05 account balances reach $100,000 or
31:08 $200,000. And if I can just add one more
31:10 thing, you mentioned earlier some people
31:12 are upset with the customer service. We
31:14 see a lot of analogies between this
31:16 business and other lowcost businesses
31:18 that we look at. One would be sort of
31:20 Ryionaire. And I think it's really
31:22 compelling to see that business, another
31:24 business we like where Michael said, "I
31:26 didn't realize looking after customers
31:28 would make me so much profit." And he
31:29 started making the customer experience
31:31 more pleasant. I think they're doing
31:32 that at Interactive, too. They've had
31:34 this obsessive focus on costs and
31:36 automation for 50 years, including in
31:38 their prime brokerage business, but
31:40 they've just rolled out what they call
31:41 the sort of white glove service, which
31:43 is a very manual, independent director
31:46 looking after your account as a hedge
31:48 fund. And I expect a bit more of that
31:51 over time, coming back into the business
31:53 on the customer service, too, which
31:54 slightly opens up their market. One
31:56 final thing they're doing as well is
31:57 really relaunching their app, which will
31:59 come in and help that customer
32:01 acquisition that Yakapo said of those
32:02 who are out there learning the ropes in
32:05 apps like E Toro and Robin Hood, but may
32:07 want to grow up into interactive later.
32:10 And so we touched upon it in relation to
32:12 M&A, but clearly a business that's
32:14 generating as much excess free cash flow
32:17 as this one, capital allocation becomes
32:19 increasingly important. What is their
32:21 demonstrated strategy as it relates to
32:23 redeploying the cash that they're
32:26 generating on an ongoing basis if M&A is
32:28 not available to them? This is a very
32:30 important question especially as the
32:32 business will eventually mature and in
32:35 fact at the moment the only capital
32:38 return we are receiving is a dividend
32:40 yield that's usually targeted to be
32:43 about.5 to 1% of the total market
32:46 capitalization. And there's a couple of
32:48 things though to keep in mind. And I
32:50 think the company wants to keep a
32:52 balance sheet that's as strong as it can
32:55 be mostly to develop the prime brokerage
32:58 and hedge funds business. And one of the
33:00 reasons being that the companies they do
33:02 compete against BMOs like Goldman,
33:05 Morgan Stanley, UBS and Bank of America
33:08 are materially larger financial
33:10 institutions. So to win over customers
33:12 and hedge funds that manage 1 to5
33:15 billion of assets, they do need
33:18 potentially stronger balance sheet than
33:20 what we actually could imagine
33:21 ourselves. The second point comes
33:24 actually with a company structure. It is
33:27 a publicly listed company but still
33:29 today insiders own roughly 80% of the
33:33 stock of which most of it 75% is still
33:36 Thomas but the CEO and CFOs or have a
33:39 significant stake in the business and
33:41 therefore launching extremely big
33:44 special dividends or share a purchase
33:46 programs is not necessarily doable until
33:49 the float of a business is increased. So
33:52 we like many other external investors we
33:54 are looking at the topic. We do believe
33:57 over time as Thomas as he rightly says
34:00 he's not immortal and he's approaching
34:02 or above 80 years of age. We will see
34:05 how that evolves. But it is something
34:07 that we do like to an extent because if
34:10 you think about ways of maturing as a
34:13 business the final phase when growth
34:15 slows down and is not what it used to be
34:18 20 years ago. any business has a choice
34:20 to make which can be growing again
34:22 through M&A whenever it is possible or
34:24 returning excess cash to shareholders
34:26 and we are not even close to there as
34:29 Freddy has discussed there's a potential
34:31 over time to probably 20x the number of
34:34 customers on the platform but once that
34:36 is done having excess capital to return
34:38 to shareholders as the structure has
34:41 probably changed by then is an option
34:43 that as investors we do like to have
34:46 there's other businesses that are in
34:47 that situation I Berkshire Haway being
34:50 an enormous one which is in a similar
34:53 position with an incredible amount of
34:55 cash and treasuries sitting on the
34:57 balance sheet. And so when you're
34:59 evaluating financial businesses, there's
35:02 always a debate about how to properly
35:04 value them. And without asking you guys
35:06 to appine upon the valuation itself,
35:09 what do you think are the most important
35:10 metrics here in it being return on
35:13 equity, price to book, PE? How do you go
35:17 about valuing a business like this? It's
35:19 really a combination of everything
35:21 you've mentioned. I think to an extent
35:23 today the RO of a business we can look
35:26 at it in two ways. One is obviously
35:29 including the excess capital and one is
35:32 excluding it. One thing you realize
35:34 quite quickly is actually how capital
35:36 light it is compared to normal
35:38 financials especially when you back out
35:40 the excess capital. So it might make 15
35:42 to 20% ROE including the 19 billions of
35:46 excess capital but it might make 10 15
35:49 times as much excluding that earnings is
35:52 and price to earnings normalized
35:54 earnings are also another way we look at
35:56 it. So sticking in our own assumptions
35:59 obviously of accounts growth and trades
36:01 per account and commissions and then
36:04 looking at what a normalized and average
36:07 net interest income could be given the
36:09 prevailing rates of interest around the
36:11 world. But as you say it is not one of
36:13 the simplest businesses to value on
36:15 either of two metrics. So we do focus
36:18 really on both and see how both interact
36:22 with each other. At the same time, we do
36:24 not feel yet confident enough to assume
36:26 a significant capital return of the
36:28 excess capital. So, we let it build in
36:30 our model with our mind going 5, 10, 15,
36:34 20 years from now, what will that
36:36 capital eventually earn. But so far, I
36:38 think they've proven to be fairly good
36:40 stewards of it. One other way to think
36:42 about it is to invert it. Given the
36:44 competitive advantages, given the
36:46 demonstrable success across these
36:48 verticals which are all very nent, given
36:50 the arguments we've made around the sort
36:52 of the limited reduction in revenue per
36:56 account either from NIM sensitivity
36:58 which will bob around or from the
36:59 commissions and trading per account.
37:01 You're making roughly $1,500 an account
37:04 in revenues at the moment. What's the
37:06 probability they can get to 10 or they
37:08 can get to 20 thus making 15 or 30
37:11 billion dollar in revenues and they make
37:13 a 75% operating margin. I think they
37:16 make 75% net margin. It'll probably be
37:18 around there. It could go up a little
37:20 higher, but that's with their generous
37:22 offering back. You're talking about a
37:24 very profitable, rapidly growing
37:26 business. And the question one really
37:27 needs to ask is who's going to stop that
37:30 happening? Is there a competitor in the
37:32 marketplace that will stop that? If not,
37:34 how fast or how slow will it happen is
37:36 the bigger question. And something
37:38 Thomas has said is we can grow at 30%
37:40 with no advertising. We can probably
37:42 grow at 40 50% if we do more targeted
37:45 advertising, but they're not looking to
37:46 do that right now. But I do think they
37:48 could accelerate the account growth if
37:49 they wanted to cuz there's a lever they
37:51 haven't pulled yet. Obviously, much of
37:53 what has been said about this business
37:54 has been overwhelmingly positive. But
37:57 when you're dealing with a business that
37:59 interacts with leverage, margin, long
38:02 and short side of the investment
38:04 industry, there's inherent risks. I
38:07 would love to hear about how you guys
38:09 assess those risks and maybe some of the
38:10 stress tests the business has faced.
38:13 Even as recent as a few weeks ago, we
38:15 saw the broader market sell off 10, 15,
38:19 20% and what that meant for their
38:20 business. I think would show kind of the
38:22 resilience and durability of the model
38:24 that they have here. Yeah, I think one
38:26 of the key things to remember if anyone
38:27 else goes away from this and analyzes
38:29 the business is that this was a market
38:31 making business in a large part as well
38:32 in the past. So it's very different to
38:34 2009 and 2014 was the day where they
38:37 really exited most of that business. So
38:38 this is now a middleman a broker in a
38:40 far more than the sort of asset risk. So
38:43 the risk as you say slightly lies in
38:44 that margin loan piece and their ability
38:47 to risk manage and collateralize against
38:49 those loans because obviously when they
38:50 make these loans or they do the
38:52 securities lending they take and hold
38:53 collateral and something Yakapo
38:55 mentioned earlier these accounts are
38:57 stopped out automatically now as if and
38:59 whenever they get too close to that
39:01 margin limit and so it's all an
39:03 automated process they claim to have
39:05 very good risk management systems but
39:06 I've never met a financial business that
39:08 doesn't claim to have good risk
39:10 management systems so your question
39:11 again is right How have they fared
39:13 through the last decade of quite a lot
39:15 of stress tests I'd argue whether COVID
39:18 or big draw downs in 2022 in the very
39:21 popular stocks or the recent hit their
39:23 largest loss was really from a very
39:25 strange sort of move in the Swiss Frank
39:27 10 or 12 years ago maybe even 14 years
39:29 ago where they lost about 1% of their
39:31 equity capital today so a very bearable
39:33 amount for a business that is multiple
39:35 times over capitalized and through the
39:38 recent turmoil of the last 3 to four or
39:40 5 years it's dimminimous the risks from
39:43 margin, the losses, the bad account
39:44 balances, it's not been an issue for the
39:47 business. So the risk management system
39:49 exposed has clearly been working. If you
39:51 think about how financials businesses
39:54 run into trouble is some sort of
39:56 liquidity mismatch that exists between
39:58 assets and liabilities. And I think in
40:01 that in new investors to the company
40:04 should take quite a bit of comfort that
40:06 most of the assets are really 30 days in
40:08 duration. Now some of that is a function
40:10 of how the yield curve has been looking
40:12 for the past four or five years which is
40:15 flat to inverted. So there was no point
40:18 in taking interest rate risk and
40:21 duration risk the capital of a business.
40:24 But in general I think the company has
40:26 always taken a prudent approach to risk
40:29 management. I think that again stems
40:30 from probably Thomas's beginning as a
40:33 market making risk manager. And if you
40:36 think about the mother of all stress
40:39 tests, which was the great financial
40:41 crisis, when the business still owned a
40:44 market making business, one of the
40:45 leading market making business in
40:46 options, the company decided quite early
40:49 on in 2007 to stop making prices to
40:53 customers in longdated options, which
40:55 eventually ended up being part of a
40:57 market that not a lot of people talk
40:59 about today that was entirely in liquid
41:02 and where losses just piled up. So I
41:05 think analyzing the liquidity of a
41:07 balance sheet and in general risk
41:10 management choices is where one can get
41:13 comfortable that downside risks are
41:15 fairly well managed in terms of
41:17 long-term risks. Freddy mentioned a
41:20 little bit about competitive landscape
41:22 and how it might evolve. I would add one
41:24 to it which is as you mentioned before
41:27 Zach there has been a huge increase in
41:30 participation in financial markets. Some
41:33 of it is very healthy. New generations
41:35 are learning earlier how to invest and
41:38 some of it is more akin to really
41:40 gambling. And if you think about that
41:43 and the ramification it might have in
41:45 terms of regulations in the future or if
41:48 losses actually pile up for retail
41:50 investors, this is an area that is worth
41:52 bearing in mind. You might have noticed
41:55 that in the past 18 months, they've been
41:57 talking a little bit more about their
41:59 new product called Forecast X, which
42:02 basically allows, it's almost like a
42:04 sports betting platform on economic
42:06 events that allows customers to really
42:09 express an opinion that is a yes or no
42:12 on individual outcomes. It might be
42:14 about inflation, about payrolls. And the
42:17 simple fact that the CFTC initially
42:21 didn't allow those products to go out
42:23 because they were too akin to sports
42:25 betting tells you that there is a
42:27 component in financial markets today
42:29 that goes through online brokerages.
42:31 That is more similar to gambling rather
42:33 than what we would normally consider
42:35 investing. And so a correlary to that
42:38 last question is one that we always
42:40 conclude with lessons learned when you
42:43 guys evaluate this business that can be
42:45 applied to others and from an
42:46 operational perspective the way that
42:49 management runs this business that you
42:50 think can be applied to other businesses
42:52 to help drive better shareholder
42:54 returns. When we're looking at what
42:56 gives our businesses a competitive and
42:58 strategic advantage over their industry
43:01 and that will endure for the long term.
43:04 One of the really best ones, and we've
43:06 only got a handful of these that have
43:08 this competitive advantage, is this
43:10 lowcost, high service model, and service
43:13 in this case means better access to
43:14 markets, quicker trading, neater
43:16 valuations. Not yet. Someone on the end
43:19 of the phone, but we'll wait and see on
43:20 that. But so this low cost to serve,
43:22 highquality product, it's brilliant
43:24 because it's so hard to compete with.
43:26 This is one of the best examples that we
43:28 have found. And obviously others being
43:30 things like Ryionaire, Costco and a few
43:33 other businesses on our lists. And I
43:36 think it leads to 10, 20, 30 years of
43:38 potential advantage which will come
43:41 through in this case through account
43:43 growth. And so that's been the primary
43:45 one. And I think when you've dug back as
43:47 long as you can in the history, and
43:48 there's quite a bit written about this
43:49 business over the last 48 years, this
43:51 obsession with technology, automation,
43:53 and costs has been there from day one.
43:55 And so that's a softer point, but it's
43:57 around the culture of a business. It
43:59 doesn't have to be founderled, but it's
44:01 often founderled, but it's certainly got
44:03 to be someone with skin in the game, and
44:04 it's got to be someone who's
44:06 intrinsically demands that of a
44:08 business. I don't think it's something
44:09 that you can come through with an MBA
44:11 and just say, "Oh, I'm going to go for a
44:12 lowcost model." I think it's got to be
44:14 something that's really in you. And I
44:16 think the final thing that this business
44:17 helped teach us is just how cheap very
44:21 high-quality cyclical businesses can
44:23 become because people misunderstand or
44:26 fear cyclicality in what is otherwise a
44:28 very strong growth business. This was
44:30 trading on 12 or 13 times earnings,
44:33 delivered earnings only 18 months ago.
44:36 It's a little more expensive now, but
44:37 it's still inexpensive. The way we look
44:39 at these things, which is with all
44:40 cyclicals, you'll always get a good
44:42 chance. You can find the great cyclical.
44:43 You might have to wait three or five
44:44 years, but you'll always get a great
44:46 chance. And the great ones are worth
44:47 waiting for. Well, Freddy Yako, I
44:51 appreciate you guys coming on so much to
44:53 discuss IBKR. Around 50 years ago,
44:55 Thomas Pedy came here with effectively
44:57 nothing and has built what is today, I
44:59 believe, a $75 billion plus business of
45:02 which he owns the vast majority of. It's
45:04 a really interesting story from both a
45:06 business history, but also business
45:08 performance perspective. I really
45:09 appreciate you guys coming on to help
45:11 tell it. Great speak to you. To find
45:13 more episodes of breakdowns ranging from
45:16 Costco to Visa to Madna or to sign up
45:18 for our weekly summary, check out join
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