Instinet instigates ECN IPO battle
Reuters unit aims to use offering to consolidate power
Feb. 12 — When it comes to executing stock trades, cost, speed, and liquidity reign supreme. By dictating the rules of the game in seconds and fractions of a penny, electronic communications networks (ECNs) have permanently altered that landscape, executing more than one-third of the billions of shares traded on Nasdaq and the New York Stock Exchange every day.
IT’S NO WONDER then that Instinet Group, currently the world’s largest ECN, is now seeking to cash in on this trend through an initial public offering. The company, a subsidiary of Reuters Group, has unveiled its plans to raise $450 million through an offering later this year.
Instinet is expected to use the IPO as a launching pad to consolidate a crowded field of dozens of ECNs. In a world where liquidity is king, Instinet reigns supreme. Last year, the ECN executed an average of 264.7 million shares per day, representing 9.1 percent and 7.8 percent of the shares traded on Nasdaq and the NYSE, respectively. “Instinet is clearly a destination for liquidity,” says Scott Appleby, a financial services analyst at Robertson Stephens. “They’re the eBay of trade execution.”
SUPERMONTAGE HOT ON ITS HEELS
But the company will face stiff competition in the coming months. The Nasdaq, which last month gained Securities and Exchange Commission approval to roll forward with its own super-ECN, SuperMontage, is eyeing a public offering of its own. Two weeks ago the exchange raised $180 million in a private placement that paves the way for an IPO. So the timing of the Instinet filing was obviously no accident.
For Reuters, selling a stake of the ECN to the public could not have come at a better time. Although Instinet’s presence in large institutions gives it the necessary access to deals to execute trades internally, its grip on that market may be slipping. One of the keys to Instinet’s business, and its biggest challenge, is that its fees for trade execution are high by industry standards. “They’re operating a three- to six-[cents]-a-share business in an industry that’s quickly going down to fractions of a penny to execute,” notes Mr. Appleby.
By way of contrast, Island ECN, which derives the majority of its business from retail customers, charges as little as 15 percent of a penny-per-share for the trades it executes, Mr. Appleby says. Instinet’s high-cost strategy is clearly reflected in its healthy financial returns. For the nine months ended September 30, 2000, the company reported net income of $107.3 million on revenue of $1.03 billion. And while year-over-year top-line growth of 45 percent is evidence that its business continues to flourish, the net margins on that business — 10.4 percent for the nine months versus 15.4 percent in the year-ago period — show that competition may indeed be intensifying.
PEER PRESSURE
While SuperMontage — which positions Nasdaq as an ECN to the ECNs by requiring them to display the bid and ask prices of stocks on their systems — would almost certainly eat into Instinet’s market share, Instinet has gone to great lengths to distance itself from other ECNs. For example, it has aggressively expanded its trading platform into international markets. In addition to the NYSE and Nasdaq, its customers can access 40 securities markets, including those in London, Paris, Toronto, and Tokyo. Last spring, Instinet expanded its platform to facilitate trading in more than 800 different U.S. dollar- and euro-denominated fixed-income securities.
Instinet’s IPO will undoubtedly pressure other ECNs to test the public markets. Island, which executed an average of more than 270 million shares in October of last year, is the most likely to take the plunge. In December, Island laid the groundwork for a possible IPO through the $700 million sale of a stake in the company by Datek Online Holdings to a buyout group headed by Bain Capital.
Another possible scenario, however, could be a merger of Instinet, with its strengths in the institutional markets, and Island, which operates largely through retail investors. Either way, it looks as if the battle between the major ECNs and Nasdaq will play itself out in the IPO market. |
