Interactive Brokers：保证金大师——[Business Breakdowns，第216期]

Octis, which was formerly known as Reorg, is today's presenting sponsor on Business Breakdowns. This is an essential credit intelligence and data provider. And they have grown to over 40,000 professionals across leading buyside firms, investment banks, law firms, advisory firms. And what they're doing is they're taking the human expertise, which is so important in credit. They're embedding it with AI, technology, data and workflow tools, and that's going to allow you to unlock all the things you need, the truths to fuel that decisive action that you need in the credit markets. So, head over to octis.com to learn how they have taken this verified intelligence platform, delivering it at speed and giving you that complete picture across the credit life cycle. You can follow Octis on LinkedIn or X. there. They will share breaking news and exclusive coverage and you can find links to everything in the show notes. [Music] This is Business Breakdowns. Business Breakdowns is a series of conversations with investors and operators diving deep into a single business. For each business, we explore its history, its business model, its competitive advantages, and what makes it tick. We believe every business has lessons and secrets that investors and operators can learn from and we are here to bring them to you. To find more episodes of breakdowns, check out join colossus.com. All opinions expressed by hosts and podcast guests are solely their own opinions. Hosts, podcast guests, their employers, or affiliates may maintain positions in the securities discussed in this podcast. This podcast is forformational purposes only and should not be relied upon as a basis for investment decisions. I'm Zack Fuss and today we are breaking down Interactive Brokers, widely recognized as IBKR. Founded in 1978, Interactive Brokers evolved from a market maker on the American Stock Exchange to a global cuttingedge electronic brokerage firm. Its founder, Thomas Peterffy, remains far and away its largest shareholder and has earned his place as one of the wealthiest people in the world. Peterffy came to the US from Hungary as an immigrant who spoke no English and taught himself computer programming in the 70s. Eventually, he pioneered automated trading and played a crucial role in the digitization of financial markets. Today, we'll explore the journey of IBKR from its early days as Timber Hill to its current status as a publicly traded company with a market cap of nearly $80 billion. We'll dig into how Interactive Brokers makes money beyond just commissions, including their net interest income and other market making activities. And we'll explore their reputation for offering lowcost access to a vast variety of global markets and sophisticated trading tools, which has made them a favorite amongst traders and institutional investors. Additionally, we'll discuss their differentiated tech stack, their global reach, and again, their famously low fees. We'll explore their competitive landscape, the risks they face, and what the future may hold for this brokerage giant. To break down IBKR, I am joined by Freddie Lait and Jacopo Di Nardo of Latitude Investment. We hope you enjoy this breakdown of IBKR.

Today we have a two-for-one special. We’re joined again, for the third time, by Freddie Lait and his partner, Jacopo Di Nardo, to discuss Interactive Brokers, which has been a quietly covered business despite the fact that its growth has been so pronounced and its role so integral to the way we interact with the markets today and its growing presence.

Freddie, Jacopo, just to set the stage about the brokerage business, discount brokerages, and the broader landscape, maybe we can kick it off there and then dive deeper into this particular business and why it’s so special.

Yeah, sure. No, it’s great to be back on the show. Thanks for having us.

Interactive Brokers is a really interesting business. It’s one we’ve owned for about 18 months, but we’ve been following it for a number of years. It’s a digital broker, so you can trade stocks, bonds, currencies, and options—pretty much anything you like through it.

It started out 50 years ago as, by far and away, the most technologically led business in the space. There’s a lot of history we can get into, but what they’ve done through investing in technology, investing in automation, and a couple of other strategic advantages is develop, by far and away, the lowest-cost model—the lowest cost to serve with the highest-quality output.

That’s what’s driving the flywheel effect. They’re generating the highest profitability at the lowest costs, driving huge growth in their customer base. That compounding is coming without advertising and without marketing, and individual investors are increasingly choosing Interactive Brokers over all of its competitors.

What’s most exciting about this business model over the last 5 or 10 years has been the doubling up of that compounding effect through growth in other channels. They’re growing from other brokers introducing business, from hedge funds, through RIAs—or what we call IFAs in the UK—and they’re really growing internationally. They’re a truly global business with huge market potential and a lot of exciting things to talk about today.

I guess a nice place to start when talking about brokerage businesses is to take us through the key revenue streams and how these businesses fundamentally make money.

It’s relatively simple. There’s a lot of complexity when you really dig into it, but at a headline level, they make money in 2 ways. They make money through charging commissions on trading, and they earn net interest margin—a spread on cash held on account or on margin loans.

It’s reasonably straightforward to model. They have 3.5 million accounts. The average account does about 200 trades per year, and the average commission is about $3. When you multiply that through, you get to roughly $600 per account in trading commissions per year, or around $2 billion a year.

On the net interest margin, they pay very good rates on cash, which is a real strategic advantage. They own quite a narrow spread on their funding, but effectively, their securities-lending and margin business, which is about 11% of client assets, is financed with customer deposits. The spread between what they pay on those 2 equates to net interest margin of about $800 per account, or about $3 billion.

Those are relatively stable per-account numbers, so the real driver for this business over time has been, and will be, account growth. When we started looking at the business, it had around 1 million accounts. It has around 3.5 million now, 5 years later, and they have various different targets to get to 10 million, 20 million, or maybe 80 million accounts as time goes by.

When I consider Interactive Brokers and the broader landscape, you’ve got Charles Schwab, Fidelity, and obviously Robinhood. What are the key differentiating factors about this particular business as opposed to its peer set?

When you look at Interactive Brokers, it was born out of a person who is, first and foremost, an engineer and a technologist. That type of culture has reverberated throughout the firm from day 1.

When you look at Interactive Brokers, it’s by far the most automated of all brokers. When you go onto the app, most of the functions you’ll use on it—including actually liquidating accounts because they exceeded the margin limit—are done automatically by a bot. This doesn’t tend to be the case for the competitors.

This has also shaped the broker into being one that is liked and used first and foremost by experienced traders. In the early days, the business was really only used by individuals and what today we call prop traders. These are individuals with account balances that tend to vary between, let’s say, $200,000 and a couple of million dollars per account of client equity.

This compares broadly favorably with other online brokerages. You’d think someone like Robinhood or eToro would have account balances averaging maybe $5,000 to $10,000, so they would be the first brokerage you go to when you learn about trading. Places like Schwab would have higher account balances, but they would be used in a much less frenetic way.

As Freddie mentioned, you make about 200 trades a year per account on Interactive Brokers, and that number might be tens of times lower if you’re using your Fidelity or Schwab account, which tend to be used for slightly different purposes—401(k)s being one of those in the U.S.

It’s impossible to really appreciate how differentiated Interactive Brokers is without spending some time discussing its founder. Thomas Peterffy came here with effectively nothing, I believe, in the 1960s, and is now one of the wealthiest and relatively unknown Americans.

Can you tell us a little about his story, how this business came to be, how it has evolved over time, and how much of the business Thomas is involved with today?

As you said, he was born in Hungary during the periods of war in Europe, and he migrated with nothing to the U.S., pursuing the classic American dream.

The business started out as a market-making business for options when Thomas bought a seat on the Chicago Board Options Exchange. Initially, his broad idea was to pioneer a way of pricing options. It was at the time when the Black-Scholes formulas were coming out, when options trading was nothing compared with today, and the company was called Timber Hill. It was really an options market maker.

But if you think about that, the way Thomas approached the business was completely different in the sense that he wanted to automate everything that could be automated. This still permeates the culture of the business today. Interactive Brokers doesn’t want to be in businesses that eventually cannot be automated in the future.

On top of that, if you think about the role of an options market maker, risk management is at the center of everything you have to do.

So you're taking both sides of a trade most of the time and just creating a market for participants. To this day, risk management is one of the most important points that differentiates Interactive Brokers from other brokerages.

There are a couple of examples, but the only time they really lost money in a significant way—which was not significant compared to the total amount of equity they have—was when the Swiss National Bank let the Swiss franc appreciate freely, and the company lost about 1% of its capital at the time. Recent examples include 2021, when interest rates were at zero and a lot of other online brokers decided it was time to take some duration risk to make more money on net interest income. The company refrained from doing that.

So I think when one thinks about the 2 vectors of why this business is so well-managed and has managed to succeed, his traits as someone who is fundamentally an engineer and focused on risk management are 2 very important aspects of the business. It's worth saying that he's also a very hard-nosed and smart businessman. Whenever he saw that the option market-making business, due to changes in regulation and the market environment after the Global Financial Crisis, was not a business that would earn excess ROE anymore, he decided to close that down to focus entirely on the online brokerage.

When you consider the business of online brokerage, there was a pretty big evolution over the course of the last decade, primarily focused on payment for order flow, or PFOF. You went from a world where commissions were $5, $10, or $25 per trade to a competitive landscape where many of their peers offered zero commissions. I'm curious: Despite that, IBKR, while still being a business that charges commissions, has seen its growth explode. What is going on? What is the debate around PFOF, which I believe is not even a legal business proposition outside of the US? How do you think about that backdrop as it relates to Interactive Brokers' ability to continue to take share?

We think this is one of their key competitive advantages: Since day one, they've always chosen to have direct market access. Imagine a kind of Costco model. They're cutting out the wholesaler. They don't have someone else, and they don't have to go to a broker. They've linked their system up directly to every exchange in the world, give or take, and they execute directly at the best price on your behalf.

Payment for order flow, which is pretty much just a US phenomenon, involves businesses that buy that order flow and clearly make a large amount of profit. That has to come out of someone's wallet, and implicitly, it has to come out of the customer's execution price. You can listen to the CEO, Thomas Peterffy, talking quite vociferously about this practice and other banking practices that have yet to be regulated, but it's something that they've always avoided. It does save them a huge amount and allows them to move much faster than a lot of competitors as well.

So it comes at no higher cost. They don't get the payment for order flow in their revenues like some other businesses do, but they don't need it because they can prove best execution. They still have lower commissions across the marketplace. They charge far less than others in most cases. Their other draws are their much cheaper margin loans and their much more generous payment for cash on deposit. They basically pay 50 basis points less than the local base rate on any cash deposits over a certain threshold. They're seen, correctly, as giving back everything they can to customers with a small margin, and that's their principal competitive advantage.

The second, as Jacopo's already touched on, is the automation of the trading itself, the risk management, the management of the business, and all the opex, which means that their cost base is just so much thinner than the others. They're able to continuously reinvest in price. I think one of the things that's interesting is that if you look at the headcount of IBKR relative to its peers, it obviously speaks to their insistence on making sure that everything is tech-enabled.

I will say that, among some investors who use the platform, they do complain about the lack of customer service at times, but it's what allows them to offer such incredibly low-cost execution. The other aspect is really your ability to use leverage at a very low cost of capital. Can we just talk about how they use their balance sheet in a way that provides such a structural cost advantage relative to their peer set?

Fundamentally, there are a couple of points here to be made. The first one is a bit like what Jamie Dimon at JPMorgan talks about: Having a fortress balance sheet in financials is of paramount importance to succeeding over time. It allows them to obviously survive crises if they happen. Interactive has a similar approach. If you look at the balance sheet today, at the end of 2025, there's probably going to be about $18 billion of excess capital, which is about 95% of the total capital they have. That allows them to grow the business in a fairly serene way without necessarily participating in the ups and downs of the market.

The second point, when offering low-cost margin loans, stems partly from that and partly from, again, going back to the automation point. The big risk when offering margin loans is that eventually those accounts will need to be basically closed because, with a market drawdown, the fall in value is superior to that of a margin loan. There are plenty of examples, with the latest one actually coming from Archegos, where even investment banks—which one would think are fairly well-invested in technology—still require quite a lot of human involvement and personal calls in order to make those decisions.

That never happens at Interactive because everything is automated, and the account, if it doesn't post the required collateral within a very short period of time, is automatically liquidated and eliminated. If you think about that dynamic, that is exactly what allows Interactive to do 2 things. One is to underprice competitors in terms of the cost of the margin loan. It's about half the cost of Fidelity or Schwab or whoever else competes in the US. It also allows them to offer slightly more leverage than the competition without really affecting the total risk, if you're able to cancel or close down that account fairly quickly and mitigate the risk of loss from that account in a better way than competitors. That again allows them to foster that competitive advantage coming from lower cost and, obviously, higher automation.

I think it would be helpful to illustrate how this manifests by demonstrating what an account looks like and how a customer uses the business. For example, let's say you have someone who's a professional trader with a $1 million account and maybe is running at $2 million or $3 million of gross long and short positions. They're obviously borrowing and lending securities. What does it look like, and how does that translate into the different revenue line items—the commission revenue, the net interest income, and the fees and services that they provide? Just to really drive home how people interact with this business and its ability to be differentiated on every service that it provides to its key customers.

The difficulty here is that one does need to disaggregate a little bit. We've been discussing this as an online broker, which makes it feel very much like it's aimed entirely at individuals logging onto a website or an app. The truth is that more than 50% of the business, and a large portion of the growth in the business—although individuals are still growing very nicely—comes from the other 3 main cohorts, which are white-labeling the platform and service: RIA advisers around the world, prop traders, and hedge funds.

They're now the fifth-largest prime broker in the world, so they're larger than many of the big banks you could name, from a standing start about 10 years ago. They're growing far faster than the market for prime because they are seen as more attractive to hedge fund groups in general.

The final one, which is just worth touching on, is what they call introducing brokers. You can think about this as another bank or another brokerage business that is outsourcing and canceling its own internal technology investments. As an example, they just brought on HSBC globally, and then they're going to plug in the underlying trading capability of Interactive. I would think about this in the same way that a lot of people have become comfortable with outsourcing administration or custody to JPMorgan or these large custody banks like Northern Trust. A large number of these huge global institutions, as opposed to investing in the technology, are renting it implicitly from Interactive, and that is where a lot of the growth is coming from.

What we see at an account level is a slight average of those things. We can make some assumptions about where the margin skews toward the hedge funds and the prop traders and, obviously, away from a lot of the RIA business. But what you see is an average account balance that, even for individual accounts, was much higher than most other firms. It's very normal to have $100,000, $150,000, or $200,000 as the average account balance.

Against that, there are 2 other interesting assets, which are the margin loans we've discussed. They used to be far higher, actually, and have come down as a percentage of equity over the last 10 years, but are ticking up again at the moment, in the short term, at about 10% to 12% of assets. So if you've got a $200,000 account, you might have $20 of margin loans against some securities in there on leverage. What's also been very popular with all of the brokerage platforms, including Interactive, has been securities lending.

And again, as we've probably become boring saying, this is fully automated. You can sign in if you want to, and your securities—your stocks—can be lent out to people who wish to borrow them and short them. They're still fully tradable, and they're fully collateralized from our perspective as shareholders by cash. The client earns most of that lending fee, and again, there's a small but very honest spread, which is all transparent.

So they have a similar amount of securities lending. For a $200,000 account, it's about $20,000 of lending, so 10% of the base. That's the kind of average, but we do believe it skews a lot. A lot of the introducing business and a lot of the RIAs, we think, are probably using less and probably trading less as well—under that sort of 200 trades per year.

And then, really, the majority of this stock lending, margin loans, and even the turnover—the number of trades, or DARTs, as they call them, daily average revenue trades, if anyone's reading the annual report after this—skews toward the hedge fund business.

When you look at this business's P&L, and I'm looking at 2024 as a reference, you have about $1.7 billion in commissions, which results in around $2 billion of non-interest-related income. And then the rest, $3 billion, is that net interest income, that NIM, resulting in about $5 billion of revenue. How do you think about how that should evolve over time—the mix and quality as it relates to the evolution of their customer base, which you just mentioned?

And then a second question related to that: when you see a business that's as significant an earner on net interest margin, you beg the question as it relates to interest rates and how they impact the business and what would happen in an environment where rates were going down versus going up. I'm just curious on those two items, really: revenue mix and NIM as the business evolves over time.

There are quite a few ways to cut it. This is clearly a cyclical business. It grows very rapidly, and account growth that had been around 25% per year is inflecting up toward 30% and 35% per year at the moment as the flywheel gathers a head of steam.

The most important thing that I want to compel you to understand from our perspective is that it's account growth that matters. And if you believe account growth is what matters, then one needs to believe in the sort of stability of the other things, like the amount of trading and the revenue per account.

When we've interrogated the number of trades that's been going on as the mix has changed and the accounts have been growing, the trades per year have been falling. Again, one would expect hedge funds to be trading many times a day, but RIAs and introducing brokers in particular are probably trading fewer than the 200 average trades per year. And so we expect, and we've observed over the last 5 or 10 years, a kind of 5% to 10% decline in trades per year.

So, if the growth is similarly skewed between the different cohorts over the next few years, obviously, in periods of volatility, one trades more; in periods of low volatility, one trades less. But as a trend, we put a deflation, if you like, in the number of trades per year, and I think there's probably a small amount of potential deflation to come through from commissions.

The management team have talked about flat average commission levels from here, and it really does depend on mix. Again, a crypto trade is a very different commission level, or an option, compared to trading Google shares. The way it's worked is you have that kind of average $500 to $600 per account of commission. It'll probably trade a little bit lower, maybe 5% down per year on an average basis, and then be cyclical with client equity. But if account growth is 35% or anything along those lines, that will dwarf any reinvestment back in price.

That's the easier one: the commissions. And obviously, you can take your own view on average client equity and average equity market performance over the long term. When you factor those things in too, they offset that reduction normally on the NIM.

And I think this is probably one of the greatest misunderstandings in the business, and it was certainly what gave us the opportunity to invest in it 18 months ago: the actual sensitivity. If you think about the alternative, if you think about a business like Schwab, which only a couple of years ago almost needed effectively a wholesale rights issue because it had what was effectively a run on its funding source, they weren't paying anything on their customers' cash. When interest rates went up, customers started saying, “We'd better go to a bank, or we'd better go to a money market fund,” and they robbed Schwab of that source of cash and funding.

The arrangement between Interactive Brokers and their customers is just far more honest, and it's very transparent. As I said, on any large balance of more than $10,000, which is about two-thirds of their entire customer cash, they just pay the local market base rate less 50 basis points. That results in a far lower risk, firstly, to the point about Thomas Peterffy's risk aversion. Clients are probably not going to leave because they get 50 basis points more elsewhere, even if they could.

But secondarily, it's actually less interest-rate-sensitive than you think, because if rates go down by 50 basis points, they still just take 50 basis points on a spread. And so they do disclose that overall interest-rate sensitivity. For a 100-basis-point move down in interest rates around the globe—and again, this is a global business, probably 40% U.S.—if global interest rates fell 100 basis points, NIM would fall by 10%.

And again, that's NIM per account. So if you're growing your accounts at 30% to 35%, it will more than offset, by a multiple of times, that net interest sensitivity. That's why we focus so obsessively on the business model and the potential for account growth.

From a NIM perspective, Zack, what's also pretty interesting is that margin loans tend to be higher-yielding products, maybe paying 100 basis points more than what they get on cash on the asset side. And these tend to be cyclical but move in the opposite way of interest rates.

For example, if interest rates were to go back down to levels that we observed in 2019, 2020, or 2021, the amount of leverage that investors are usually willing to take on is slightly higher. So the margin loan per account was materially higher back then. And so, in the mix, as interest rates fall, we would also expect margin loans to pick back up, helping a little bit with a NIM fall.

If you go back in time, 2019 and 2020 were pretty difficult years for whoever was exposed to rising interest rates, and the company was still making maybe 30 basis points less than today in net interest income. They have proven themselves through the cycle to be able to earn a fairly attractive spread on assets and liabilities.

And so you guys had mentioned the international opportunity here and where some of the growth is coming from. Obviously, we've seen, through the COVID backdrop, participation in capital markets and investing exploding—perhaps the advent of Robinhood as an on-ramp for that—but also just the financialization of Western economies.

What are the growth opportunities for this business? And I ask that in the context of, on their earnings calls, they're very often asked if there are any M&A opportunities. Because they operate at such low costs and provide such attractive margin loans to customers, the pro forma earnings of acquisitions make the math very difficult for them. And so, I guess, weighing organic versus acquisitive growth, where are they going to see their business continue to expand?

Interesting—you picked up on that comment too, because it's one we've discussed in the past, which is this idea that if we buy a business but then we take it to our spreads and our offering, the underlying revenue and profits would collapse in that business. So they're not able to pay what the owner thinks they can pay, because if they give back to customers as much as they give back in their main business, it would be a very different profit level. And so that, to us, is incredibly telling.

They are open to acquisitions. They have done them in the past, but there's nothing out there which would make sense. They have one of the lowest advertising budgets of all of the online brokers and, despite that, have outgrown anyone we look at. They're growing organically. They're growing because their rates are just better than everybody else's.

And if you are trading any meaningful amount of capital, I'm not here to sell it, but I'm sure some people listening to this will be trading their own shares. And it's worth a look, because it's a meaningful saving to go to a business like this.

I think at the moment what they're getting asked more about is this sort of potential for growth in the more B2B channels that we've discussed—the RIAs, the hedge funds, and the introducing brokers. But notwithstanding that, individual accounts are growing very rapidly too. So the mix isn't changing very quickly.

When we think about growth potential, I mentioned earlier a few different big, hairy, audacious goals for the management team. Schwab have, I think, 25 million accounts, principally in the U.S. I think Fidelity is something around that level. They are smaller on average, so there's a tail of those accounts which would be less profitable for this business, but 3 12 or 4 million accounts that we have today is still a fraction of that domestically.

They talk about 20 million globally as a sort of first stop in their growth story. And then, at a sort of later stage, they talk about this 80 million number, because in a couple of countries where they operate, they are already at sort of 1% of the population. And that would be that sort of level of penetration.

The key thing to that potential is that people will continue to trade a lot. Whatever happens with markets becoming more digital, and with outsourcing within the B2B channel, that will probably continue for the next 5, 10, and 20 years.

The big question is: can someone compete with this? Can someone come up with a way to stop them from organically growing share? Given the counterpositioning, and that first comment about acquisitions, competitors would have to reinvest to try to build direct market access and invest in pricing, costs, and automation like this business has. Everyone is folding and using this business instead of trying to compete with it.

To your comment about more participation in financial markets by all sorts of individuals, especially after COVID, we believe that to be a pretty good tailwind, too. As we said at the beginning, someone who is inexperienced and might have a smaller account balance might start a Robinhood account, an eToro account, or whatever else they can get their hands on, depending on the jurisdiction.

But after a certain period of time, after becoming more accustomed to trading and, honestly, after having increased their own disposable income, we do believe the proposition of joining Interactive Brokers, especially as an active trader, is so much better than anything else that's around. We do see a lot of these customers eventually moving over to Interactive Brokers as soon as their account balances reach $100,000 or $200,000.

And if I can just add one more thing: you mentioned earlier that some people are upset with the customer service. We see a lot of analogies between this business and other low-cost businesses that we look at. One would be Ryanair. I think it's really compelling to see that business—another business we like—where Michael O'Leary said, “I didn't realize looking after customers would make me so much profit.”

He started making the customer experience more pleasant. I think they're doing that at Interactive Brokers, too. They've had this obsessive focus on costs and automation for 50 years, including in their prime brokerage business, but they've just rolled out what they call the white-glove service, which is a very manual, independent director looking after your account as a hedge fund. I expect a bit more of that over time, coming back into the business on the customer service side, too, which slightly opens up their market.

One final thing they're doing as well is really relaunching their app, which will help with the customer acquisition that Jacopo mentioned among those who are out there learning the ropes in apps like eToro and Robinhood, but may want to grow up into Interactive Brokers later.

And so we touched upon it in relation to M&A, but clearly, in a business that's generating as much excess free cash flow as this one, capital allocation becomes increasingly important. What is their demonstrated strategy as it relates to redeploying the cash that they're generating on an ongoing basis if M&A is not available to them?

This is a very important question, especially as the business will eventually mature. In fact, at the moment, the only capital return we are receiving is a dividend yield that's usually targeted to be about 0.5% to 1% of the total market capitalization.

There are a couple of things, though, to keep in mind. I think the company wants to keep its balance sheet as strong as it can be, mostly to develop the prime brokerage and hedge fund business. One of the reasons is that the companies they compete against—behemoths like Goldman Sachs, Morgan Stanley, UBS, and Bank of America—are materially larger financial institutions.

So, to win over customers and hedge funds that manage $1 billion to $5 billion of assets, they do need a potentially stronger balance sheet than what we might otherwise imagine they need. The second point actually comes with the company structure. It is a publicly listed company, but still today insiders own roughly 80% of the stock, of which most of it—75%—is still owned by Thomas Peterffy.

The CEO and CFO also have a significant stake in the business, and therefore launching extremely large special dividends or share repurchase programs is not necessarily doable until the float of the business is increased. So, like many other external investors, we are looking at the topic.

We do believe that over time, as Thomas rightly says, he's not immortal, and he's approaching or above 80 years of age, we will see how that evolves. But it is something that we do like to an extent, because if you think about ways of maturing as a business, the final phase—when growth slows down and is not what it used to be 20 years ago—gives any business a choice to make.

It can grow again through M&A whenever that is possible, or it can return excess cash to shareholders. We are not even close to that. As Freddie has discussed, there's a potential over time to probably 20x the number of customers on the platform. But once that is done, having excess capital to return to shareholders, as the structure has probably changed by then, is an option that we do like to have as investors.

There are other businesses that are in that situation, Berkshire Hathaway being an enormous one, which is in a similar position with an incredible amount of cash and Treasuries sitting on the balance sheet.

And so when you're evaluating financial businesses, there's always a debate about how to properly value them. Without asking you guys to opine upon the valuation itself, what do you think are the most important metrics here? Is it return on equity, price to book, or P/E? How do you go about valuing a business like this?

It's really a combination of everything you've mentioned. I think, to an extent, today the ROE of a business can be looked at in 2 ways. One is obviously including the excess capital, and one is excluding it. One thing you realize quite quickly is actually how capital-light it is compared to normal financials, especially when you back out the excess capital.

It might make 15% to 20% ROE including the $19 billion of excess capital, but it might make 10 to 15 times as much excluding that. Price-to-earnings on normalized earnings is also another way we look at it. We put in our own assumptions, obviously, of account growth, trades per account, and commissions, and then look at what a normalized and average net interest income could be, given the prevailing rates of interest around the world.

But as you say, it is not one of the simplest businesses to value on either of those 2 metrics. So we focus really on both and see how they interact with each other.

At the same time, we do not yet feel confident enough to assume a significant capital return of the excess capital. So we let it build in our model, with our minds on what that capital will eventually earn 5, 10, 15, or 20 years from now. But so far, I think they've proven to be fairly good stewards of it.

One other way to think about it is to invert it. Given the competitive advantages and the demonstrable success across these verticals, which are all very nascent, and given the arguments we've made around the limited reduction in revenue per account—either from NIM sensitivity, which will bob around, or from commissions and trading per account—you’re making roughly $1,500 per account in revenues at the moment.

What's the probability they can get to 10 million, or they can get to 20 million, thus making $15 billion or $30 billion in revenues, with a 75% operating margin? I think they make a 75% net margin. It'll probably be around there. It could go up a little higher, but that's with their generous offering back to customers.

You're talking about a very profitable, rapidly growing business. The question one really needs to ask is: who's going to stop that happening? Is there a competitor in the marketplace that will stop that? If not, how fast or how slowly will it happen? That's the bigger question.

Something Thomas has said is, “We can grow at 30% with no advertising. We can probably grow at 40% to 50% if we do more targeted advertising,” but they're not looking to do that right now. I do think they could accelerate account growth if they wanted to, because there's a lever they haven't pulled yet.

Obviously, much of what has been said about this business has been overwhelmingly positive. But when you're dealing with a business that interacts with leverage, margin, and the long and short sides of the investment industry, there are inherent risks. I would love to hear about how you guys assess those risks and perhaps some of the stress tests the business has faced.

Even as recently as a few weeks ago, we saw the broader market sell off 10%, 15%, or 20%, and what that meant for their business. I think that would show the resilience and durability of the model that they have here.

Yeah, I think one of the key things to remember if anyone else goes away from this and analyzes the business is that this was, in large part, a market-making business in the past as well. So it's very different from 2009, and 2014 was when they really exited most of that business.

This is now a middleman—a broker—with far less of that sort of asset risk. The risk, as you say, slightly lies in that margin-loan piece and their ability to risk-manage and collateralize those loans. When they make these loans or do the securities lending, they take and hold collateral.

As Jacopo mentioned earlier, these accounts are stopped out automatically if and whenever they get too close to that margin limit. So it's all an automated process. They claim to have very good risk-management systems, but I've never met a financial business that doesn't claim to have good risk-management systems.

Your question, again, is right: how have they fared through the last decade of quite a lot of stress tests? I'd argue that whether it was COVID, the big drawdowns in 2022 in the very popular stocks, or the recent hit to the market, their largest loss was really from a very strange sort of move in the Swiss franc 10 or 12 years ago, maybe even 14 years ago, where they lost about 1% of their equity capital at the time.

That's a very bearable amount for a business that is multiple times overcapitalized. Through the recent turmoil of the last 3, 4, or 5 years, the risks from margin, the losses, and the bad account balances have been de minimis. They have not been an issue for the business.

So the risk management system in place has clearly been working. If you think about how financial businesses run into trouble, it’s some sort of liquidity mismatch that exists between assets and liabilities. I think that new investors in the company should take quite a bit of comfort from the fact that most of the assets are really 30 days in duration.

Some of that is a function of how the yield curve has been looking for the past 4 or 5 years, which is flat to inverted. So there was no point in taking interest-rate risk and duration risk with the capital of a business. But in general, I think the company has always taken a prudent approach to risk management. I think that, again, stems from probably Thomas’s beginnings as a market-making risk manager.

If you think about the mother of all stress tests, which was the Great Financial Crisis, when the business still owned one of the leading market-making businesses in options, the company decided quite early on in 2007 to stop making prices to customers in long-dated options. That eventually ended up being part of a market that not a lot of people talk about today, one that was entirely illiquid and where losses just piled up. So I think analyzing the liquidity of a balance sheet and, in general, risk-management choices is where one can get comfortable that downside risks are fairly well managed in terms of long-term risks.

Freddie mentioned a little bit about the competitive landscape and how it might evolve. I would add one point to that: as you mentioned before, Zack, there has been a huge increase in participation in financial markets. Some of it is very healthy. New generations are learning earlier how to invest, and some of it is more akin to really gambling.

If you think about that and the ramifications it might have in terms of regulations in the future, or if losses actually pile up for retail investors, this is an area that is worth bearing in mind. You might have noticed that in the past 18 months, they’ve been talking a little bit more about their new product called ForecastEx, which is almost like a sports-betting platform on economic events that allows customers to really express an opinion that is a yes or no on individual outcomes. It might be about inflation or payrolls.

The simple fact that the CFTC initially didn’t allow those products to go out because they were too akin to sports betting tells you that there is a component in financial markets today that goes through online brokerages that is more similar to gambling rather than what we would normally consider investing.

And so, a corollary to that last question is one that we always conclude with: What are the lessons learned when you guys evaluate this business that can be applied to others? From an operational perspective, is there a way that management runs this business that you think can be applied to other businesses to help drive better shareholder returns?

When we’re looking at what gives our businesses a competitive and strategic advantage over their industry, and what will endure for the long term, one of the really best ones—and we’ve only got a handful of these that have this competitive advantage—is this low-cost, high-service model. Service in this case means better access to markets, quicker trading, and neater valuations.

Not yet. Someone on the end of the phone, but we’ll wait and see on that.

This low-cost-to-serve, high-quality product is brilliant because it’s so hard to compete with. This is one of the best examples that we have found. Obviously, others include things like Ryanair, Costco, and a few other businesses on our lists. I think it leads to 10, 20, 30 years of potential advantage, which will come through, in this case, through account growth.

And so that’s been the primary one. I think when you’ve dug back as long as you can into the history—and there’s quite a bit written about this business over the last 48 years—this obsession with technology, automation, and costs has been there from day one.

That’s a softer point, but it’s around the culture of a business. It doesn’t have to be founder-led, but it’s often founder-led. It’s certainly got to be someone with skin in the game, and it’s got to be someone who intrinsically demands that of a business. I don’t think it’s something that you can come through with an MBA and just say, “Oh, I’m going to go for a low-cost model.” I think it’s got to be something that’s really in you.

And I think the final thing that this business helped teach us is just how cheap very high-quality cyclical businesses can become, because people misunderstand or fear cyclicality in what is otherwise a very strong growth business. This was trading at 12 or 13 times delivered earnings only 18 months ago. It’s a little more expensive now, but it’s still inexpensive. The way we look at these things is that, with all cyclicals, you’ll always get a good chance. You can find the great cyclical. You might have to wait 3 or 5 years, but you’ll always get a great chance. And the great ones are worth waiting for.

Well, Freddie and Jacopo, I appreciate you guys coming on so much to discuss IBKR. Around 50 years ago, Thomas Peterffy came here with effectively nothing and has built what is today, I believe, a $75 billion-plus business, of which he owns the vast majority. It’s a really interesting story from both a business-history and business-performance perspective. I really appreciate you guys coming on to help tell it. Great to speak to you.

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