Virtu Financial: Outperforms on Clear Ethereum Catalyst (NASDAQ:VIRT)

Torsten Asmus

Virtu Financial Presentation

Virtu Financial (NASDAQ:VIRT) outperformed yesterday. Volatility and volumes are down, so some downside was to be expected, but they managed to grow. In particular, some outperformance came from VIRT being reliant on crypto volumes and trading which are up year-over-year as the risk-on environment has returned as well as the launch of institutionally backed crypto exchange-traded products. This is probably also where some of the short interest is coming from as we get about 10% of daily net trading revenue in these products on a per-day basis. The buyback on the earnings outperformance continues, which markets must be liking at about 1% buyback yield this quarter, hence the price rally on the earnings release, and also the news of Ethereum (ETH-USD) could make a difference to the results. We think Virtu seems a bit underrated, taking a crude approach to dampening crypto activity, but that comes from that crypto exposure.

Financial Benefits of Virtu

Let’s start with the Ethereum aspect, perhaps. There are several points to make here.

So, we’re sitting here today. If you had said to me three years ago, hey, you’re going to have over $600,000 of adjusted net transactions and almost $700,000 coming from those three categories, which effectively resulted in a zero P&L three years ago.

Douglas Cifu, CEO of Virtuin reference to various crypto products and options so far and their daily trading net income figures.

It is worth noting here that company-wide run rates are around $6 million in daily trading net profit, so crypto products already account for 10%.

Ethereum products have been allowed to be traded in force with the accessible spot products, and Virtu will create markets for these products. These products come to market on the July 23. It is critical to note that much of the infrastructure currently used to distribute and create markets for block products will be the same for Ethereum products. Analysts on the call attempted to determine the relative popularity of Ethereum products versus other block products based on launch numbers, hoping for half as much popularity, but with the cannibalization effects on volumes and the rate at which issuers are approved, the number is likely closer to a third. Whatever activity levels it eventually reaches will be monetized at a net margin of 100%, as those margin dollars are virtually costless on today’s fixed infrastructure and network.

So whether it’s half or a third of the size, I think it’s probably closer to a third than a half, is what I would say. So, look, it’s, and the marginal dollars that actually flow into Virtu’s bottom line after we pay the exchange fees and the SEC fees and all that kind of stuff is essentially 100%.

– Douglas Cifu

Investors can hope that this will ultimately lead to a terminal increase of around 30-50% in crypto-related product activity, which should be reflected in net trading revenue as growth of that magnitude. Ultimately, one would expect major operating leverage effects that could see EBITDA increase by 12% from this effect, which would take an additional $200,000 of net trading per day and put it directly on the operating income line. This would take perhaps around three years, which is how long it has taken the current suite of blockchain products to scale, assuming of course that crypto doesn’t crash again, which could easily be the case.

Snapshot (8-K)

In terms of most recent resultsWhile not necessarily looking ahead, performance was definitely ahead of peers. Most volumes were down across most markets, including fixed income and equities, both sequentially and year-over-year. In crypto, volumes were down sequentially across the market by 30%. Overall, institutional and retail activity was mixed to down. This is consistent with the Brokerage results We see this in other financial choices. Market makers and brokers, both of whom are money generators for Virtu, want volume and volatility in order to maximize spreads and commissions and maximize. Despite the poor fundamentals of the industry, they have managed to decent sequential performance of around 4%in net business income growth, and they achieved a good annual performance in terms of net business income of around 39%.

Conclusion

Valuation is a challenge. A brokerage would have a PE of ~18x, based on US peers. Market makers would likely be about the same, and Virtu has a mix anyway. However, the operating leverage and 10% (and growing) reliance on crypto products is likely where investors pause, as forward PEs are ~10x, with LTM PEs ~19x. Crypto going live is not something a reasonable market participant can trust to stay sustainable, as it is a market that crashes regularly. Roughly speaking, we would say that discounting the crypto business, a 14x PE is what comes out of futures, wiping ~$600k per day of net trading revenue from the operating line. 14x is a discounted multiple compared to the ~18x you get on brokerages. Furthermore, this ignores the benefits that will come from creating markets for crypto products, even if it ends up being nothing more than a bargain. It’s not a bad proposition. It’s on sale, but the reasons are surely cryptographic, so it’s not to our taste.

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