Credit Suisse
KCG Holdings announced their intention to explore strategic
options for their institutional spot foreign-exchange-trading
business Hotspot.
What is Hotspot? Hotspot is KCG's (ticker: KCG) dealer-to-client
foreign-exchange-trading (FX) business that comprised 13% of
disclosed industry FX volumes during the third quarter, up from
about 4% in second-quarter 2009. Launched in 2002 and acquired by
Knight in 2007, Hotspot caters to hedge funds, commodity trading
advisors (CTAs), corporate treasuries and institutional asset
managers.
Why is the asset valuable? Institutional FX is moving rapidly
away from voice execution to electronic venues such as Hotspot. In
addition, liquidity is migrating to non-bank players. The rise of
Hotspot, [Thomson Reuters ( TRI) unit] FXAll, FXCM ( FXCM) and Gain
Capital's ( GCAP) institutional FX offerings and demise of EBS [a
unit of ICAP, which is traded in London] are examples that
highlight this shift in liquidity. As per the Bank for
International Settlements (BIS) non-dealer financial institutions
comprised 58% of spot volumes traded in 2013 up from 29% in
2001.
Bloomberg is reporting a price tag of $300 million for the
business. Although there are no official financials we find this
estimate reasonable for a business that we estimate generates about
$15 million-$20 million in net income from trading and data thereby
implying a 15 times-20 times multiple. First-round bids are due
next month.
We see several potential suitors spanning market-structure
firms, trust/custodial banks and exchanges. They include: 1) Nasdaq
OMX Group ( NDAQ) -- recall the firm has been focused on growing
their fixed income, currencies and commodities (FICC) business and
bought U.S. treasury platform eSpeed in 2013 -- this acquisition
would allow the firm to foray into spot FX; 2) FXCM -- the firm has
been actively growing their institutional FX business purchasing a
stake in FX market maker Lucid (2012), buying institutional FX
research provider Faros (2014) and entering into a joint-venture to
form FastMatch -- this acquisition would allow the firm to further
solidify their institutional offering; 3) Northern Trust ( NTRS) --
all trust banks operate FX trading businesses to complement their
core custodial offerings -- the firm has been actively trying to
diversify further into third-party FX and Hotspot would allow them
to significantly enhance existing capabilities; 4) State Street (
STT) and Bank of New York Mellon ( BK) both these banks have larger
third-party FX offerings in place already (State Street purchased
Currenex in 2007) and would be interested for scale reasons.
Other likely suitors include Thomson Reuters who purchased
buy-side institutional-oriented FXall in 2012, Bloomberg and CME
Group ( CME). With that said, buyers with pre-existing FX
infrastructure such FXCM and the trust/custody banks stand to reap
significant expense synergies (40%-plus) and may prove to be better
owners of the asset.
-- Ashley N. Serrao
-- Christian Bolu
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