When Deta Index started out in 2001 they were playing to a tough crowd. There was a lot of distrust of all things financial worldwide but particularly in Ireland. A combination of the Eircom debacle and the dotcom meltdown had left a bitter tastes in the mouths of many Irish investors, but, more recently, spread betting has begun to garner a serious following in the Republic. Today, Delta Index's customers include a taxi driver and an 86-year-old retired man. The growing appeal of spread betting helped treble Delta Index's business in just two years, with up to 64 per cent of its business stemming from client referrals.
Delta Index has proven to be a good bet for its investors down through the years, reports Bary McCall
Trying to start up a technology-driven business based on a totally unproven concept in the post-dotcom bust of late 2001 might initially sound like pure madness, but that's exactly what Delta Index founders and joint managing directors Conor O'Neill and Michael O'Shea did. What makes their story different is that they succeeded.
'I had just retired from AIB having spent more than 30 years in the financial markets running proprietary risk, group treasury and so on,' recalls executive chairman Dermot O'Donoghue. 'I had decided to take a rest from all that in 2001 and look for something else when I was approached by Conor and Michael. They had come up with the idea of a financial spread betting company and asked me to work with them on it. It all started from there.'
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The trio first looked at the venture capital community for investment. 'They had no interest,' O'Donoghue says bluntly. 'We needed a proven business model to attract them. We were left with the problem of trying to prove the model with very modest resources. We spent the first year proving the order capital processed and building the back-end risk management and customer relationship management technology that we needed. After that we started trying to sell the concept of financial spread betting to customers.'
This was funded by an investment of EUR 550,000 from the classic 'three Fs' - friends, family and foolish investors. But as far as the latter is concerned they turned out to be very wise indeed. Since that initial fundraising the company raised and additional EUR 950,000 in 2004 and a further EUR2 million in 2005.
While the business has accumulated losses of EUR 2.7 million, it is now healthily profitable at the operational level and market analysts put its valuation at around EUR60 million - up from zero in 2001. Building the business initially proved to be something of a struggle. 'None of us came from a sales and marketing background,' O'Donoghue says. 'We didn't really know how to sell the concept. We ran seminars and various other events to try to explain the concept of financial spread betting, what it is and how to do it.' They eventually succeeded and the company now has 1,500 active customers regularly making financial spread bets with it.
But how does it work, and more importantly how does Delta Index make money out of it? From the customer's point of view, it's a question of making a bet on whether a particular share or commodity is going to go up or down in price. If you bet correctly you win, and if you're wrong you lose. But the losses and gains are multiplied by the degree to which you are right or wrong - or the spread in other words. 'Take a share in a leading Irish financial institution that is trading at, say EUR 16 at the moment,' O'Donoghue explains. 'If you were to go on to our site you would see a sell/buy spread of around EUR 15.95 to EUR 16.05. 'This means that if you are betting that the shares will go up, you can buy them at EUR 16.05, and if you are betting that they'll go down, you sell them at EUR 15.95. If you have bet EUR1 per point that they will go up and the share s go up to EUR16.50 over the next week it means that you will be sitting on a profit of EUR 45. On the other hand if they fells to EUR 15.55 you would be sitting on a loss of EUR50.'
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This is very simple and straightforward. But O'Donoghue points to the risks as well. 'That's a EUR 1 bet,' he says. 'What if you have bet EUR10 and the shares fall to EUR15.05 - your loss is magnified to EUR 1,000. We try to educate our customers about these risks, and not betting more than they can afford to loses, not matter how confident they are of winning.'
'We also have various systems and tools on the site to assist them. For example, they can put a stop loss order on a bet. This will close it out if a loss gets to a certain amount. We also help them exploit winners.' 'There's always a temptation to keep chasing a winner but markets are cyclical and you can end up losing all your gains if you're not careful. We show people how to change their stop losses order and move it with the stock price so that they are protecting most of the winnings in the event of a sudden turn in the markets.'
And helping the punter to win is surely the antithesis of the standard betting industry. 'We are very different,' O'Donoghue says, 'We are fairly unusual in the financial spread betting market in that we are completely market neutral. We hedge all the bests that our customers place, so that we are completely indifferent in a pure financial sense to whether they win or lose. Indeed it is in our interest that they win so that they continue to do business with us.'
And that is the key. Delta Index makes its profit from the margin within the sell/buy spread mentioned earlier. 'We have calculated this at around 0.7 per cent of the share price,' says O'Donoghue. 'When we hedge the bet we will get a tighter margin than this and it is the difference between the margin that we get and the margin that we offer our customers that gives us our profit. After that we really do hope that all our customers' bets are winning ones.' While the company has achieved much over the past six years, O'Donoghue sees the near future as holding out great prospects for both domestic and international expansion. 'The new EU MiFID (Markets in Financial Instruments Directive) is coming into force in November,' he points out. 'This will bring about major changes in our market. For the first time, we will be regulated by the Irish Financial Services Regulator. This will be very good for us on the domestic market as customers do like to deal with regulated companies but it will also open up tremendous opportunities for us in Europe.'
These opportunities will be created by the European Single Market. Financial services companies regulated in one member state are allowed to sell their products in other member states, subject to normal local legal restrictions. For Delta Index this means that they will be allowed to trade in countries like France, Germany and Spain. However, the gaming laws in those countries would probably preclude them from offering financial spread bets, instead they will sell a financial instrument knows as a Contract for Difference (CFD) which will also be regulated for the first time under MiFID.
CFDs have been available from stockbrokers and other financial services providers for many years and are, in essence, the same as a financial spread bet, but they are not treated as such either in law or by the financial markets. 'We will never do anything that is not totally in accordance with local law,' says O'Donoghue. 'This means that we will most likely only offer CFDs in mainland European markets.'
The company is already gearing up for expansion. 'We have 33 people here at present and are currently recruiting a further 15,' he says.
'We will be adding another 12 to 15 by the middle of 2008, and that will bring us to about 60 people. We will concentrate our resources here in Dublin. Also, we will organize the international sales and marketing effort along language lines rather than countries so we will have a German or Spanish-speaking team looking after all German or Spanish speaking customers.'
It's come a long way from trying to interest a skeptical investment community in an unproven product, but Delta Index has proved a consistent winner for its own investors over the years.