Judgment Day: should you buy shares in IG Group

The Group has three main operating companies in Britain.
IG Index is a financial spread-betting firm. It offers prices on a range of indexes, currencies, commodities and individual shares. It also runs a sports spread-betting service.

IG Markets acts as a market-maker in financial derivatives such as contracts for difference. Binarybet.com offers fast online two-way betting.

Founded in 1974, IG Group was floated on the London Stock Exchange in 2000. In 2003 the group was delisted after a management buyout led by Nat le Roux, the current chief executive, and backed by CVC Capital Partners. IG Group companies have more than 15,000 active clients worldwide.

The two experts below have been selected for their skill in several investment areas. They, or the funds they manage, may buy or sell shares in the companies or sectors that are discussed in this column.

Andy Brough, fund manager at Schroders:

The acquisition of IG Index in September 2003 by the management and the venture-capital firm CVC shows how they make money. Acquired on a price/ earnings ratio of 14.5, they grew the profits of this company for 18 months and generated cash by strict cost control. Profits were £14.3m in 2003 and are estimated by brokers to increase to £32m for the year that will end on May 31, 2006.

This figure is the profit before interest because IG Group is paying a high interest charge on the debt used to finance the buyout. The company now aims to pay off this debt by raising equity at an indicated p/e ratio of between 17 and 19 on the 2006 estimate.

This makes the return on the original equity investment very large indeed. Now don’t get me wrong, I have no problem with people making a profit. But what exactly have the management and the backers done to suggest that profits are big enough to justify a p/e ratio 20% to 30% higher than when they bought the business? Technology has indeed increased the level of online trading and given all the scaleability benefits. In addition, the market has doubled in size over the past five years, although it remains to be seen whether growth will continue at this rate.

Looking at the past 18 months in terms of turnover, and breaking it down into the individual six-month periods suggests that progress in the financial division is slowing. Binary products are proving to be the main area of growth.

So having sold the company to the management and CVC, do I feel bitter? IG Group is a nice business but its prospects do not deserve a higher rating than the 14.5 at which it was acquired. It is time for the investment institutions to take a stand and say no to the management and the venture capitalists. Okay, you have made money by increasing the profits and putting in expensive debt but please don’t try to put a higher p/e rating on the same profits that were there before.

Judgment: Wait for the price to come down to a p/e ratio of 14.5. If it doesn’t, avoid.

Tim Steer, fund manager at New Star:

What goes around comes around. So it is in the world of venture capital. Familiar names such as Debenhams and Pizza Express are, we hear, planning on relisting their shares soon after delisting from the stock market. You can bet that when these companies come back to the market, venture capitalists will have made a tidy profit by selling the company to, often, the same investors who sold it to them.

Well, investors have the chance to perhaps look foolish again this month with IG Group. Management and venture capitalists bought the company from institutions for £143m about 18 months ago. Now we are expected to pay about £400m for it.

Analysts supporting the IG float have chosen to value it using the high price/earnings ratios associated with internet and traditional gambling companies. This is helpful only to those who wish to maximise the profit for the sellers. Sportingbet will double its earnings in 2005 and many of the traditional gambling groups such as Stanley Leisure are subject to bids or bid speculation.

Since the management buyout of IG Group in 2003, the market has been kind, and operating profits have risen 47%. My concern is that in the period since the buyout, IG’s clients — many of whom work in the financial-services industry — have put on bets based on the feelgood factor that the bull market is back. For their sake I hope it is because the average punter is losing £2,500 each year as the FTSE 100 index finds it difficult to break through the 5,000 level.

The period before the buyout was a tough time for IG Group as it reduced its hedging, but I hear management has increased it now so the City Index problem — with its private client The Plumber — is less likely to be repeated here.

Although IG Group looks more scaleable, I would prefer to value it in line with private- client stockbrokers (IG Group clients are normally private clients) and thus would like to see the shares closer to 100p than the indicated range of 112p-139p.

Judgment: Worth a punt at a pound.

IG Group at a glance.

Predicted share-price range: 112p-139p.

Predicted value on flotation: £375m-£435m.

Flotation date: May 4.

Pre-tax profit in 2004: £7.9m.

No dividend to be paid in first year.

CVC shareholders will cut their stake from 59% to 20%-25% after flotation. Nat le Roux, chief executive, is expected to hold 4.7%.

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