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Wanted to get a discussion going for the only pure play public HFT market maker and see if I am missing anything from what may look like a 'too good to be true' scenario. VIRT currently operates with two segments, market making and execution. Its market making segment is payment for order flow, and very much correlated with (i) volume of retail trades and (ii) how wide the bid/offer is while its execution segment is much more stable (VIRT acts as an agent on behalf of clients as an execution trader) and makes ~$2m in net revenue per day.

 

There a few ways to track market share and revenue estimates (relatively only) for its global equities business in almost real time. First, you can go to RANK <go> on bloomberg. YTD, VIRT has traded $56bn in notional each day on its top 250 equities, which compares to ~$45bn per day last year. Of course this done not mean anything with out knowing the bid/offer but is useful for relative comparisons. Second, rule 605 and 606 data is readily available from FINRA, which provides monthly price improvement data. In January, VIRT did $93m of price improvement, which is $1.2bn annualized against its $1.3bn in price improvements during 2020. Again, not very helpful unless you make other assumptions. However, management also alluded that it is currently earning revenue at similar rates it did last year, which makes me think these data points are a good benchmark to ballpark what used to be an unpredictable and unreliable earnings stream. Its execution services are also helping add a floor to what it can earn while also executing on synergies from previous acquisitions.

 

$2/sh in earnings (after stock comp) seems to be a very sustainable floor unless legitimate business deterioration occurs, and I see $2.5/sh as being achievable as the company expands its execution, options trading, and capital markets offerings. 11-14x floored EPS on a company with massive earnings potential in the occasional volatile year seems like an attractive portfolio addition. I am personally in the camp that believes these guys provide an immense service to the retail investor, and do not scam or rip them off.

 

Take for example a ten year period, where seven years the company earns $2/sh, two years where the company earns ~$4/sh (think VIX averages 30), and one year where the company earns $6/sh (VIX averages 60). While not necessarily as cut and dry, you can adjust the distribution as you see fit to get average earnings over an entire cycle, which gets you ~10x P/E.

 

Difficult to say if this business can trade at a high P/E multiple similar to CME or ICE, as they are still highly regulated and Citadel has paid its fair share of fines and received scrutiny from media. However, it seems to cheap to ignore even if retail trading begins to quiet down. 

 

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11-14x floored EPS on a company with massive earnings potential in the occasional volatile year seems like an attractive portfolio addition.

 

Haven't looked at Virtu in a long time. But after owning IBKR and watching their market maker go to 0, it isn't something I'd want to own again.

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I was wondering when someone here would pick up on this one. I've been following Virt closely since the summer (the HTZ fiasco) wen it became clear the WSB phenomenon was able to move markets greatly and wasn't going anywhere anytime soon. I agree in the crrent environment, VIRT is extremely cheap, however I have held off and will likely continue to hold off from buying for the following 2 reasons.

 

1. Regulation. It was made clear during the GME squeeze that the financial markets are directly in the crosshairs of the Democrats. Politicians (bipartisan mind you) were all quick to shout that "something must be done". In almost all cases, this meant regulation. I believe that we have not yet reached a boiling point in the WSB phenomenon, and when that time comes retail traders will be incur great losses. This boiling point moment will bring even more outrage, and millions of retail traders (many green and clueless) will demand that "something be done". Politicians in turn will then enact some heavy (and likely misguided) restrictions that will hurt the business greatly.

 

2. Buying the WSB Top. Manias come and go. We're clearly in one now and VIRT is profiting greatly from it. The question is when does the mania go. We've seen a pretty significant tantrum in the treasury markets recently and personally I feel this is the only way that the current WSB fueled market dies. A high interest rate environment would be poison to speculative equities. This could lead to a slowing of trading volume which would eat greatly at VIRT's earnings. In short, I can't see a better market for VIRT than today, but I can see many worse ones

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CEO on Twitter:

 

Hey @andrewrsorkin    I run Virtu.  We get zero client data just a lot of orders we try hard to price improve.  We also don’t front run anyone.  Sorry to ruin your narrative. Let me know when you want to learn how markets work. 212-418-0111.  Here all day

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Owned this for five years & love the company. However, don't assume $2/share is a base.  Remember 2018 with very low actual volatility (this drives not VIX) company made nothing like this.  It is a much better quality business with ITG integrated & management team is exceptional. Happy long term holder. Past history suggests chasing in high 20s not been ideal; better in the 22-23 area.

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I don't think that a high rate environment would necessarily be bad for Virtu.  Yeah, prices would be lower and indiscriminating ubergrowth investors would have lost some money, but after that settles you will still have things that go up and down a lot, changes in sentiment, and everything else associated with the trading "mania".  Other than SPACs, of course.  The fact is that trading is pretty fun and apparently free trading on Robinhood is even more so.  And not only is it becoming easier to trade, but wealth is slowly moving from low velocity retirement accounts of Boomers and Gen Xers into higher velocity hands.  And that only covers legitimately motivated amateur trading.  What an amazing casino we have at our fingertips enabled by the likes of Virtu.  Why would anyone ever buy lottery tickets or play slots anymore?  Yeah, regulation is probably a big risk. 

 

But I think this was a long time due: we just needed smartphone ubiquity, people born after 1980 to get a little richer, and a few coordinating events to spark a snowballing interest (Trump bull market, Tesla, and coronavirus).  And there are huge, fundamental network effects (not just for interest in and adoption of trading apps, but for all the algorithmic technology to work well, too)

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I don't think that a high rate environment would necessarily be bad for Virtu.  Yeah, prices would be lower and indiscriminating ubergrowth investors would have lost some money, but after that settles you will still have things that go up and down a lot, changes in sentiment, and everything else associated with the trading "mania".

 

I should rephrase, I don't think I stated my point properly. In a high rate environment if markets trade sideways, the mania will die. Currently equities are a casino, the Vix has been above 20 for over a year. If we get into a situation where things calm down (which I believe we may be heading towards), retail wil find other outlets to scratch their itch (sports betting, poker, actual casinos....)

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CEO on Twitter:

 

Hey @andrewrsorkin    I run Virtu.  We get zero client data just a lot of orders we try hard to price improve.  We also don’t front run anyone.  Sorry to ruin your narrative. Let me know when you want to learn how markets work. 212-418-0111.  Here all day

 

Vincet Viola is a stand up guy, I worked with him in a non-business capacity years ago. Also he has maybe the nicest private home on the UES I have ever seen. Virtu is a capable organization, but I personally am not a fan of the market making business.

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