Gain Exposure to the Fast Growing FX Market With This Stock

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FXCM (NYSE: FXCM) represents one of the few ways to derive forex exposure in the stock market. It is the largest retail FX broker in Asia and the U.S., and has attracted interest from Michael Price and Paul Tudor Jones, who recently initiated new positions in FXCM in the fourth quarter of 2012.

Founded in 1999 and listed in 2010, FXCM is the largest online foreign exchange (FX) broker in North America and second largest globally, offering trading and related services to retail and institutional customers worldwide. In addition, FXCM offers educational courses on FX trading, and provides free news and market research through DailyFX.com. 

FX becomes relatively more attractive

While companies in the financial sector are usually adversely affected by any new regulations, FXCM is an unlikely beneficiary of the recent regulatory change. In the wake of collapses at two futures commission merchants, MF Global and Peregrine Financial Group, the Commodity Futures Trading Commission (CFTC) is proposing increased margin requirements among other measures to overhaul futures trading.

Also, the proposed European Union financial transaction tax will apply to many financial instruments including derivatives, but not spot FX. These regulatory changes will increase attractiveness of spot FX and drive FXCM’s business going forward.

Survival of the fittest

FXCM has made only four acquisitions since October 2010. They include ODL Limited, a U.K. CFD broker in 2010; two Japan-based foreign exchange providers, FXCM Japan and Foreland FX in 2011; and Lucid Markets, a non-bank market maker to institutional FX markets. However, the pace of acquisitions is expected to pick up, in light of new regulatory changes and market conditions.

Smaller players in Europe are unlikely to meet new minimum capital requirements and could be forced to sell their businesses to companies like FXCM. Furthermore, the currency market has been experiencing an extended period of low volatility, with average annual volatility declining for the third consecutive year in 2012, based on the CVix Index. Under such market conditions, the FX market becomes a ‘survival of the fittest” scenario, with small players struggling to cope.

Peer comparison

FXCM’s peers include Investment Technology (NYSE: ITG), Interactive Brokers (NASDAQ: IBKR), and MarketAxess (NASDAQ: MKTX). Investment Technology is an independent research and execution broker that partners with global portfolio managers and traders to provide unique data-driven insights throughout the investment process.

Interactive Brokers is a global electronic broker and market maker, specializing in various financial instruments on more than 100 electronic exchanges and trading venues worldwide. MarketAxess operates an electronic trading platform for corporate bonds and other types of fixed-income instruments.

Both FXCM and Interactive Brokers trade at 14 times forward P/E, while Investment Technology and MarketAxess are valued at 17 times and 23 times forward P/E, respectively. A similar valuation pattern is seen with enterprise valuation multiples.

MarketAxess is valued by the market at 13 times trailing twelve months EV/EBITDA, while FXCM and Interactive Brokers trade at six to seven times EV/EBITDA. Investment Technology is not comparable with its peers using enterprise valuation multiples, as it is loss-making in the trailing twelve months.

Except for Investment Technology, all the other three stocks are dividend paying, with MarketAxess having the highest dividend yield at 4.6%. In comparison, FXCM has the lowest dividend yield at 1.7%.

Risks

I have discussed in great detail about how regulatory change has, or can benefit FXCM in the form of increased market share and M&A opportunities. However, laws and regulations are a double-edged sword.

While FXCM is regulated by authorities in the U.S., the U.K., and other countries, approximately 48.7% of its total customer trading volume is generated from customers resident in jurisdictions in which FXCM is not licensed or authorized by any governmental bodies. FXCM is generally restricted from direct marketing to retail investors in such jurisdictions, and is subject to uncertainty with potential new laws or regulations in the future.

Conclusion

FXCM’s stock price is up 35% year-to-date, reflecting market expectations of it being a beneficiary of recent regulatory changes. Given current valuations, I will prefer to wait for a better entry point.


Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Interactive Brokers. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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