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Curatia Analysis for Thu, Oct 17

Profiles in Coverage: Virtu’s Virtues

Following a heady stretch in which it announced the dual billion-dollar acquisitions of KCG and ITG, Virtu has appeared to struggle in 2019, seeing its stock fall 36% amid flagging volumes and volatility and enduring a spell of unflattering media coverage.

Those struggles reflect growing pains for the market maker as it toils to integrate its new businesses and adapt to the more image-conscious dynamics of a client-facing operation. But they also validate Virtu’s decision to diversify away from its proprietary market-making cash cow, suggesting the firm’s future remains bright.

Struggles

Half of the 36% fall in Virtu’s stock price YTD came on a single day in August. That was when its Q2 earnings announcement revealed profit had undershot even the lowest analyst estimate. The revelation reverberated through the trading world, weighing on the stock prices of other trading-sensitive firms from Tradeweb to Goldman Sachs and exchanges ICE, Cboe, and CME.

Behind the blow and Virtu’s subsequent market struggles lay a sharp downturn in volumes and volatility. From Q4 2018 to Q3 2019, US equities trading volume fell 19%, while the VIX sank 25% — troubling trends for a firm that handles around 20% of US equities trading volume.

Recent regulatory decisions have likewise needled Virtu. Volcker Rule revisions could hurt the electronic trading firm by allowing banking rivals to trade more freely. And, at the end of September, the SEC fined Virtu $1.5M over regulatory violations by its MatchIt dark pool — infractions that occurred prior to Virtu's takeover of MatchIt as part of its 2017 deal for KCG.

At times, Virtu has also been roughly handled in the press. The firm’s Q1 earnings release elicited the injurious, if misleading, report that the firm had logged a “55% YoY Decline in Revenues for Q1.” While that figure was technically accurate, it stemmed from one-time charges related to Virtu’s acquisition of ITG. Virtu’s stock price held steady on the news.

Alphacution Research Conservatory chimed in with two bizarre blog posts of its own. One attributed headcount reduction at an imaginary combined Virtu/KCG/ITG entity before Virtu’s acquisition of either firm to the need to juice earnings based on “challenged revenues.”

Another called out Virtu’s lack of diversification and said “other players in the market – bigger, faster and smarter players – are eating their lunch, which has now likely been twice-cooked; sautéed in a pan and seared over an open fire…”

Emerging Market Maker

Those pieces have helped shape the prevailing — if somewhat skewed — media narrative of Virtu’s present struggles.

The emergence of that narrative in recent months certainly has its origins in Virtu’s retreating stock price. But it also highlights the challenge of emerging into the media spotlight — a crucible through which every firm (except apparently Citadel) must pass as it grows and diversifies.

Virtu’s particular background and circumstances have contributed to that challenge. Its proprietary trading legacy brands it an object of suspicion to some. At the same time, its status as a public company compels a level of transparency unprecedented in its line of work — a paradox through which Virtu is likely still sorting as it transitions to a client-facing business.

Additionally, the technological, logistical, and branding burdens of integrating three distinct billion-dollar companies must be, um, considerable. One could forgive Virtu for being distracted.

And that’s before factoring in the launch of MEMX. Virtu is a founding member in that project, which figures to be a lightning rod in the ongoing market data fee controversy.

Reputationally, Virtu is known as a no-nonsense tech juggernaut that runs a lean-and-mean operation. That company blueprint doesn’t typically come with a public relations gene.

Turn That Liquidity Frown Upside Down

Nevertheless, an opportunity exists for Virtu to reshape the prevailing media narrative.

There’s certainly no shortage of interest. Virtu boasts the highest average popularity score with Curatia readers among topics with five or more articles in the last 30 days (85), edging out Citadel by less than half a point.

In addition, MEMX sports the highest average popularity score of any topic (97) — albeit with just two stories in the last month. Those figures signal immense interest in Virtu’s projects.

A reversal of fortune (not the hot-dog-eating contest kind) starts with a reframing of Virtu’s recent struggles. They are exactly the reason Virtu acquired KCG and ITG.

Virtu wanted to diversify away from volatile market-making revenues in favor of more consistent technology and execution services revenues. It expects those revenues to leap from a 4% share of net trading income prior to the KCG deal to 38% once ITG is fully integrated.

Recent initiatives like the planned launch of an outsourced trading desk and the delivery of ITG's Triton EMS to FX markets resonate with that overarching theme by making good on the promise to expand scalably using robust technology platforms.

Finally, Virtu can buy more companies. That worked well in the past. In fact, its recent hire of Marc Rosenthal as EVP of strategy and corporate development could be a sign the firm is considering more acquisitions. Commenting on the hire, CEO Doug Cifu said Virtu “‘continue[s] to seek growth opportunities.’”

Another deal could mean another integration period — and another shift in corporate identity. Which could mean another Curatia profile in coverage. And another call for more deals...