Betting on IG Group

Gambling and gamblers won't go away, so investing in a firm that provides gambling facilities has its attractions. These days, making a wager has been turned into a fine art by companies such as IG Group. It specialises in taking bets on movements in financial instruments, such as currencies and equities, in particular through spread betting, which is simple enough - punters place bets on whether a price will rise or fall and IG hedges its exposure and makes a turn by keeping the difference between the buying and selling prices.

Of course, gamblers make mistakes and can easily see an open position running into a loss. So IG asks for a deposit - or margin - that can be drawn down against a loss-making position. But even this presents a risk because the amount of money held on margin can run out very quickly; indeed, in the year ending 31 May 2009, IG clocked up bad or doubtful debts of £18.2m just as a result of this. However, IG's solution was to close out loss-making client positions automatically just before margins were used up.The improvement was dramatic - in the six months to end November bad debts shrank to just £63,000.

Trading volume bears a close correlation with price volatility. In other words, when there is uncertainty over trends in prices, there is a greater opportunity to make money and, hence, a greater temptation to gamble. And last year has provided volatility and uncertainty by the bucket load, leading to strong client recruitment that averaged over 3,000 new accounts every month.

So, with uncertainty a marvellous incubator for more spread betting, IG has been exporting its business model; so much so that income generated outside the UK now produces 58 per cent of group profits. In Australia, for example, the first half of 2009-10 saw turnover up by 65 per cent at £22.2m. The operation on mainland Europe has seen similar gains, with turnover up 64 per cent at £13.3m. And, while European markets remain relatively undeveloped compared with the UK, they already contribute around 15 per cent towards group turnover. Meanwhile, turnover in the Singapore office grew by 23 per cent to £5m.

However, some countries that offer the greatest potential are proving to be a disappointment. One such is the US. It does not help that the US has odd and possibly illegal restrictions on some forms of gambling (outside Las Vegas, of course), and in the first half of the financial year IG's US income was a nominal £1m. This could change in a big way, but the group is still awaiting clearance for Nadex, the North American Derivatives Exchange, to accept clients' bets through intermediaries. Clearance would come from the Commodity Futures Trading Commission. Until this happens, the US operation is doing little more than treading water.

Japan also has a significant band of financial gamblers, but with half-year turnover of just £11m IG has yet to make significant penetration in a market where competition remains fierce. So much so that rivals have tightened spreads in order to win new business. In response, IG has targeted experienced gamblers in forex trading as well as promoting more specialist betting instruments where competition is limited. Elsewhere, sports betting in general has also been disappointing, with first-half revenue slipping from £4.2m to £3m, although this now represents just 2 per cent of group turnover.

Looking ahead, there are significant opportunities awaiting in the US, as well as in Japan, while the virtual elimination of bad and doubtful debts has pushed profit margins up from an already-impressive 48 per cent to 56 per cent.