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Uncertainty all around ICAP

Trading is weak at interdealer broker ICAP, and the company is threatened by regulators probing the rigging of Libor interest rates
February 14, 2013

The Libor-rigging scandal sprang back into life this month after Royal Bank of Scotland (RBS) was hit with a £390m fine. The scandal has now spread beyond the banks that set the rate and, late last month, money markets broker ICAP (IAP) said one of its subsidiaries was the subject of a Financial Services Authority (FSA) investigation. If the Libor probes into the banks are a guide, investors shouldn't expect a speedy outcome - leaving ICAP's shares exposed to lengthy uncertainty.

IC TIP: Sell at 344p
Tip style
Sell
Risk rating
High
Timescale
Long Term
Bull points
  • Electronic broking trading well
  • Significant cost-cutting programme
Bear points
  • Facing Libor-related probe
  • May have to put up more capital
  • Weak trading
  • Shares trade far above estimate of fair value

The details are sketchy but, when Swiss bank UBS (UBSN: VX) was forced to pay its $1.5bn (£947m) Libor fine in December, it emerged that its traders had used interdealer brokers such as ICAP - which acts as a go-between for banks' trading - to pass on requests for other banks' traders to bid specific Libor rates. So far, ICAP has suspended one employee and has placed three on leave. Meanwhile, US regulators are understood to be looking into ICAP, too.

Certainly, ICAP isn't involved in the rate-setting, so a fine of the magnitude levied on the banks looks unlikely. But the fallout could go beyond a fine, with a possible effect on the so-called Capital Requirements Directive (CRD) waiver that ICAP has benefited from since 2007. Essentially, the waiver allows ICAP's regulated and non-regulated operations to be treated as one entity - allowing ICAP to set aside less capital than would otherwise be the case. "If the regulator decides that there is operational risk within ICAP it could call the CRD waiver into question," say analysts at broker Numis Securities. "A worst case scenario would be the removal of the CRD waiver before its maturity [in 2016] and if that happened it could mean a rights issue."

ICAP (IAP)

ORD PRICE:344pMARKET VALUE:£2.22bn
TOUCH:344-344.5p12-MONTH HIGH:432pLOW: 273p
DIVIDEND YIELD:6.6%PE RATIO:10
NET ASSET VALUE:166pNET DEBT:14%

Year to 31 MarTurnover (£bn)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
20091.5919028.217.05
20101.6124725.517.55
20111.7423328.129.95
20121.6821721.122.00
2013*1.5129833.522.60
% change-10--+3

*Numis Securities estimates (profits & earnings not comparable to historic figures)

Normal market size: 7,000

Matched bargain trading

Beta: 1.4

That's not the only reason to focus on ICAP's capital. It's also ready to roll out swap execution facility (SEF) services (essentially financial-market insurance contracts) in the US, but the capital requirements are still being hammered out with regulators. Broker Numis expects these regulations to require extra capital to support ICAP's SEF which, when added to the capital implications from a potential threat to the CRD waiver, may leave the attractive dividend payout in doubt.

ICAP's trading is hardly impressive, either. Interdealer brokers thrive on volatility as that boosts trading volumes. But in today's comparatively calm conditions, ICAP is struggling. True, activity improved in January - electronic broking volumes rose 17 per cent year on year, helped by increased volumes in the US Treasury market. ICAP is also cutting costs and expects to make over £50m of savings in the current financial year. But third-quarter group revenue fell 13 per cent on the year and Numis Securities expects adjusted earnings for the year to end-March to fall 16 per cent.

Yet the share price has jumped 25 per cent since mid-November and, based on estimates from broker Espirito Santo, looks pricey. Following half-year figures in November, the broker did a detailed calculation that suggested ICAP's shares were worth just 251p each. First it valued ICAP's telephone broking division on the same rating as shares in telephone broking specialist Tullett Prebon (TLPR). That produced a valuation of £452m. Espirito then assumed that weak volumes merited a nine times rating on ICAP's electronic broking arm, yielding a £617m divisional valuation. Finally, Espirito applied a 12 times rating to earnings of the post-trade services' unit - reflecting reasonable growth there - meaning a £713m divisional valuation. After deducting debt, that suggested fair value of £1.62bn, or 251p a share.