The group of private equity firms that took a chance on online brokerage Datek several years ago is looking at a potential windfall if it can complete the sale of the second jewel of the Datek crown, Island.
The group, which includes Bain Capital, TA Associates and SilverLake Partners, reportedly plans to sell Island, in which it owns close to a 90% stake, to
. A deal between the two electronic stock-trading platforms could be worth $500 million, according to
The Wall Street Journal
, which reported the talks. Earlier this year, the private equity group sold Datek to
for $1.3 billion, a substantial premium to earlier deals in the sector.
While the $500 million price tag for an Island sale is just an estimate, a combined $1.8 billion for Datek and Island would represent quite a windfall for the private equity partners. Their initial investment in the two companies totaled approximately $770 million, according to estimates, about $700 million of which they shelled out in December 2000.
At that time, the long-term viability of online investing and electronic trading was far from certain, particularly after the equity market's catastrophic meltdown, as plummeting trading volumes depressed earnings in both businesses. Datek was also struggling under the weight of investigations into inappropriate trade execution practices, only settling with federal regulators over charges of securities fraud in January of this year.
In fact, according to the calculations of Putnam Lovell analyst Todd Halky, assuming the investors spent $600 million of the total $770 million for Datek, Bain, TA and SilverLake got Datek at a 28% discount to where Ameritrade was trading at the time, in terms of price per account.
The brutal competition that followed the market downturn resulted in a wave of consolidation that seemed to bring out the best in Datek and Island. A customer base of highly active traders -- a breed that is hard to come by these days -- and strong technology made Datek a hot acquisition target for many players in the industry when the group put it on the block early this year. Island is also known for the strength of its technology, which helped it squeeze past Instinet at the end of last year into first place in terms of market share.
The $500 million price on Island represents about 3.3 times estimated 2001 revenue of $150 million and 16 or 17 times 2001 earnings of about $40 million pretax. "It seems a little rich," said Raymond James analyst Michael Vinciquerra. "But Island is the biggest ECN. It has a well-respected technology platform. You have to pay out to get the market leader. Island doesn't have to sell. They're doing fine on their own," he said.
Bain, TA Associates and SilverLake couldn't immediately comment. Instinet declined to comment, and Instinet's parent company
and Island couldn't immediately comment. Instinet shares, which have fallen almost 60% since their debut last spring, were lately soaring, up 14% to $8.
Under the Datek deal, the private equity investors maintain a 50% stake in the new combined company, but there is no lockout on their shares -- in other words they could potentially sell their stakes after the deal goes through. Steve Pagliuca, a managing director of Bain Capital, has said that he believes the sector is heading for a turnaround and he and his partners plan to profit from it.
Halky says a deal between Instinet and Island, which would create the biggest ECN in the market, could be an attractive longer-term investment for the group. Together, Island and Instinet would control about 25% of
market share and pose a major challenge to Nasdaq's SuperMontage system, which will be rolled out this summer. The system was designed to compete more directly with ECNs, which have been stealing market share from the stock exchange.
There's also a lot of cost-savings potential in the deal, says Halky, particularly if everything is transferred to Island's technology platform. Island has approximately 150 employees, whereas Instinet has close to 1900. Instinet posted revenue last year of $1.5 billion and net income of $144.8 million.
But Raymond James' Michael Vinciquerra is more skeptical. "The investors are simply looking for a potential cash-out. They're not the type of investors who are going to be long-term holders," he said. "Right now the industry is at a crossroads. The product is more commoditized. It's tough to make a buck."
TA Associates has multiple investments in financial services and Internet services in a wide variety of business stages. SilverLake holds about 11 companies in its portfolio, many of which are technology related. Bain Capital has investments in information technology, including several in the Internet category, communications, health care, retail and manufacturing.