Reuters Lays Shortfall on Instinet

Updated from 12:03 p.m. EDT

American electronic trading network

Instinet

(INET)

is becoming a real drag for British financial media parent

Reuters

(RTRSY)

.

The trading unit, which has taken its own blows from a slowdown in trading volumes, a drop in market share and a price war with rivals, was behind an overall decline in first quarter revenue for the restructuring media giant. In the middle of a major corporate overhaul, Reuters has been cutting costs and working to move its financial news and information distribution fully online for the past two years. But cost cutting and price reductions at Instinet haven't gotten the electronic trading subsidiary anywhere.

Despite a dismal environment for its core subscribers at investment banks, and excluding Instinet, Reuters' overall revenues rose 5% in the first quarter to $1.08 billion. Including Instinet, Reuters revenues fell 6% to $1.30 billion.

After just nine months on the job, Reuters' new American CEO Tom Glocer faces some hard choices. Glocer is reportedly considering several alternatives for the struggling subsidiary, including buying back remaining public shares, forming a strategic alliance or putting the company on the block. Some say a partial or total sale is Reuters' best option.

Salomon Smith Barney wrote in a recent research report that it expects "Reuters will dispose or otherwise reduce its holding in Instinet (perhaps via a merger with another ECN) if it can find an efficient way of doing so." The firm notes that in a recent business review, Glocer divided up Reuters business into "our business" and "our portfolio", with Instinet falling into the latter category. In the same review, Glocer said he planned to "extract operating synergies" from those segments closely aligned to the company's overall strategy, and to dispose of those segments that are not.

Without Instinet, and after a recent acquisition of rival Bridge Information Systems, Reuters might be on track for a strong year. With the help of Bridge News, otherwise declining subscription revenues will grow in 2002, Reuters said in its earnings release Monday. Revenue from Reuters' investment banking and brokerage customers grew 10% versus last year to $312 million in the first quarter, while asset management customers revenue rose 13% to $242 million, both of which reflect the inclusion of Bridge business, Reuters said. Bridge Trading, meanwhile, outperformed expectations, with first quarter revenues up 30% versus the year ago period.

In contrast, the outlook for Instinet isn't getting any better. The company saw revenues drop 39% for the quarter to $217 million, and it posted a penny loss. In a new threat to Instinet's market share, its biggest rival, Island, recently announced plans to partner with Nasdaq's SuperMontage platform, set to debut in the third quarter, and designed to compete more directly with the electronic trading networks. The American Stock Exchange also announced plans to begin trading Nasdaq stocks, which could further dig into Instinet's withering market share. And despite the damage that price-cutting has already done to its bottom line, Instinet said in its first quarter earnings report that it will be forced to cut prices another 20% in the second quarter.

Just one year ago, the picture was very different. In the first quarter of 2001, Instinet was still the dominant player in the ECN space, and its share of trading volume in Nasdaq securities was increasing. It was also making an important contribution to Reuters' growth: Instinet's revenues grew 27% in the first quarter of 2001 to US$357 million, contributing 26% of total Reuter's revenues.

But the summer of 2001 changed all that. A new trading regulation, decimalization, was implemented, which swallowed up revenues per trade for many of Instinet's biggest customers, the already suffering broker-dealers. Many of them cut back on trading, and others, looking to reduce costs, were lured away by lower-priced rivals, like Island and Archipelago. By November, Island had usurped Instinet's market leadership and soon after, it launched a full offensive, slashing prices even further to keep grabbing share.

Once upon a time, Instinet probably seemed like a pretty sure thing. The very first electronic trading network, it pioneered the technology that made the business. But it let that advantage slip away. Now Reuters' has to decide whether it's worth winning back.