Note: IBKR’s dutch auction process closes today (5/3) and it is the last day to bid for IPO shares.

Thanks for all the emails sent to me regarding to this IPO coverage. I would like to answer a lot of your questions by laying out the risks and rewards that I see that is related to this company. After reading them, you should be able to decide whether this IPO is a good investment for yourself. Here are the pros and cons for the pricing of the IPO and where it would trade the day it becomes public:

Pros:

1. IBKR makes money (comparable to ETFC and AMTD). IBKR had a 55% revenue growth and a 34% earnings growth for 2006 compared to 2005. ETFC’s 2006 vs 2005 revenue growth was 42% and 54% growth for earnings. AMTD had 80% revenue growth and 40% earnings growth for that time period. IBKR may see much higher growth rates after they IPO and begin executing new synergies like how AMTD and ETFC have been successfully doing in the past few years. IBKR also made $734.2 million in net earnings in 2006, higher than AMTD and ETFC’s $586 million and $653 million, respectively. From the prospectus, IBKR anticipate acceleration of growth through this IPO.
2. They make comparable amounts of net income compared to its competitors, but with a higher consistent earnings growth rate. Investors like that and will pay a premium for it. I would forecast its valuation using the PEG ratio (0.9 to 1.10). Assuming a PEG of 1.0, EPS of $1.21 for 2006 and using 2007’s valuation (forward-looking), and growth of 19% per year, the firm’s fair value is $27 per share. Assuming earnings growth of 40%, it will be at $67 per share. Realistically, it should be somewhere in between.

EBITDA earnings rose 33.8% for 2006 compared to 2005. If this growth is repeatable this year, this company would be valued at $54 per share, which if IBKR opens above that, I would sell 80% of my shares.

calculation:
PEG = 1.0 ~ PE 19 with a 19% growth
Price = EPS * (1+growth) * P/E
P(19) = (1.21 * 1.19) * 19 = $27.36
P(33.8) = (1.21*1.338) * 33.8 = $54.72
P(40) = 1.21 * 1.40) * 40 = $67.76

3. Brokerages and exchanges have been hot in the past few years. The stock market is not an efficient market. Rather, it is an evolutionary market. This means that there is correlation to how this IPO will perform based on the performances of recent IPOs in the same industry.

4. At $31 per share, it is fairly priced (assuming supply and demand is constant), but demand is obviously increasing for the stock.

5. IBKR is a new brand, soon to be a mainstream brand. Not everyone knows that they have the best options executions and lowest commissions all across the board (except in FX, which they charge, but have the tightest spreads). IBKR is also sponsoring Yahoo Finance’s options commentary and options data feed. Finally, the new IBIPO system allows IB customers to get into any future IPOs that is offered by WR Hambrecht. This is going to bring forward demand for new accounts and accelerate growth of the company’s earnings.

6. IBKR makes more money as trading volume increases. Since they deal with options, futures, and FX, these are relatively untapped markets to the retail investors. They will make money when these markets move up or down, as long as it stays liquid.

7. At my firm, which is a participating dealer in this IPO, a trader from the trading desk said that IBKR IPO shares are “selling like hot cakes.” If they demand is really that high, no IPO pricing will be high enough to satisfy all the buying demand that will happen in the first day. This increases the probability of a big first day gap open.

8. 34.5 million shares versus a demand that is comparable to the recent hot IPOs means that it can pop up on the first day. 34.5 million shares is considered a relatively low float stock. In fact, if the first day’s volume is more than 10% of the float, expect the stock to move. CMG IPOed with 30 million shares and the first day traded 13 million. The stock was up about 100%.

Cons:

1. More than half of their money comes from their proprietary options trading systems. Should this fail, the earnings will go with it. So far they have been able to make money for a decade or more.

2. 90%+ of the IPO’s $1 billion proceeds will go straight to the founder’s wallet. Is this IPO just for him take some profits from the company that he built decades ago? After all, it’s only about 9% of the company. A close source said that the founder is just “testing the market” by IPOing a small portion of the company. He has plans to sell more shares in the future should this one be successful.

3. Hype. If this stock gets overly hyped, it will be priced way too high and ultimately will correct, which may in investors losing money, depending on the priced paid. However, this risk is much less if you got the shares with the IPO pricing. In fact, hype is how I think I will be making most of the profits.

4. Competition. Just like any other businesses, as competition increases, it becomes harder to get a bigger piece of the pie. There are rumors that AMTD and ETFC may merge together in the near future, which would lower their operating costs and thus improve earnings and make their business more efficient. This could put pressure on IBKR. The good thing is that IBKR, once publicly traded, will be better known for having the lowest commissions and superb trade executions. Also, IBKR has a better position in the options market, whereas AMTD and ETFC are just beginning to tap into it because they acknowledge the fact that it is the next big retail market.

I’m sure there are more risks and rewards for IBKR, but those are the ones I can quickly think of at the moment. For those who are participating in this IPO, good luck. For those who are interested in watching the results, I guarantee you an enjoyable time learning how this will pay itself out. Regardless, this IPO will go in the history books as one of the hotter IPOs for 2007.