From the WSJ's "Heard on the Street" column:
January 16, 2002
Heard on the Street
Instinet Faces Pressure To Revive Its Stock Price
By KATE KELLY and STEPHANIE GRUNER
Staff Reporters of THE WALL STREET JOURNAL
Last spring, the electronic-trading firm Instinet Group was on a cloud as it completed its initial public offering of stock in a period of market turmoil. Less than a year later, the company appears to be caught in a storm that won't go away.
Instinet's shares began a downward slide in June, bottoming out in mid-December at nearly 50% off their May IPO price of $14.50. And given the tough environment facing the electronic-trading industry, market watchers believe there may be worse news -- and more stock-market pain -- yet to come.
"It's become really vogue to trash them and probably rightly so," says J.P. Morgan Chase trading-firm analyst Greg Smith, who just downgraded Instinet's rating to a "long-term buy" from a "buy."
Instinet of New York is one of the largest alternative trading platforms, or "electronic-communications networks," for global stock trading. It made a name for itself by allowing broker-dealers and institutions to cheaply trade stocks while not disclosing their identities to competitors. British news and technology company Reuters Group, which acquired Instinet in 1987, still owns 83% of its shares.
In the third quarter of 2001, Instinet's net income dropped 75% to $8.2 million from $32.7 million a year earlier. Quarterly revenue declined 8% to $320 million. The company blamed the four-day closure of U.S. stock markets that followed the Sept. 11 terrorist attacks and increasing competition for the decline in profit.
Instinet shares were down 11 cents at $8.10 each at 4 p.m. Tuesday in Nasdaq Stock Market trading.
People close to the company say Instinet's longtime chief executive, Doug Atkin, is under mounting pressure from the board to improve the company's share price and do a better job of keeping up with the competition.
In an interview, Mr. Atkin refused to comment on whether he was feeling any heat from Instinet's board. However, he acknowledged the company's predicament. "Am I happy with the performance of the stock price? I'm not happy," he says. "Although I don't think we're alone ... that doesn't make it any better, and I think the real issue from where I sit is, what does it look like out in the future."
Andre Villeneuve, chairman of Instinet's board, says the board planned no changes in the company's top management. "Obviously, times are challenging for the financial-service industry at the moment, but the board has confidence in Doug and in the Instinet management team," he says.
To some degree, Instinet is a victim of its own success. For three decades, Instinet had a virtual monopoly in the alternative trading market, becoming a fixture on Wall Street trading desks. But as the stock market boomed in the late 1990s, a handful of aggressive new players began vying for a piece of Instinet's business. Analysts say Instinet failed to keep up with the new companies' innovations, including cheaper user fees. Instead of upgrading its core product, Instinet began offering new services like bond trading and independent stock research.
"This is a company that's gone from being the only game in town to having many competitors," says Mr. Smith of J.P. Morgan. "Instinet's been able to just keep up with the market generally, but other ECNs have grown much faster."
In November, for the first time ever, another ECN executed more trades of Nasdaq-listed stocks, according to data compiled by the National Association of Securities Dealers. Island ECN, New York, jumped ahead of Instinet because of Island's open stock order book, quicker technology and lower trading costs, analysts say.
Needless to say, investors aren't pleased with the situation at Instinet.
"Where is the earnings growth going to come from?" asks one institutional investor who has sold off Instinet shares in recent months. "The issue is how much market share they are losing."
Analysts believe there is more trouble in sight. "Although the stock has certainly been beaten down and the risk-reward ratio is starting to look attractive, there are still significant issues with what's going on with [Instinet's] broker-dealer market," says Rich Repetto, the analyst who covers the company for Putnam Lovell Securities. "They've got significant costs in their system as compared to newer, leaner competitors. I'd expect Instinet to make some dramatic changes to their offering, to that segment of their business."
For Instinet to viably compete, those changes had better be around the corner. Not only has Island surpassed Instinet for Nasdaq market share, a third ECN, the trading platform run by Archipelago Holdings, intends to merge with one of its rivals, Redibook ECN, deepening Archipelago's pool of liquidity, or ease of trading, for investors. Meanwhile, the Nasdaq Stock Market, which competes with the ECNs for trading market share, is in the midst of rolling out its souped-up new platform, SuperMontage. And the National Association of Securities Dealers, Nasdaq's longtime parent, will establish its own stock-quoting and trade-reporting system when it spins off Nasdaq, as soon as this year.
Mr. Atkin says he is taking steps to improve things at the company by offering a new range of products and services to broker-dealers, including a new program-trading system, new front-end technology, and potentially reduced trading costs for broker-dealers. "There is a sea change going on in this marketplace, and a lot of people are focusing on it," he says, "[but] I feel pretty excited about what we are in the process of rolling out to our customers."
Instinet's woes could spell trouble for Reuters, its main owner. While Instinet has historically accounted for about 25% of Reuters' revenue, the business over the past six years has contributed 55% of top-line sales growth, according to analyst Michael Nathanson at Sanford C. Bernstein. In last year's first half, Instinet made up one-third of Reuters' operating profit. With Instinet floundering, Reuters' own earnings and shares could suffer. "The worry is that as you head into 2002, there could be further downgrades to Reuters' numbers as analysts realize the slowdown in Instinet's business," says Mr. Nathanson.
Last May, Reuters reaped cash proceeds of £341 million ($494.4 million) from the successful IPO of Instinet. A spokesman for Reuters, which reports annual financial results on Feb. 12, declined to comment on Instinet's current problems. |
