One of the most powerful firms in the secretive high-speed trading industry reported on Wednesday that its profit and revenue had been declining steadily since the financial crisis.
Getco, a privately held company, released its financial results for the first time as part of its impending purchase of Knight Capital Group, the trading firm that suffered a debilitating software malfunction last August. Getco, which was founded in Chicago in 1999, won a bidding war for Knight in December, offering a combination of cash and shares that valued Knight at around $1.4 billion.
It was no surprise to analysts that Getco had struggled in the last few years because of withering trading activity in many financial markets, but the magnitude of the decline was striking. The company’s profit in the first nine months of last year was $25 million, down 82 percent from a year earlier, and its trading revenue fell 43 percent, to $414 million, in the same period. That was a much sharper drop than the decline in trading volume on the markets where Getco makes most of its money.
The disclosure did not appear to weigh on the prospects for the Knight deal. Getco said the decline in profit was in large part because of its investment in new business lines, which it projects will begin to pay off this year. Richard Repetto, an analyst at Sandler O’Neill, said that the drop in profit and revenue was sharper than expected, but that “the math on the deal is still pretty safe.”
Knight’s stock, which rose after the deal was announced in December, gained 2 cents, or 0.5 percent, to $3.72 on Wednesday.
Beyond the deal, Getco’s struggles illustrate the larger challenges facing computerized trading companies. While these high-speed firms have come to dominate the trading world, accounting for more than half of all stock trading, they have encountered sliding trading volumes and less extreme short-term swings in the prices of financial assets.
Getco’s overall expenses have fallen in recent years, but the costs of keeping computers close to the big exchanges and maintaining high-speed data streams were more than three times as high in the first nine months of last year as they were in all of 2008. Trading revenue in the first nine months of 2012 was barely a third of what it was in all of 2008.
Getco said in its filing that many competitors were “making decisions about their long-term ability to compete across asset classes and product types,” leading some of them to close or scale back. Knight announced recently that its profit in the fourth quarter of 2012 was $6.5 million, down 84 percent from a year earlier, in part because of costs related to its Aug. 1 programming problem that flooded the market with errant trades, leading to losses of $458 million. Its fourth-quarter revenue fell 16 percent, to $288 million.
Through the merger with Knight, Getco will become a publicly traded company. Together, the firms will become one of the largest players in the trading of American stocks, though they did not discuss their market share in Wednesday’s filing.
A majority of Getco’s revenue comes from trading American stocks, using sophisticated computer algorithms to dart in and out of trading positions and take advantage of small moves in stock prices and the rebates offered by exchanges. The company has been expanding in other markets around the world, but trading volume has declined in many of those markets as well.
Getco is also pushing to expand its business trading on behalf of clients. But it still made 94 percent of its revenue last year from trading with its own money.
The filing was made on Wednesday as part of the process of winning shareholder support for the merger. The deal is subject to the approval of shareholders and regulators, but the companies expect to close it in the second quarter of this year.
Knight was attractive to Getco in part because it has a reliable business buying and selling the shares of small retail investors, who are generally easier to make money trading against than large institutional investors.
The companies’ best hope for future growth appears to be in the changes that financial reform legislation is making to markets in the United States and Europe. Wednesday’s filing said these changes were likely to push more trading of bonds and derivatives onto electronic platforms where Knight and Getco can participate.
In the filing, Getco also said that it was positioned to take advantage of the broader challenges facing the high-speed trading industry and predicted that its earnings would rise sharply this year.
“Getco believes that it stands to benefit from this period of rationalization and consolidation,” the filing said, “as it is positioned to potentially capture a greater share of activity if and when market volumes and volatilities increase.”
DealBook: In First Disclosure, Getco Reports Years of Sagging Profit
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DealBook: In First Disclosure, Getco Reports Years of Sagging Profit
