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August 11, 2008

Liquidnet's Growth Matures, Readies for IPO

By Peter Chapman

Liquidnet is showing its age. The operator of the popular block-trading system, which plans an initial public offering, released its financials last month. They show a company that has grown rapidly since launching in 2001, grossing more than $1 billion and making its shareholders very wealthy.

But after seven years of operations, the broker is slowing down. Its financials show a maturing company experiencing a drop off in growth of revenues and operating profits in the past year. To boost revenue growth, Liquidnet is expanding its product line and overseas sales.

"Since the beginning of 2007, we have been transforming our business from a single product," the company states in its Form S-1 (see link for "Liquidnet Stats" at bottom of story)

Liquidnet's revenues grew 29 percent in 2007, from $252 million to $346 million, a healthy jump by most measures. But they advanced 52 percent and 46 percent in 2006 and 2005, respectively. The slackening is most pronounced in Liquidnet's core U.S. negotiation business which grew 19 percent in 2007, to $275 million. The trend continued into the first quarter of 2008.

With respect to its core negotiation business, Liquidnet notes that its "market opportunity was limited to the portion of natural liquidity we matched, which is approximately 14 percent of the latent liquidity received from our members." Liquidnet has 514 members worldwide that collectively account for $15.9 trillion in equity assets under management.

With its investment in such services as Liquidnet H2O, a trading desk and its "Supernatural" orders, its members will be able to trade 100 percent of their orders through Liquidnet, the company asserts.

Still, the investments have taken a toll on operating profits. The crimp in revenue growth and a ramp-up in spending meant growth in operating profits fell off last year. From 62 percent in 2006, operating profits grew only 18 percent last year to $191 million.

A surge in hiring is largely to blame. To support its move into algorithmic trading and foreign markets, Liquidnet hired 121 people last year, bringing its headcount at year-end to 327. The acquisition of the Miletus brokerage firm (for $38.2 million) brought in 27 of those employees.

The firm plans to hire another 120 staffers this year, including 30 overseas, according to the company. At the end of May, its headcount was 379 employees. "These headcount additions have had, and continue to have, a negative impact on our operating margins," Liquidnet said.

During the first quarter of 2008, its operating margin was about 50 percent. That's down from 64 percent in 2006. The company expects its hiring rate to slow in 2009.

Liquidnet expects to go public in the fourth quarter. It could raise as much as $500 million, according to the S-1, although it is not disclosing the number of shares or the price of the offering. Major selling shareholders include founder and chief executive Seth Merrin and his wife, as well as three private equity firms.

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