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July 1, 2011

ConvergEx IPO Weighed By Deals

By Peter Chapman

ConvergEx is still searching for that pot of gold. Formed five years ago and built up through numerous acquisitions, ConvergEx is struggling to make a profit. The industry downturn and charges related to the firm's several acquisitions have conspired to keep its aggregate net income below sea level.

Although operating revenues have grown by half since the privately held agency brokerage and technology vendor was created in 2006, net income for the five-year period that ended Dec. 31, 2010, is negative. ConvergEx made $45 million in its first year of operations, but subsequently lost $49 million over the next four years.

These facts came to light in May, when ConvergEx filed a Form S-1 with the Securities and Exchange Commission, a preliminary step toward an initial public offering. The company, valued at $1 billion in 2006, is looking to raise at least $400 million from an IPO. At the same time, ConvergEx is said to be looking to sell itself, as well.

The firm started out life as BNY ConvergEx Group, a merger of the Bank of New York's institutional brokerage division and Eze Castle Software, a vendor of order management software. The goal at the time was for the firm to become more of a vendor and less of a broker.

That's sort of what ConvergEx has done. In 2006, only 23 percent of operating revenues came from the distribution of technology products and services. The rest came from traditional brokerage services. In 2010, about 61 percent came from software. Notwithstanding the shift, ConvergEx still takes in the majority of its revenues from transactions.

The transformation was done primarily through acquisitions. But a sharp decline in revenues from traditional brokerage activities has also altered the makeup. Program trading, commission recapture and sales trading have all suffered in recent years.

Altogether, ConvergEx has spent about $450 million to acquire eight businesses, becoming a mini-conglomerate in the process. The company's headquarters is in New York, while various businesses operate independently in Chicago, Atlanta, Boston and Summit, N.J. Since going on its buying spree, ConvergEx has doubled the number of its employees to about 1,200.

In its largest deal, ConvergEx paid $200 million for Chicago-based Liquidpoint, a brokerage that routes 31 percent of the options industry's orders, according to the firm. Other large acquisitions include the recent $80 million purchase of RealTick, a vendor of execution management software.

Accounting rules require ConvergEx to amortize, or write down, a portion of its acquisition costs every year. In each of the past three years, the company has recorded a sizable $70 million to $80 million in acquisition-related intangible asset expenses, mostly customer lists and technology. That has hurt the bottom line.

Amortization of deal-related intangible assets is not an insignificant expense for companies that have grown through acquisitions. A perusal of half a dozen or so technology companies reveals the expense item generally ranges between 1 percent and 10 percent of revenues. For SunGard, a financial technology vendor, the ratio was 9 percent last year. For Integra Life Sciences, a medical technology firm, the ratio was 1.5 percent.

In ConvergEx's case, the expense has ranged between about 12.5 percent and 15 percent of operating revenues for the past three years.

The burden of writing down intangibles isn't the only cross ConvergEx has had to bear. In the past two or three years, institutional brokers across the board have watched helplessly as volume dried up. Agency brokers are getting the worst of it as flow is going to firms with research.

ConvergEx's traditional brokerage business has been hit the hardest. Revenues in high touch and program trading dropped from $122 million in 2008 to $76 million in 2010. ConvergEx fired 50 employees in groups related to those operations last year. The firm's commission management and commission recapture businesses have seen declines as well.


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