DWT: IT Spend Hinges on Need for Growth

That’s the finding of the DWT Stock Index’s focus on some of themajor consumers of trading technology—namely global, sell-side tradingfirms.

While the Index normally chronicles the fortunes of the IT suppliers that countamong their best customers the major sell-side firms of Wall Street, Europe andAsia-Pacific, this week we are in keeping with DWT’s review of the tradingtechnology landscape in 2005 (starting on page 4) by trying to discern a fewinsights into technology spending and a firm’s prospects in the market.

One firm that has made clear its intention to invest in technology is Bank ofAmerica (BofA). According to its latest quarterly report, issued in November2005, BofA is in the middle of a $675 million program to upgrade its global capitalmarkets and investment banking capabilities, with approximately 80 percent ofthis investment earmarked for personnel, technology and other infrastructurecosts.

Over the last five years, BofA has hardly been a cash cow. According to dataculled from ThomsonOne Analytics, BofA has only registered a five percent risein earnings per share, and is expected to post a nine percent growth rate overthe next three to five years. The $675 million expenditure amounts to approximatelyfour percent of BofA’s projected net income of $17 billion in 2005, accordingto Thomson Financial information.

As of September 2005, there were 4 billion BofA common shares outstanding, andthe $675 million cash outlay equals $0.16 per share in additional net earningsper share. On Wall Street, one penny per share can mean the difference betweenreaching a 52-week high or falling to a 52-week low. Obviously, with billionsin market value hanging in the balance, executives at BofA feel that the rewardof investing $675 million in trading technology is worth the risk. Apparently,the analysts who report to ThomsonOne Analytics think so, too. In the next threeto five years, they project that BofA’s earnings per share growth ratewill nearly double to at least nine percent per year, versus five percent peryear over the last five years.

Another firm that stands to benefit from technology investments is the Bank ofNew York (BNY), if recent U.S. Securities and Exchange Commission (SEC) reportsare taken into consideration. In September, BNY’s third quarter 10Q report,posted with the SEC reveals that, “the company consistently invests intechnology to improve the breadth and quality of its product offerings, and toincrease economies of scale.” The same report makes reference to continuedincreases in technology spending, and on a year-over-year basis such expenseshad risen from $83 million to $100 million.

Some firms foresee so much value in a particular technology that they buy a vendoror invest in one.

The most obvious example is Citigroup and its acquisition of financial applicationservice provider (ASP) Lava Trading (DWT, July 5, 2004). Despite the slings andarrows, Citigroup felt compelled to own the aggregator of market data and orderexecution capabilities for listed and OTC venues as well as ECNs and ATSes. Citihas been working hard to remind the industry of a wall of safety between itselfand Lava.

Other firms have made similar moves. Lehman Brothers in the waning days of 2005acquired Townsend Analytics, maker of the RealTick platform (see story, page1).

Although the terms of the Lehman-Townsend deal were not disclosed, it is easyto assume that the vendor that created the Archipelago Exchange and RealTickengines did not get acquired at a discount. Over the last five years, LehmanBrothers has not been the model of growth, but according to ThomsonOne Analytics,Wall Street was expecting Lehman to post stronger returns over the next threeto five years. Now, with the acquisition of Townsend, Lehman’s three-to-five-yearprojection is likely to rise above the current 12 percent forecast.

When sell-side firms buy IT vendors, the results and reactions are unpredictable.Still, if big banks need any model for the rewards of investing in technology,they need to look no further than to Morgan Stanley.

In recent months, Morgan Stanley has increased its bottom line potential by reapingthe benefits of its acquisition of high-growth vendors such as Barra, which becamea part of the firm in the spring of 2004. Of course, Morgan Stanley has joltedits bottom line through other embraces of technology such as its $150 millionin IT infrastructure savings due to its aggressive Linux-Intel deployment (TradingTechnology Week, Dec. 1, 2003).

On Wall Street, the firms that are able to consistently grow their earnings areoften the same firms that reap the highest stock price valuations.

The table below focuses on 12 leading financial institutions, and their stockprices as of Dec. 19, 2005. Along with this data, we have included their earningsper share growth rates over the last five years, and their annualized year-over-yearprojected growth rates according to the analysts who report to Thomson Financial.

On our list, the number of firms that are projected to increase their earningsis in line with those whose earnings are set to diminish. In coming years, itis a good bet that financial institutions will be working hard to boost growthrates. So, when looking for the firms most likely to increase their technologybudgets in 2006 and beyond, a good place to start would be those banks with ebbingforward growth rates.