The Next Private Equity Bid

D.E. Shaw has won permission to boost its stake in Investment Technology Group, an electronic trading platform

by Ben Steverman and Matthew Goldstein

D.E. Shaw, the giant quantitative hedge fund, has won permission to boost its stake in trading technology outfit Investment Technology Group (ITG).

In June, Shaw disclosed it owned 6.2% of the company and said it was pushing for changes at ITG to boost its stock price. On Sept. 4, the Federal Trade Commission approved Shaw's request to further increase its stake to 15%. The FTC action, under the Hart-Scott-Rodino Act, waives a waiting period and clears away antitrust concerns.

It's a step commonly taken by activist investors. "It provides them the freedom to increase their ownership of the company," says Damien Park, president of Hedge Fund Solutions. Last month, shares of Biogen (BIIB) hit a one-year high after activist investor Carl Icahn won FTC clearance to increase his stake in the company.

In a letter sent to ITG's chief executive in June, D.E. Shaw said ITG's stock price "fails to reflect the true fair value of [its] global trading products and platforms." Shaw proposed ways to boost the stock, including selling off all or part of the company or buying back lots of stock. By quadrupling its debt to $600 million, ITG could buy up to 30% of its shares outstanding, Shaw said.

In response, ITG did institute a $50 million stock buyback program. But it said it needs cash first to expand its business, particularly overseas, and to make acquisitions.

D.E. Shaw would not comment on the FTC permission. ITG issued a statement: "We value all interactions with our shareholders, and continue to have an ongoing dialogue with D.E. Shaw."

A bigger stake would give Shaw more clout to make changes at ITG. The FTC move allows D.E. Shaw to increase its stake up to 15% without triggering certain restrictions under the law in Delaware, where ITG is registered.

Keefe, Bruyette & Woods (KBW) analyst Niamh Alexander calls ITG "among the technology leaders transforming the trading process from an art to a science." Though trading volume on exchanges is spiking, ITG also faces increased competition from low-priced trading venues, Alexander wrote on Thursday.

ITG's stock, which closed at $41.13 on Sept. 6, is down 4% for the year. Now trading at a price-to-earnings ratio of 19, ITG hit its 52-week high of $50.34 a year ago.

D.E. Shaw, the manager of about $30 billion in assets, was founded by former computer science professor David Shaw. The privately owned firm has pioneered the use of rapid computer trading.

Some of Shaw's funds were hit hard amid August's market volatility, with its so-called quantitative strategy funds posting double-digit losses, sources say. Many "quant" funds, which rely on mathematical computer programs to drive trading strategies, suffered steep losses in August. But in recent weeks, a number of those funds have rallied back.

KBW's Alexander is skeptical of the measures Shaw has proposed to boost ITG's stock. Given ITG's expansion plans around the world and the need to operate in cyclical markets, putting on lots of debt for buybacks is "aggressive and unlikely." Also, she says, there is a shortage of potential buyers of ITG, and the threat of new, increased competition would hurt any purchase price. (KBW seeks investment banking business from ITG.)

Steverman is a reporter for BusinessWeek's Investing channel. Matthew Goldstein is an associate editor at BusinessWeek, covering hedge funds and finance.