As bankers and regulators scrutinize the risk and rewards of investing in derivatives, a Silicon Valley software firm has developed a profitable niche serving this volatile market.
Since its inception in 1986, Cats Software Inc. of Palo Alto has developed derivatives trading systems for money-center banks and investment houses.
The company's rapid growth parallels the financial industry's growing use of derivatives, the complex financial instruments held by banks in most cases to help hedge against currency fluctuations and interest rate swings. Recently however, derivatives have been blamed for big losses suffered by a number of banks, corporations, and investment funds around the globe.
Six of the world's 10 largest banks use Cats software to help manage their derivatives investments. The firm recorded $18.5 million in revenues in 1994.
And in another sign of the maturation of its business, Cats successfully floated an initial public offering of stock in March, selling 1.3 million shares at $12 each.
But whereas IPOs at many other high-flying technology firms are motivated by a mountain of debt or venture capitalists clamoring for a quick profit, Cats' key reasons were strategic, according to Rod A. Beckstrom, the company's 34-year-old founder and chief executive officer.
"There were no short-term needs - we already had $10 million in cash. We are now the largest company in the world focusing purely on (derivatives software), and going public is a powerful marketing message," he said.
Additionally, Mr. Beckstrom said, a public stock listing provides an extra measure of comfort to money-center institutions and investment banks seeking a stable technology partner to help them keep a handle on their burgeoning derivatives portfolios.
"We are moving from providing simply trading systems to firm-wide risk management, which is a mission-critical application," Mr. Beckstrom said. "We wanted to send a message that we are aggressively pursuing the advancement of our products."
Bankers appear to be responding positively to Cats' call. Last month, the company announced first quarter 1995 earnings of $735,000, or 14 cents per share, a 34% increase over the corresponding quarter last year. Revenues rose 27%, to $5.2 million.
Cats counts among its clients BankAmerica Corp., Bankers Trust New York Corp., and Credit Suisse, as well as some of Japan's biggest financial institutions: Dai-Ichi Kangyo Bank, Mitsubishi Bank, and Sanwa Bank.
More than 76% of the company's revenues come from outside the United States, Mr. Beckstrom said, illustrating the global nature of the derivatives business. "Our main focus has been on banks with more than $20 billion in assets," he noted.
And while the recent multibillion-dollar derivatives losses suffered by California's Orange County and Britain's Barings PLC has made some central bankers and regulators anxious over the inherent volatility of some derivatives, Mr. Beckstrom thinks his company can benefit.
"In general, the occurrence of losses point to the need of better risk management systems," he said. "In the Barings case, they had systems, but they were tool kits, not business solutions. That really cost them."
As long as regulators continue to move banks toward using mark-to-market and value-at-risk accounting techniques, demand for the derivatives trading systems and risk management software Cats provides should grow, he noted.
In fact, bank regulators have already been beating a path to the company's door, seeking insight on how its software is being used by financial institutions to evaulate their derivatives risks. "We've met with at least 10 regulatory bodies over the last two years," Mr. Beckstrom said.
Mr. Beckstrom, who started his career as swaps trader for Morgan Stanley International in London, said his firm may use some of the proceeds from its common stock offering to make acquisitions, but he stressed that no deals were in the works.
Cats sells software for pricing and modeling swaps, options, and futures, running on Sun Microsystems Inc. hardware with the Unix operating system. Its most recent product offering is called Ficad, which uses so- called object-oriented programming techniques to speed the development of customized derivative instruments.
