Bgc Group Inc

NASDAQ:BGC

Earnings Call Transcript 2019-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to BGC Partners Third Quarter 2019 Earnings Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Vice President of Investor Relations, Ujjal Basu Roy. Please go ahead, sir.

[Ujjal Roy, executive]

Good morning. We issued BGC's third quarter 2019 financial results press release and the presentation summarizing these results earlier this morning. You can find these at ir.bgcpartners.com. BGC spun-off all the shares of its former subsidiary, Newmark, held by BGC to the stockholders of BGC on November 30, 2018. Because BGC did not own any shares of Newmark as of the year-end 2018, Newmark's results are presented as discontinued operations within BGC's consolidated results for all periods through the November 30, 2018 spin-off date.

Newmark's results are not included in BGC's consolidated results presented after the spin-off. Unless otherwise stated, all financial results and outlook discussed in today's call reflect only continuing operations of BGC, and therefore, will not match the results and tables in the company's press release for the third quarter of 2018 dated October 25, 2018. Unless otherwise stated, the results provided on today's call compare to only the third quarter of 2019 with the year-earlier period. We will be referring to our results on this call only on adjusted earnings basis unless otherwise stated.

We may also refer to adjusted EBITDA. We may refer to our liquidity, which we defined as cash and cash equivalents plus marketable securities that have not been financed to reverse repurchase agreements and securities owned, less securities loaned and repurchase agreements.

We define total capital as redeemable partnership interest, total stockholder's equity and noncontrolling interest in subsidiaries. All non-GAAP results discussed herein are comparable to and reconciled with the most directly comparable GAAP figures from BGC's continuing operations.

Please see today's press release for results under Generally Accepted Accounting Principles or GAAP. Please also see the relevant section in the back of today's press release for the complete and updated definitions of any non-GAAP terms, reconciliations of these items to the corresponding GAAP results and how, when and why management uses such terms. Additional information with respect to our GAAP and non-GAAP results mentioned in today's call is available on our website at ir.bgcpartners.com and in our investor presentation. And we refer to the company's fully electronic businesses as Fenics. These offerings include our fully electronic brokerage products as well as the sale of market data, software solutions and post-trade services.

I also remind you that the information regarding our business on today's call that are not historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended. Such statements involve risks and uncertainties. Except as required by law, BGC undertakes no obligation to update any forward-looking statements.

For a discussion of additional risks and uncertainties, which could cause actual results to differ from those contained in the forward-looking statements, see BGC's SEC filings, including, but not limited to, the Risk Factors and the special note on forward-looking information set forth in these filings and any update on such risk factors and special note on forward-looking information contained in subsequent reports of the Form 10-K, Form 10-Q or Form 8-Ks.

I'm now happy to turn the call over to Howard Lutnick, Chairman and CEO of BGC Partners.

[Howard W. Lutnick, executive]

Thank you, Ujjal. Good morning, and thank you for joining us for our third quarter 2019 conference call.

With me today are BGC's President, Shaun Lynn; our Chief Operating Officer and Interim Chief Financial Officer, Sean Windeatt; and our Chief Accounting Officer, Sean Galvin.

Our revenues improved by over 14% driven by strong growth generated across several of our businesses despite the $9 million foreign exchange headwind with respect to the strengthening U.S. dollar.

I'm pleased to report that the company's Board of Directors has declared a qualified dividend of $0.14 per share. This translates into a 9.8% dividend yield based on yesterday's closing stock price.

We continue to study restructuring our partnership into corporation, which would simplify BGC's organization. We will provide an update on this analysis before the end of the year, although any action we may take will not occur until next year.

Lastly, we continue our search for a permanent Chief Financial Officer, and I hope to update you by the end of the year.

With that, I'll turn the call over to Shaun Lynn.

[Shaun Lynn, executive]

Thank you, Howard, and good morning, everyone. Our rates revenues grew by 29%, which reflected strong growth from both Fenics as well as voice/hybrid business. BGC's energy and commodities business improved its top line by 25%, led by the acquisitions of Poten and Ginga Petroleum, as well as organic growth, partially offset by the sale of CSC Commodities.

Revenues from equities, insurance and other asset classes increased 19%, led by the acquisition of Ed Broking. Turning now to Fenics, our fully electronic brokerage revenues increased by 12%, while our high-margin data, software and post-trade business was up by 11%. Fenics net and total revenues improved by 12% and 16%, respectively, for the quarter.

During the quarter, around 20 of our voice/hybrid desks across multiple asset classes globally achieved significant year-on-year electronic revenue growth. We expect to have continued success converting voice/hybrid desks over time as we roll out our enhanced Fenics platform across more products and geographies.

We are making excellent progress with our new Fenics stand-alone fully electronic offerings, which currently include Lucera, which is our software defined network, offering the trading community direct connectivity to each other. Fenics GO, our electronic trading platform for the arrangement and execution of exchange listed equity futures and options in partnership with 3 of the largest electronic liquidity providers.

Capitalab, Nikkei 225 options compression service, which is in partnership with the Singapore Exchange and our expanded Fenics FX platforms, including MidFX, Spot and FX Options. We are launching Non Deliverable Forwards or NDFs this quarter and FX Forwards early next year. Asset U.S. Treasuries platform continues to gain market share. Based on Greenwich Associates data, Fenics UST's share of central limit order book trading or CLOB in the underrun U.S. Treasuries has grown from approximately 2% in September 2018 to 8% in September of 2019. We gained significantly more market share year-on-year than any other electronic platform tracked by Greenwich, whether CLOB or otherwise.

Quarter-on-quarter, Fenics UST volumes were up over 50% versus 2% for Federal Reserve Primary Dealer Treasury Volumes. We believe that these new stand-alone, fully electronic businesses have already created tremendous shareholder value. And that will become more evident over time.

We expect Fenics to drive the earnings of the company going forward as we execute our plan to convert our voice and hybrid business to higher margin fully electronic trading and continue to grow our stand-alone financial technology business.

Fenics is the growth engine of the company. We plan to host a Fenics Analyst Day in early April, and we will announce the detail shortly. With that, I'm happy to turn the call over to Sean Windeatt.

[Sean Windeatt, executive]

Thank you, Shaun, and hello, everyone. Our overall revenues increased by 14.4% to $521.1 million. Asia Pacific revenues improved by 20.2%. Europe, Middle East and Africa grew by 16.9%, while the Americas were up by 7%. Our overall revenues would have been approximately $9 million higher, but for the relative strengthening of the U.S. dollar. This currency headwind was approximately $4 million greater than we guided on our last call.

With respect to expenses, compensation increased by 25.5%. Approximately 14 percentage points of this increase related to acquisitions, 3 percentage points reflected technology-related expense, primarily for the previously mentioned Fenics businesses and 8 percentage points were associated with the increased revenue and our front office producers.

Our total technology head count increased by 18% year-on-year to over 650, related primarily to our stand-alone fully electronic offerings, some of which Shaun discussed earlier. BGC's non-compensation expenses increased by 11.7% to $159.2 million, driven by acquisitions, the company's increased investment in technology as well as interest expense, largely related to our acquisitions.

We expect revenues from our Fenics stand-alone fully electronic services to grow faster than expenses starting 2020. We expect our insurance brokerage business to operate around breakeven for the next 2 years as we seek to double this division's current revenues. We expect our investment to turn sharply profitable and deliver margins in excess of 15% in 2022. This is similar to the trend in revenues and profitability of our former real estate services business, Newmark, over its first 3 years as part of BGC. Overall, our expenses were up 20.1% to $436.2 million in the quarter.

Moving on to our earnings. Our pretax earnings before noncontrolling interest in subsidiaries and taxes were $87.7 million compared with $89.5 million. BGC's pretax earnings would have been approximately $14 million and $8 million higher in the third quarters of 2019 and 2018, respectively, excluding investments in our stand-alone Fenics products.

We expect our net loss relating to our Fenics investments to be around $55 million in 2019, which, of course, is included in both our results and guidance. And we expect that to improve by $15 million next year, and we expect these newer financial technology businesses to breakeven during 2021. If one excluded these investments, we believe that our established Fenics businesses have margins generally comparable with Tradeweb's recent non-GAAP results.

Moving on to post-tax results. Our tax rate for adjusted earnings for the quarter was 11.5%, which was consistent with our full year outlook of between 11% and 12%. Our post-tax earnings were $77.3 million or $0.15 per share compared with $75.4 million or $0.15.

Our fully diluted weighted average share count was 346.1 million under GAAP and 528.4 million for adjusted earnings compared with 523 million in the second quarter of 2019 for both GAAP and adjusted earnings. In the third quarter of 2018, our fully diluted weighted average share count was 437.1 million under GAAP and 487.6 million for adjusted earnings. Our fully diluted weighted average share count under GAAP may be lower than that for adjusted earnings in certain periods in order to avoid early dilution.

As of quarter end, our share count was 528.4 million. Our year-over-year change in quarter end share count included the issuance of 20.8 million share equivalents that reduced noncontrolling interest but had no dilutive impact or effect on earnings per share. The remaining 19.8 million increase in fully diluted share count related to acquisitions and ordinary stock-based compensation. But for the change in noncontrolling interest, our year-over-year spot share count would have increased by 4%. We continue to expect our year-end fully diluted share count to grow by between 2.5% and 3.5% year-over-year in 2019 versus 518.8 million as of December 31, 2018.

With respect to our balance sheet, as of September 30, 2019, our liquidity was $472.7 million compared with $410.9 million as of year-end 2018. Notes payable and other borrowings were $1,105.5 million compared with $763.5 million. Book value per common share was $2.07 versus $2.28. And total capital was $824.1 million compared with $887.9 million. On September 27, we closed our offering of $300 million of 3.75% senior notes. We used the net proceeds for general corporate purposes, including to pay down our credit facility.

With that, I'm happy to turn the call back over to Shaun Lynn.

[Shaun Lynn, executive]

Thank you, Sean. Turning to our outlook for the fourth quarter compared with last year. Global industry volumes have started lower this quarter, and our guidance assumes volumes remain around these levels for the balance of this year. We expect to generate revenues of between $465 million and $505 million compared with $466.4 million. We anticipate pretax adjusted earnings to be in the range of $63 million to $79 million versus $86.3 million. We anticipate our adjusted earnings tax rate to be in the range of 11% to 12% for the full year 2019 as compared to 11.7% for the full year 2018.

Our guidance assumes no material acquisitions, buybacks, extraordinary transactions or meaningful changes to the company's stock price. We expect to update our outlook toward the end of December.

With that, operator, we would like to now turn the call over to questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Rich Repetto of Sandler O'Neill.

[Richard Repetto, analyst]

Howard and Sean and Shaun, I guess, my first question is on Fenics growth, excluding the intercompany data revenues, it looked like it reaccelerated, up 12% year-over-year from 4%. But I'm trying to understand is that reacceleration of that increased growth rate. Is that driven by just the market environment where we saw big year-over-year increase, say, in the CME's interest rate and equity futures or versus more conversion to electronics? Just trying to understand how you get back up to that 12% because it was 12% year-over-year growth in the first quarter as well.

[Sean Windeatt, executive]

Rich, it's Sean. I think the easiest way to describe it is, as we mentioned last quarter, that we started to see, once again, in 2018, we had the growth of our Fenics conversion to electronic was growing at twice the rate of our overall business. And that's exactly what has happened again this quarter. If you take out the insurance acquisition, you'll see that our Fenics has grown at more than twice the level, our conversion to electronic has grown at more than twice the level of our underlying overall business.

[Richard Repetto, analyst]

Okay. Then -- okay. So next question would be, when you look at the fourth quarter guidance, you take -- just use the midpoints, it looks like we're coming up with a margin of 14.6%, 14.7%, substantially lower. And I guess, would you say that that's all related to the incremental? Or what would you expect the incremental Fenics investment where you're not getting the revenue contribution to be in 4Q?

[Sean Windeatt, executive]

I'm sorry, sorry. Could you just explain that so I can answer it correctly for you?

[Richard Repetto, analyst]

Yes. On the fourth quarter guidance, just take the midpoints of the revenue midpoints of the pretax income, and you can calculate a midpoint margin. And it comes out to 14.6%, 14.7%, and which is lower than -- much lower than the margins we've seen all year. And I understand fourth quarter the seasonality, but I'm trying to get down to that margin. And how much is -- do you expect that Fenics, I guess, investment to be without -- how much incrementally is that -- do you expect that to be in 4Q? What will it be?

[Sean Windeatt, executive]

I get it. So I think as we guide, as you know, we guide what we see right now. And as Shaun said, in -- just before the guidance. Obviously, we're seeing currently as of today's date, we're seeing lower volumes within the marketplace. What we also highlighted is that our Fenics spend, where we're increasing our Fenics spend. You remember from -- up from the net loss of $50 million up to $55 million, so the Fenics is spending on new Fenics businesses. And then also, we made a number of new hires within our insurance business as well during Q3 and Q4.

[Richard Repetto, analyst]

Okay, okay. And then my last question would be sort of on this, Howard, on the unlocking of value or trying -- you said in the prepared remarks, you think you've created shareholder value with the development of the Fenics platform. I guess could you give us some more support for that? And why you think that? Is that just looking at electronic platforms and get higher valuations or more explanation of why you put that in the release? And I guess, the whole CFO search and so forth, any incremental comments on that.

[Howard W. Lutnick, executive]

Sure. So we'll start with value. So we build technology last year from the mid-30s. We spent on new electronic products, and that's what we're talking about for the moment. This year, we expect our net loss, meaning net of our revenues on the new products to be in around $55 million. And then next year, we begin. So next year, we expect revenues to exceed our investment amounts in these products, and that loss to decline $15 million as our revenues exceed our investing. And our expectation is in 2021, these businesses will generate sufficient revenue to cover the entire investment. And so our earnings will be up, all else being equal, $55 million through the next 2 years, and that is on full electronic businesses.

I have become a more popular amongst exchanges, they visit, they talk, they talk about our new products. I think when one takes a $55 million investment and puts in on a multiple, right, let's say, a 10x multiple. One would say that it has a negative $550 million of value. I think these businesses, if you just compare with liquidity edge sold for, and you just look at that as compared to, say, just our U.S. Treasury platform growing from 2% to 8% in a much bigger market, in a much more important manner, you would see that these are enormous value assets that we are building. And if we carry on.

As we carry on, right, we have partnerships with SGX. We have partnerships with the liquidity providers in options, that value proposition will accrue to the benefit of our shareholders in a big way. So we are excited about it, but we understand it costs us $55 million this year. And if people don't pay attention to the asset value of our market share gains and our position then they think it was negative $55 million, and we're earning $55 million less. We are not -- we are investing $55 million that we think will turn very well for the shareholders of this business.

And with respect to the CFO, we are deep in the search. And I guess that's the simplest way I can say it. We are deep the search and we hope to inform you of our choice in the near term.

[Operator]

Our next question comes from Patrick O'Shaughnessy of Raymond James.

[Patrick O'Shaughnessy, analyst]

Yes. So what are the moving parts of a potential C-corp conversion that you guys are working through right now? What are the pros and the cons that you're kind of debating and what has to take place for you guys to be able to pull the trigger on that?

[Howard W. Lutnick, executive]

Well, we have a team of accountants and lawyers working on it all the time. Tax would be the first. You have to do it correctly. So it doesn't create a tax event in such a conversion. So that's number one.

Number two, to do it smartly so that the outcome for the company is an expected tax rate that while that tax rate might increase somewhat that the efficiency of the scale, the simplicity of the company will reduce our expense and that will offset itself. We have to modify and figure out precisely how to take all of our employees who are partners and come up with a stock-based compensation model that modifies them, and that is just a thoughtful process. I think we are optimistic, meaning we have a line on how to do it, but it's just a thoughtful process that requires lots of talking. And so basically, we are optimistic. We are working hard at. We think we will get there. So we are optimistic, and of course, there is that joy of the U.S. election next year, and the possibility of change. So we are keeping our head up and our eyes open to make sure we are in the best position to make sure we maintain shareholder value with respect to the structure, but we are well in it, and those are sort of some of the moving parts.

[Patrick O'Shaughnessy, analyst]

Got it. That's helpful. As we turn to your insurance brokerage and your growth aspirations in that business, how much of that upside that you were speaking to earlier, do you think you can come up organically or just kind of hiring people? And how much is going to take subsequent acquisitions?

[Howard W. Lutnick, executive]

So as you know, we guide what we see. So today's guidance of doubling our revenues breaking even through the next 2 years, effectively breaking even and then turning sharply profitable in 2022 is with those people who we have hired or are hiring currently. And the acquisitions we have made does not require any additional acquisition and additional acquisition would then change those numbers depending on who -- what we did. So that is who we have in our sites and what we expect today. So we are -- the revenues will grow materially, doubling over the next 3 years, and we think in 2022, much like the trend that Newmark was when you hire all sorts of people, it takes them 3 years to be fully operational. But as they come on, you will see sharply higher profits beginning in 2022. And we are -- but it won't cost us money between that one.

[Patrick O'Shaughnessy, analyst]

Okay. And if you do additional deals in that space, would that accelerate the time line to breakeven and profitability? Or could it potentially push back that time line?

[Howard W. Lutnick, executive]

Well, if for instance, you have these giant mergers and those giant mergers cost of overlap and then people depart. So if we haven't aligned on hiring an enormous number of a new class of people that would change the near-term events. But given the math of things, I do not think it is the company's expectation at all. Scale of what we expect to turn profitable in 2022 of at least 15% margins of revenues that are double, and this year's revenues are expected to be north of $150 million, you're going to get substantial profits, and those profits in 2022 should well overwhelm whatever other growth and additions we do. So I think we are confident in the way we have described it today and our other moves that we will do going forward, we'll just need to grow the company in 2023 and beyond. But we have the tools and the assets and what we think our first-class world-class people who have joined us that will deliver the model. We've done it before. We've rebuilt this company after 9/11, we've built a Newmark, and I think we have -- we feel good about our current position. It won't cost the shareholders money going forward we're breakeven. And I know 2022 is a while, but the insurance business just it has just its structure takes a little longer.

[Patrick O'Shaughnessy, analyst]

Okay. Got it. A question on the competitive front. So this past quarter, we've heard from Tradeweb and MarketAxess, about the success that they've been having, introducing electronic trading into the dealer-dealer credit space. What's your perspective on the competitive landscape right now? And I think, in particular, with electronic venues trying to edge into a business that I think historically, we would have thought would have kind of belong to firms like you and TP ICAP?

[Shaun Lynn, executive]

You've seen that the majority of the revenue is generated by MarketAxess. Tradeweb is buy-side focused. We have seen some offerings from both of those individual companies that could touch on the bridge of our industry, too. You've seen us invest heavily with regards to our Fenics platform and create not only hybrid platforms but fully electronic platforms such Fenics U.S. Treasuries and now Fenics GO, on FX Options, Spot FX and the other platforms that I mentioned in my remarks earlier. We see that the market is going to continue to expand. I think that the opportunity is good for ourselves to be in -- within the market growing on both sides of the industry, on both sides of the businesses, I mean, from the buy side and the sell side. As the clients grow, with regards to connectivity and our strength, such as Lucera, giving that connectivity to all clients. It's not just about execution, it's also about that connectivity, which is so crucial in the marketplace. We sit right in the middle of all of that connectivity with at -- at clients that we've been dealing with for many, many years. We now connect that they have invest in our connectivity, speed of execution straight through to their API connectivity, which then helps them and helps them to their buy side, too. So I think it's positive. I think it's opportunity. And I think we're excellently placed.

[Howard W. Lutnick, executive]

So I give you 2 points. Well, let's talk about U.S. Treasuries for a minute. So in U.S. Treasuries, the Tradeweb's offering Dealerweb has been around for more than a decade. And we have built a CLOB, that is the fastest-growing by far over the last year. On November 1, our product rolls out its electronic competitor to a dealer to buy side alternative and competitor to Tradeweb's RFQ model and that comes out November 1. Now that is just the first day, but it's something we've worked on and talked about a long time. That is part of the economics of what we build. And it goes live on November 1. And it seeks to not disintermediate the dealers. But in fact, to help the market makers and the bank's transact business with their clients in a manner that we like. So I think the world goes 2 ways. And we like the fact that we're going into their pool. It's a large and extraordinarily opportunistic pool that we're excited to enter.

The other thing I would mention is that their product offerings tend to be rather constrained, and our product offering tends to be very, very, very broad. And so I would just leave at that. We have 600 or 700 desks around the world. There is some overlap. But I would suggest that the breadth of our capacity is what sets us apart.

[Patrick O'Shaughnessy, analyst]

Got it. And then one last one for me. To the extent that you have been making some pretty aggressive investments in Fenics and insurance brokerage as well. Are there other areas of the business that you have or could potentially cut back on spending to kind of internally finance some of those investments that you're making?

[Howard W. Lutnick, executive]

Well, I think they are -- so we've made the investments in insurance. And now we're in the harvesting phase. And we've made the investments in Fenics, and we're in the harvesting phase. So we expect, as an example, as I said, in 2020, our revenues to grow sufficiently to reduce our spend $15 million, as just an example of Fenics and then in the next year to cover all $55 million of what we're currently spending to get to breakeven. So I think we expect our Fenics businesses and then our insurance business to internally finance all of the things that we hope to do. I don't think we have another area that we're seeking to open. There's not a front we're seeking to open. We are very comfortable with this model. We know insurance is adjacent to our core business. So the fact that it will not cost us EBITDA and not cost us adjusted earnings is important as we harvest it. So I think we are in a good spot.

[Operator]

At this time, I would like to turn the call back over to Shaun Lynn for any closing remarks.

[Shaun Lynn, executive]

Thank you for joining us today, and we look forward to speaking to you, again, next quarter. Thank you.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.