BGC Group, Inc. Q3 FY2020 Earnings Call

Hello, and welcome to the BGC Partners Third Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Jason Chryssicas, Head of Investor Relations. Please go ahead.

Good morning. We issued BGC's third quarter 2020 financial results press release and the presentation summarizing these results earlier this morning. You can find these at ir.bgcpartners.com. You can find additional details on our quarterly results in today's press release and investor presentation. Unless otherwise stated, the results provided on today's call compare only the third quarter of 2020 with the year-earlier period. We will be referring to our results on this call only on an adjusted earnings basis unless otherwise stated. We may also refer to adjusted EBITDA. We may refer to liquidity, which we define as cash and cash equivalents plus marketable securities that have not been financed, 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 non-controlling interest in subsidiaries. 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 items, reconciliations of these items to the corresponding GAAP results and how and why and when management uses such terms. Additional information with respect to our GAAP and non-GAAP results mentioned on today's call is available on our website at ir.bgcpartners.com and in our Investor Relations Presentation. 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 businesses on today's call that are not historical are forward-looking statements. These include statements about the effects of the COVID-19 pandemic on the company's businesses, results, financial position, liquidity and outlook. Any forward-looking statements involve risks and uncertainties. Except as required by law, BGC undertakes no obligation to update any forward-looking statements. Any outlook and target we discuss on this call assume no material acquisitions, buybacks, ordinary transactions or meaningful changes to the company's stock price. 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 special note on forward-looking information set forth in these filings and any updates to such risk factors and special note on forward-looking information contained in subsequent reports on Form 10-K, Form 10-Q and Form 8-K. With that, I'm happy to now turn the call over to Howard Lutnick, Chairman of the Board and CEO of BGC Partners.

Good morning and thank you for joining us for our third quarter 2020 conference call. Joining me virtually for today's call are BGC's Chief Operating Officer, Sean Windeatt; and our Chief Financial Officer, Steve Bisgay. We've made excellent progress this quarter with respect to our investments. Our Fenics brokerage revenues grew by double-digits for the second consecutive quarter. Fenics UST and Fenics GO, two of our newer fully electronic offerings, reached record levels of market share, and our insurance brokerage group is positioned to turn profitable for the fourth quarter and for the full year of 2021. You can see these improvements as they come through our fourth quarter guide. The investments we've made in our comprehensive integrated and standalone electronic platforms leave us well-positioned to capture market share across our businesses. We view the macro trends of accelerated adoption of electronic trading, record levels of global debt issuance, and the hardening insurance market as driving positive fundamentals for our business. In the third quarter BGC generated strong revenue growth of 20% and 9% in its Fenics and insurance brokerage businesses respectively. As a result of these improvements, we expect to match last year's fourth quarter earnings, even in this tougher market environment. We view our stock as demonstrably undervalued, as our earnings return to 2019 levels in the fourth quarter, while our current stock price is over 50% below where it was last year. So with that, I'd like to turn the call over to Sean Windeatt.

Thank you, Howard, and good day everyone. Our Fenics business continued to demonstrate strength and resilience, performing well in a challenging macro trading backdrop in the third quarter. Fenics US Treasuries and Fenics GO, two of our newer fully electronic offerings, reached record levels of market share in their respective markets. In the span of just two years, Fenics US Treasuries has rapidly grown in its position to the clear number two among Central Limit Order Book trading platforms, with an estimated 13% market share in September. Fenics US Treasuries generated substantial growth year-over-year with notional volumes up by approximately 86% year-to-date compared to a 4% increase in overall primary dealer treasury volumes. Fenics US Treasuries is estimated to have saved our clients approximately $115 million since January 2019 by offering the tightest spreads in the market. As a result of our continued technological innovations and strong client support, we expect both volumes and market share to continue to outperform the overall market. Our Fenics GO fully electronic options trading platform more than tripled its volumes since the first quarter of 2020. The Fenics GO platform went live in Euro Stoxx 50 options just over a year ago and went live in Nikkei 225 options in the first quarter of this year. In this short time, we estimate Fenics GO now commands over 6% and 13% market share in Euro Stoxx 50 and Nikkei 225 front-month block-sized options, respectively. Month-to-date in October, Fenics GO has already surpassed its previous monthly record volume. The state-of-the-art technology and trading protocols underpinning these platforms were designed to scale across products and asset classes. We plan to leverage these platform investments as we introduce new products such as repos, NDF, and EGBs to drive fully electronic growth across our businesses. Our data, software, and post-trade businesses, which are predominantly comprised of recurring revenue, grew by more than 17%. This strong performance was driven by Lucera's Connect platform winning new SaaS client contracts and the acquisition of Algomi. Lucera has a fully built scalable infrastructure that provides clients electronic trading connectivity with their counterparties within two days, as opposed to months and at a significantly lower cost. Lucera Connect is quickly becoming the industry standard for the FX market. Algomi is a disclosed credit marketplace for bank streaming to buy-side funds and provides the buy-side aggregated access to bank liquidity. As we continue to electronify significant parts of our business, profitability and margin profile are expected to continuously improve. With that I'm now happy to turn the call over to Steve Bisgay.

Thank you, Sean, and hello everyone. Our insurance brokerage group grew its brokerage revenues by 9% this quarter, driven by new hires in aviation and reinsurance. Peak, our aerospace insurance brokerage business, achieved a significant milestone by winning Rolls-Royce as a client during the quarter. We expect around 20% top-line growth in this business next quarter to over $50 million as previous front-office hires and newly launched business lines increased productivity. Furthermore, our insurance brokerage group has reached its size and scale. We expect it to be profitable for the fourth quarter and to improve BGC's bottom line by over $25 million in 2021 compared to 2020. Moving on to Fenics. This quarter BGC's quarterly GAAP pre-tax earnings would have been $18.4 million higher but for the impact of our continued investment in our standalone Fenics offerings and insurance brokerage business. As we expand our product offerings, optimize our commercial agreements, and add new clients across our electronic platforms, we continue to expect profitability in our newer Fenics stand-alone businesses, which includes Fenics UST, Fenics GO, and Lucera, to improve by $40 million and collectively break even next year. This improvement in Fenics, combined with the $25 million improvement in insurance brokerage profitability, will drive overall pre-tax adjusted earnings and adjusted EBITDA at least $65 million higher in 2021, all else equal. This is a further increase of $15 million above what we expected last quarter. Moving to our quarterly results. Starting with our revenues by geography: Europe, Middle East and Africa revenues declined by 11.8%; the Americas were down by 15.7%; while Asia-Pacific revenues declined by 10.4%. In terms of expenses, we remain focused on reducing our cost base to improve margins. Our compensation expenses under adjusted earnings decreased as a result of lower commissionable revenues as well as our $35 million cost reduction program. Our non-compensation expenses decreased primarily due to lower selling and promotion expenses. The decline in selling and promotion expenses was due to a continued focus on tighter cost management as well as the impact of the COVID-19 pandemic. The decrease in these expenses was partially offset by an increase in interest expense, driven by the $300 million of 3.75% Senior Notes due 2024 and the $300 million of 4.375% Senior Notes due 2025, less lower interest expense on a revolving credit facility, which was paid in full during the quarter. Moving on to our adjusted earnings. Our pre-tax income was $69.2 million compared with $87.7 million. Our post-tax earnings were $61.9 million or $0.11 per share compared with $77.3 million or $0.15 per share. Turning to share count. Our fully diluted weighted average share count increased by 3.9% to 549.2 million under adjusted earnings in the third quarter of 2020. As of September 30, 2020, our spot share count was 548.1 million, an increase of 0.3% sequentially. We expect to use relatively more cash with respect to compensation and acquisitions to minimize dilution. We still expect our 2020 year-end fully diluted share count to increase by approximately 4% to around 550 million. With respect to our balance sheet, as of September 30, 2020, our liquidity was $549.1 million compared with $473.2 million as of year-end 2019. Notes payable and other borrowings were $1,318.5 million compared with $1,142.7 million and total capital was $825.9 million compared with $767.4 million. The quarter end balance sheet figures reflect the issuance of $300 million of 4.375% Senior Notes due 2025 to pay down our revolving credit facility in full, $44 million of tender 5.125% Senior Notes due May of 2021, and ordinary movements in working capital. And with that, I'm happy to turn the call back over to Howard.

Thank you, Steve. Turning to our outlook for the fourth quarter of 2020 as compared with a year earlier, BGC's revenues were approximately 4.4% lower year-on-year for the first 17 trading days of the fourth quarter of 2020. We are beginning to see evidence of a return to growth. For example, in the first 17 trading days of the fourth quarter of 2020, our Asia-Pacific revenues have increased around 5% and Continental Europe is running up over 10%. These represent our first regional increases in revenue since the start of the pandemic. So looking forward for the fourth quarter, we expect to generate total revenues between $440 million and $490 million and that compares with $487.2 million last year. We anticipate pre-tax adjusted earnings to be in the range of $65 to $85 million; that's compared to $73.2 million last year. And we anticipate our full-year 2020 adjusted earnings tax rate to be in the range of 10% to 12% and that compares to 11.4% for the full year of 2019. Beginning at the end of December, we will be modifying the way we update guidance. Going forward, we plan to either affirm our quarterly guidance range or provide an update if we expect the results to be above or below the previously guided range. With that, operator, we'd like to open the call for questions.

Thank you. We will now begin the question and answer session.

Yes. Good morning, Howard and Sean and Steve. So the first question is on Fenics. The intercompany revenues went down as quoted about $14 million in the data, software, post-trade revenues intercompany. So that's the first time it's been down to below $20 million in the past four or five quarters. So can you give a little color or feedback what's going on there?

Sure, Rich. It's Sean here. You may remember in the past that we said as revenue moves into our fully electronic business—which is, of course, what we want—that there will be some revenue migration from intercompany into fully electronic as it becomes fully electronic revenue. That has happened. Secondly, remember Fenics provides the technology and trading for our voice businesses and when the voice business is fractionally lower, by definition that intercompany line is fractionally lower as well.

So the electronic revenue then—I'm sorry—the electronic revenue of Fenics that was previously intercompany isn't broken out as intercompany anymore. Can you give us a feel for how much that is?

No, so again—there are two parts to the intercompany. One is where our technology platform, Fenics, provides the technology for our voice-side business and charges a fee. So, of course, that would go down if the revenues of our voice businesses declined. Equally though, our aim is—as we discussed before—as those voice hybrid revenues become electronic revenues, those revenues move into our electronic brokerage line as we convert that voice business into electronic. So you see increases in our electronic revenue line. So it's a mixture of those two effects.

Okay. All right. And then, I guess, another question: you make a good point about how earnings are on par with last year, but the stock price is down materially. One big difference is there's no dividend now compared to last year. So any updates that you have on the capital return policy—I know you've talked about year-end—but do you see that as a difference too? And what can we— is there anything you can update us on that?

Hey Rich, it's Steve Bisgay. The Board is currently considering its capital return policy and we will be prepared to discuss that in our next conference call. Historically, as you're aware, the firm has been entirely dividend focused. As part of our planning, we will definitely consider evaluating share buybacks as part of our capital return policy, but we will have more to say certainly next quarter.

Okay. And I guess the last question is, it looks like your net debt is up about $100 million year-to-date and it doesn't seem like it's capturing all the cash, the pay downs of the revolver, et cetera. I was just wondering whether you could just walk through cash flows on that: you paid down debt and why isn't the net debt higher than that $99 million or so year-to-date?

Well, our total liquidity is up to about $549 million, so it's certainly up significantly year-to-date. We did do a tender of about $44 million to $45 million this quarter; that's part of it. We paid down the revolver entirely as well. The $300 million note that we took was effectively a pre-funding for the May 2021 notes that are coming due. So bear that in mind as well.

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

Hey, good morning. To build off of that last question from Rich, Steve, maybe to lay it out a different way: year-to-date adjusted earnings have been a little bit more than $240 million, net debt increased by about $100 million so that is directly $340 million of cash flow in. Dividends and distributions year-to-date I think have been around $90 million. So what are some of the other big uses of your cash flow year-to-date?

Well, it's definitely CapEx, there's no question about that. On a quarterly basis we average roughly $20-ish million of CapEx. We have continued to invest—although we're turning the corner, as we've said—certainly on turning towards profitability for the insurance business; historically it has been a bit of a drag. And our investment in Fenics also continues. So we're looking very much forward to much shorter cash generation as planned going forward.

Got it. And then speaking of the insurance brokerage business, you've mentioned that you've done some hiring to build that up. Has there been a lot of signing bonuses paid up front to those folks to bring them on board?

Yes. Pat, when we hire big producers with long-term contracts they often have upfront payments as part of their sign-on. So yes, that has historically been our model and that is our model here. As those profits turn, the business will be cash flow positive and be able to grow using its own cash and contribute to the cash of the company. That investment period has been significant in the past few years, but it's really a good feeling to be in the fourth quarter and to say that that has turned as of now. Literally in the fourth quarter, the company will be profitable. And we expect, as Steve said, it to be $25 million more positive than it was in 2019. So the turn from 2019 to 2020, from 2020 to 2021 will be an improvement of $25 million. We can continue to grow that business, invest in these people—hiring talented producers for the long term—and do that on the profits of the business, which is now driving. I think we're in an excellent position to grow that business.

Got it. And then, as we think about modeling our cash flow expectations for next year, would you expect any moderation in terms of the upfronts to higher producers or your capital expenditures or is it just kind of a good run to be thinking of?

I think it's reasonable to consider it a good run rate as we continue to hire strong producers in both our insurance and financial services businesses. So I think it's a good run rate to think of for the time being.

Got it. And then you guys brought up that Fenics plus insurance brokerage business is expected to provide an incremental $65 million of EBITDA in 2021 relative to 2020. Last quarter that was an incremental $50 million. So where did that incremental $15 million that you're speaking to this quarter come from?

It came from both improvements in our expectation for insurance and improvements in our expectations for Fenics. Both numbers have improved and therefore we feel good about increasing our expectation of improvements from those two line items to our adjusted earnings and EBITDA for next year.

Is it more on the insurance brokerage front? Last quarter the language for Fenics remained that it's going to be break-even next year, so that implies the incremental upside is more specific to insurance brokerage. Am I thinking about that the right way?

That is absolutely correct, Patrick. It is both, but it is definitely more weighted to insurance at this point.

Okay. Got it. TP ICAP announced an acquisition of Liquidnet a few weeks back. Would you guys look at buying something like a buy-side connectivity platform? Obviously we've just talked about cash and other priorities, but strategically how would you guys look at adding buy-side connectivity to what's historically been an interdealer business model?

We made a strategic acquisition—comparatively small—in Algomi, which we discussed on the call. It allows banks to stream credit product to their clients and provides an aggregator that the buy-side can use to aggregate all the different streams from the banks and present it in an attractive, aggregated manner to the buy-side. That combination—banks driving their liquidity to the buy-side and our provision of an aggregator to the buy-side—is our way of growing that business. It leverages our position and our network and it drives our bottom line. The Algomi business had a substantial number of buy-side clients but lacked the bank connectivity which we have. So that combination bodes well for us. I don't think we will pursue a very large strategic acquisition like some others have, but I do think you should expect us to press forward with our strategy and perform strongly over the coming year.

This past quarter the big banks all had another blowout quarter in terms of fixed income sales and trading. I totally get that your revenue doesn't necessarily correlate to their revenue because they have spreads and gains and other things that factor into that. But are there indirect effects on BGC—maybe bank capital available for trading, banks being optimistic in hiring into their trading desks? Are there any second-order effects that you think are going to be beneficial to BGC?

Yes. We have always viewed ourselves as somewhat of a rubber band against our clients: when markets are horrible, volumes during that period can be high, but banks may lose money and later pare back their volumes. When they have blowout quarters, even if we don't directly profit from their spread trades, the strengthening of the banks makes them more willing to invest in trading. That bodes well for our future. We tend to see a lag—about six months—so the next six months coming are positive: the more the banks make, the more they feel comfortable trading, and that's good for our business.

Got it. And then one last one from me. Within Fenics, what stood out this quarter was the FX business: revenues were up about $6 million sequentially while volumes were basically flat quarter-over-quarter. Was there anything unusual or one-time in your Fenics FX revenues or is this a positive mix shift that is sustainable going forward?

The good news is it's the latter. There was nothing one-time in there; it's just a positive development. FX is a strong asset class for us and performed well this quarter.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Lutnick for any closing remarks.

Well, thank you for joining us today and we hope you stay safe and stay healthy. We look forward to coming back and talking to you next quarter in the New Year. Thanks everybody. We look forward to speaking again soon.