Earnings Call Transcript - BGC Q1 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the BGC Partners Inc. First Quarter Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker presentation, there will be a question-and-answer session. Operator instructions were provided. Please be advised that today’s conference is being recorded. Operator instructions were provided. I would now like to hand the conference over to your speaker today, Jason McGruder, Group Head of Investor Relations. Thank you, and please go ahead.

Jason McGruder, Group Head of Investor Relations

Good morning. We issued BGC's first quarter 2020 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 in the 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 year-end, Newmark's results are not included in BGC's consolidated results presented after the spin-off. Unless otherwise stated, the results provided on today's call compare only the first quarter of 2020 with the year-earlier period. We will be referring to our results on this call on an adjusted earnings basis, unless otherwise stated. We may also refer to adjusted EBITDA. We may refer to our liquidity, which we define as cash and cash equivalents, plus marketable securities that have not been financed, reverse repurchase agreements if any, and securities owned, less securities loans and repurchase agreements, if any. We define total capital as redeemable partnership interest, total stockholders' equity and non-controlling interest in subsidiaries. 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 presentation, which is next to the press release on the left side. 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 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. These include statements about the effects of COVID-19 on the Company’s business results and 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 targets discussed on this call assume no material acquisitions, buybacks, extraordinary 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 forms such as Form 10-K, Form 10-Q or Form 8-K. I am now happy to turn the call over to Howard Lutnick, Chairman and Chief Executive Officer of the company.

Howard Lutnick, Chairman and Chief Executive Officer

Good morning. And thank you all for joining us for our first quarter 2020 conference call. Joining me virtually for today’s call are BGC's President, Shaun Lynn; our Chief Operating Officer, Sean Windeatt; and our Chief Financial Officer, Steve Bisgay. Before we talk about the company, I’d like to say that we at BGC express our deepest sympathy to those who have experienced loss of loved ones, economic hardship and difficulties due to the ongoing pandemic. We remain thankful for the healthcare professionals, first responders and other essential workers who are helping the world to get through this unprecedented crisis. The company has faced monumental challenges in the past, which we have overcome. We implemented business continuity plans. However, we never imagined implementing them globally all at the same time. BGC’s employees have worked tirelessly over this past month; they remained focused on serving our clients during these difficult circumstances. Our employees and our technology are why we continue to operate effectively. With respect to BGC’s performance, BGC’s revenues improved by 10.7% for the first quarter of 2020, as compared to last year. While we benefited from generally higher industry volumes, this was partially offset by the dislocations faced by BGC's employees and clients due to COVID-19. Absent these disruptions, we believe our revenue improvement would have been greater. Looking forward, we expect our voice/hybrid and fully electronic brokerage business across rates and credit to benefit from the unprecedented amounts of global government and corporate debt issuance. Over time, we believe this issuance will reach a previously unimaginable scale. This vast supply will create significant long-term opportunity for BGC. The company continues to explore a possible conversion of its UP-C partnership structure into a simpler corporate structure. If the company determines to execute such a conversion, it would be subject to the approval of the Board of Directors and the relevant committees and would not be completed earlier than year-end 2020. Any such transaction would be subject to tax, accounting, regulatory and other considerations and approvals. So, with that, I'll turn the call over to Shaun Lynn.

Shaun Lynn, President

Thank you. And good morning everyone. Our business can be examined in three components: BGC’s integrated voice and electronic liquidity pools; Fenics fully electronic marketplaces; and our data, connectivity, software and post-trade businesses. Of these categories, the dynamics of our integrated voice and electronic liquidity pools were impacted the most by the current crisis. We see brokerage revenues excluding insurance were up by 9% year-on-year in the quarter, while March grew by more than twice this rate. This reflected substantially higher growth in volumes and volatility across nearly every financial asset class in the last weeks of the quarter. As we have said in the past, during periods of market turbulence, our clients often value the insights our brokers provide. As a result, voice brokers added more liquidity and market share over these past several months in many areas where clients had access to liquidity equally via voice or electronics. This dynamic caused what we believe was a temporary shift by traders toward voice execution in many markets. This was due to both the extreme levels of volatility across many asset classes, as well as the disruptive physical dislocations faced by brokers, clients and customers of our clients. However, our clients have indicated that the dislocations caused by COVID-19 have resulted in an even greater demand for our electronic execution. The driver of this demand is our best-in-class market liquidity that only integrated global firms like BGC can provide. BGC’s platform is an integral part of our clients’ technology. So when they execute remotely, our systems are synchronized in real time. We expect the trend towards automation to improve our electronic brokerage revenues and profitability over time. With respect to our fully electronic marketplaces, our standalone platforms generated a strong improvement in the quarter. Fenics UST generated substantial growth year-over-year, with notional volumes up by more than 300% in the first quarter compared to 14% for primary dealer volumes. We believe that Fenics UST has gained significant market share and is distinguishing itself as the clear number two among central limit order book, or CLOB, trading platforms. Moreover, Fenics fully electronic foreign exchange volumes increased by 23% compared with a year earlier, as the market has continued to embrace electronic execution in this asset class and as our foreign exchange offerings such as Fenics FX, MidFX, and Fenics Direct gained further market share. In addition, our Fenics Global Options fully electronic trading platform, Fenics GO, continues its successful roll-out with numerous record volume days. It was the leading broker for certain Euro Stoxx 50 options contracts on some days during April. Our data, connectivity, software and post-trade services include a large percentage of recurring and predictable revenue streams. As a result, our data, software and post-trade businesses once again generated solid top-line growth in the quarter and were up by over 8%. With respect to our connectivity and software business, we acquired Algomi in March. Algomi provides technology to aggregate buy-side clients' access to venues, trading counterparties and exchanges. This subscription software-as-a-service, or SaaS, improves their workflow and liquidity through data aggregation, pre-trade information analysis and execution facilitation. We expect to integrate this business with our Lucera SaaS connectivity subscription services in order to provide both data and execution capabilities directly between banks, dealers and their buy-side customers. The ongoing crisis has slowed the roll-out for some of our newer Fenics offerings over the short-term due to the fiscal dislocations experienced by our brokers and clients. We do not expect our medium- to longer-term strategy for these financial technology businesses to be impacted. Turning to our insurance brokerage business, this industry typically generates significant amounts of predictable revenues at specific times of the year as different categories of clients sign or renew policies. Although certain clients may be facing financial hardship or dislocation due to the pandemic, the insurance brokerage industry has generally performed well during past economic downturns. We expect reduced near-term insurance earnings because of the scale of the recent new hires. We anticipate this division's second quarter to be well below the second quarter of 2019, and to improve in the third and fourth quarters but remain just below breakeven. We expect the insurance brokerage to operate profitably in 2021 and to reach a 15% margin by 2022, including additional new hires. We believe that our insurance brokerage platform is worth materially more than our investment in it. Our goal is to maximize value for our investors, and we are exploring ways to do so with respect to this business. With that, I'm now happy to turn the call over to Steve Bisgay.

Steve Bisgay, Chief Financial Officer

Thank you, Shaun. Hello, everyone. You can find details on our quarterly results in today's press release and investor presentation. I just want to touch on a few important items related to our financial position. Because we are not a capital-intensive business, we have historically returned most of our earnings to shareholders rather than building up retained earnings. This policy was designed for more ordinary economic conditions. These past few months have been the most difficult and tumultuous markets anyone on the management team at BGC has ever seen. They're probably the most uncertain markets any of our partners would have ever seen. And no one knows how long the effects of the global pandemic will last. Therefore, we have taken steps designed to further strengthen our financial position. These include reducing our quarterly dividend to common shareholders and distributions to unit holders. We did so out of an abundance of caution due to the potential negative impact COVID-19 might have on our clients, our industry, the overall economy and the world, not due to any company's specific concern with respect to BGC. While our revenues have improved year-on-year in March and April, it is impossible to predict whether current market conditions will continue or if the pandemic will directly or indirectly impact any of our employees, clients, vendors or other market participants. In addition, as Howard said, we think the massive amounts of debt issuance underway globally will lead to more revenues for us over the medium and long term. However, it is possible that the massive quantitative easing measures taken by global central banks, lower or negative interest rates and the drop in commodity prices could temporarily lower industry volumes. We believe that the right thing for the company to do given the global macroeconomic uncertainty is to prioritize our near-term financial strength and fortify our balance sheet. We expect the Board to regularly review our capital return policy as global conditions with respect to the pandemic evolve and hopefully become clearer. When the time is right, we expect the Board to consider what amounts should be returned to stockholders. During the quarter, we acted to reduce our compensation-related cost base and streamline our operations, which resulted in $22.7 million of GAAP charges recorded in the first quarter. This restructuring program is expected to reduce the company's GAAP compensation expenses by over $35 million for the remainder of 2020. With respect to our standalone fully electronic Fenics products such as Lucera and Fenics UST, we expect to significantly grow revenues over the next three years. And with our lower costs behind us, we expect the overall expenses for these businesses to decline. We anticipate the net investment costs for these businesses to be less than $40 million for full year 2020 and breakeven for full year 2021. Turning to share count, our fully diluted weighted average count increased by 4.3% to 538.4 million under both GAAP and adjusted earnings in the first quarter of 2020. As of March 31, 2020, our spot share count was 538.6 million. This represented a 4.3% year-on-year increase. We expect to continue using relatively more cash with respect to compensation in order to minimize dilution. Largely as a result of this, we still expect our 2020 year-end fully diluted share count to increase by approximately 4% to around 550 million. With respect to the balance sheet, as of March 31, 2020, our liquidity was $512.3 million, compared with $473.2 million as of year-end 2019. Notes payable and other borrowings were $1,368.2 million, compared with $1,142.7 million, and total capital was $739.4 million compared with $767.4 million. Historically, the first quarter has been our most profitable quarter. It is also the quarter where we structurally use the most cash. The quarter-end balance sheet reflects ordinary movements in working capital, cash paid with respect to annual employee bonuses, company employee-related taxes, the aforementioned restructuring program, acquisitions including earn-out payments and investments in our newer Fenics platforms and significant broker hires. This cash use was offset by increased borrowing under our revolving credit facility. The company has paid down $75 million of its revolving credit facility since quarter end, and we expect to continue to pay down the revolver throughout the balance of the year. We believe that our credit metrics, cash generation, and access to credit all remain strong. We continue to manage our business with a focus on our investment-grade ratings. Because we've received many questions regarding our operations over the last several weeks, I would like to remind you of some key facts about our low-risk brokerage business model. BGC's brokerage business is designed to execute transactions that are either named give-up, matched principal or clear with central counterparties. Our transactions are therefore not balance-sheet intensive. In named give-up transactions, we match buyers and sellers and charge a fee. In matched-principal transactions, we execute both sides of a transaction simultaneously which eliminates market risk. A significant and growing percentage of our brokerage business is essentially cleared and therefore eliminates counterparty risk. For example, in numerous transactions the buyer and seller are novated to a central counterparty such as LCH or ICE Clear. Furthermore, we are not market makers and we do not hold inventory. We do not trade on a proprietary basis. We don't have margin calls related to inventory. The margin we do place with clearing organizations is not material to our balance sheet. We also do not issue loans or provide margin to clients nor do we rely on short-term lending markets, such as repos or commercial paper to fund our operations. In short, we are a brokerage business. With that, I'm happy to turn the call back over to Shaun Lynn.

Shaun Lynn, President

Thank you, Steve. Turning to outlook for the second quarter of 2020 compared with a year earlier: BGC’s revenues excluding our insurance brokerage business increased approximately 2% year-on-year in the first 21 trading days of the quarter. This reflects mixed global industry volumes thus far in the quarter, as well as continued dislocation for BGC’s brokers and their clients due to COVID-19. Our guidance assumes that industry volumes and non-insurance brokerage revenues are flat to down slightly year-on-year for May and June. In addition, we expect our insurance brokerage revenues to be relatively flat year-on-year in the quarter, but to generate accelerating growth throughout the balance of the year. Due to the unpredictable nature of the continuing macroeconomic environment, we have a wider outlook range than normal. We expect to generate total revenues between $525 million and $575 million compared with $551.2 million in the prior year. We anticipate pre-tax adjusted earnings to be in the range of $89 million to $109 million versus $102.3 million in the prior year. This includes the impact of our recent insurance brokerage hires, who are incurring costs and are not yet generating meaningful revenue. At the midpoint of our range, adjusted earnings would have been up year-over-year. We anticipate full year 2020 adjusted earnings tax rate to be in the range of 10% to 12% versus 11.4% for the full year 2019. We expect to update our outlook toward the end of June. With that, operator, we would now like to open the call for questions.

Operator, Operator

Operator instructions were provided. Please stand by, while we compile the Q&A roster. Your first question comes from the line of Rich Repetto with Piper Sandler.

Richard Repetto, Analyst (Piper Sandler)

Yes. Good morning, Howard. Good morning, Shaun and Steve, hope everybody's family is safe and healthy. So the first question is on Fenics, on the fully electronic revenue. Howard, you had sort of talked about this prior — that in volatile markets customers tend to go back to their old ways. The revenue was down 5% year-over-year when I look, but I guess my question is when I looked at the notional volume that you disclosed, it was up 20% year-over-year, without any big change in mix and with each product category up in the high teens or above. So I'm just trying to understand — I get the general explanation, but how do the numbers support that? What's behind it?

Shaun Lynn, President

Well, Rich, as we've seen in these volatile times, and as Howard said, and as we've seen in the past, our business gravitates directly towards where the liquidity pool is and where the experience is. As the dislocation happened, voice brokers were on hand with the technology, but they also had the in-depth knowledge. Therefore, there was a substantial movement toward voice execution at this time, which was a slight headwind for electronic revenue. Some of our electronic platforms performed really well, but in greater volatility markets, such as in certain rates and credit markets, we saw the voice brokers come to the fore.

Richard Repetto, Analyst (Piper Sandler)

Sorry, my mistake here. So, my next question: you paid down the revolver $75 million, I believe after quarter end or toward quarter end, and your guidance is reasonably reasonable for the second quarter. Is this an indication that you're more comfortable with the scenario? I noted Steve's somewhat cautionary tone as well, but I just see no big losses — it seems like you didn't take any customer losses. So what's the view, Howard, on the business in general? I have one more follow-up after.

Steve Bisgay, Chief Financial Officer

Hi, Richard, it’s Steve. Yes, we did pay down $75 million after quarter end. Our plan is to continue to use excess cash to pay down the revolver as we continue to perform. We did not suffer any significant or material losses in Q1 with regard to our client activity or brokerage activity. So yes, we do plan to continue to pay down the revolver.

Howard Lutnick, Chairman and Chief Executive Officer

And Richard, your comment — yes, if we could be assured that April was the future of the pandemic, then of course we would be more comfortable. But since no one can articulate what May and June will be, or what will happen in the fall, our view is that we just want to be strong. It may be that we've been through a lot — this management team has been through a lot — and we just want to make sure that the company is very strong as it heads into uncertain times. So if April were the future, of course we would be more confident to pay back, as Steve just said, we decided to pay back $75 million to the revolver and that clearly demonstrates that. Do we expect to generate substantial cash going forward? Of course we do. Do we expect to pay down the revolver through the rest of the year? Of course we do. So we feel much better. We implemented our business continuity plan. Lots of brokers were very effective from home, and as they start to come back to the office they will become more and more effective. We've reconfigured our offices and we're ready for them. We are looking forward to more traditional times when our staff comes to the office and works together. But for the time being, we wait for governments to tell us what we can do. We wait for our staff to be comfortable and healthy and taken care of. April gave us some comfort, yes, and no — as Steve said — nothing happened at BGC specifically. But we just don't know what the future holds, and frankly nobody does.

Richard Repetto, Analyst (Piper Sandler)

Got it. We're all waiting for a return to more normal times, Howard, for sure. One last quick question: as you look at the capital return policy overall, you have taken a precautionary step given uncertainty. If you continue to build up cash toward year-end, you could either buy back shares or reinstate dividends. Would the capital return policy evolve to something other than a pure dividend? If it's still a dividend policy, could you ever make a commitment to paying back some percentage of what you earn once you have the all-clear?

Howard Lutnick, Chairman and Chief Executive Officer

I think what I said at the beginning sounds right: the Board will examine our dividend and capital return policy when we're feeling comfortable that the future is more balanced and more certain. So we will do a capital return policy review. We are a capital return company and have historically been, but as we entered this pandemic we felt that we were going into uncharted territory. We felt we needed to fortify, as Steve said, fortify our balance sheet, stay strong and be strong so that we could handle whatever came our way. Looking forward, might that be share buybacks, might that be reinstating a dividend policy or creating a new dividend policy? I need to leave that open. But you should understand that we are committed to capital return in the future — that is where we plan to be and where we have been in the past. Through this period, we need to be strong and act prudently for our shareholders to ensure the company is very strong for the long haul. We have great assets, we have our insurance business, which we think is a valuable asset. We just want to make sure we act prudently and effectively for our shareholders. We will look to deliver superb returns over time, but we must remain strong and focused throughout these difficult periods to get there.

Richard Repetto, Analyst (Piper Sandler)

Got it. Thank you and be safe.

Howard Lutnick, Chairman and Chief Executive Officer

Thanks, Rich.

Operator, Operator

Your next question comes from the line of Patrick O'Shaughnessy with Raymond James.

Patrick O'Shaughnessy, Analyst (Raymond James)

Hey, good morning. How is employee morale holding up in light of the decline in the value of the partnership units and the reduced dividend?

Howard Lutnick, Chairman and Chief Executive Officer

Employee morale is obviously affected by the overall pandemic, but morale is very good in the sense that employees have been able to go home, work, and look after their families. Many have been able to work from BCP sites and some still from our offices where possible. It's a worrying time for the market as a whole, of course, but morale and spirits are good. Our performance has been good relative to what's been happening globally. I think the biggest factor reassuring our employees is the strength of the company: the strength of our technology, infrastructure and the investments we've made over the years. Our execution platform allows them to operate and still connect to their clients electronically, whereas smaller brokers might not be able to compete. So I think they feel comforted in the knowledge that they work for a great company.

Patrick O'Shaughnessy, Analyst (Raymond James)

Got it, appreciate that. In your prepared comments you spoke about how the unprecedented amount of debt issuance could be a long-term tailwind for the business. What did you guys see post the Great Financial Crisis, when there was large issuance, and how did that impact your rates business?

Howard Lutnick, Chairman and Chief Executive Officer

It was a little different. The volumes from the Fed's quantitative easing and related measures came in later after the GFC. In this case, interventions were more immediate. In April, volumes were muted from what they otherwise might have been. Central bank intervention this time was massive and impressive. So you'll have two forces: massive issuance by governments and corporations, and massive quantitative easing by central banks. Since we have a strong rates business globally, we think government issuance will be the first to dramatically change and be a tailwind for the company. As central banks taper purchases of corporate bonds, credit business will also improve because many companies that are not performing as well will need to issue debt to cover shortfalls. That debt will remain outstanding for decades and provides more raw material for trading. So I think you'll see the benefit in government markets first, and over time in corporate credit as well. There will be offsets and variations quarter to quarter, but fundamentally it is a large baseline tailwind for our industry.

Patrick O'Shaughnessy, Analyst (Raymond James)

Got it. I want to circle back to Fenics brokerage revenues: I understand your explanation, but some other fully electronic venues had very strong first quarters — MarketAxess, Tradeweb, BrokerTec, for example. What was specific to some of the Fenics platforms that led to underperformance relative to those other electronic platforms?

Shaun Lynn, President

Fenics UST had a very strong quarter. Fenics GO had a really strong quarter. MidFX had a strong quarter. We saw strong performance in several of our fully electronic platforms. The headwind relative to certain electronic-only competitors is that those competitors are electronic-only and focus on client segments differently. We are an integrated firm with significant voice broking capability, and many of our clients had a choice between voice and electronic. In periods of extreme volatility, clients gravitate towards voice because of the added insights and liquidity brokers can provide. So while that dynamic was positive for our overall revenue and voice component, it was a headwind for our aggregated electronic revenue in the quarter.

Steve Bisgay, Chief Financial Officer

To add to Shaun's point: think about the liquidity we provide between wholesale banks and market makers. Our customers have a choice between voice and electronic. We've seen customers migrate toward voice because they have that choice. MarketAxess, Tradeweb and BrokerTec are electronic-only and don't offer the voice alternative. We believe that as markets normalize, the long-term trend toward electronic execution will continue and our integrated model will drive growth and profit over the medium and longer term.

Patrick O'Shaughnessy, Analyst (Raymond James)

Okay, understood. Thanks. And then last one: Regarding the insurance brokerage business, you've spoken about trying to figure out how to extract the most value from that franchise and a potential option was selling that business. Given current market conditions, is the window to potentially sell that business closed for now?

Howard Lutnick, Chairman and Chief Executive Officer

I don't think it's closed. I think these businesses are generally solid and can be countercyclical in some respects — the desire for insurance has probably increased given the pandemic. There will be some clients in stress, which is problematic, but many clients will re-examine insurance needs and purchase insurance. So demand or investor interest hasn't necessarily dissipated; valuations may be different in the near term, but the business is doing well. We've hired talented people and they have joined us. Insurance brokers tend not to be fully productive in their first year, so we are mindful of that. We are examining the best ways to maximize value for our investors and shareholders.

Shaun Lynn, President

One other point: we are a broker, not an underwriter. We don't take underwriting risk. Some of the stresses you're seeing with underwriters relate to indemnity or underwriting exposures, which affect underwriters, not brokers. I wanted to make that distinction clear.

Patrick O'Shaughnessy, Analyst (Raymond James)

Okay, understood. Thanks. One more question for you, Howard: several years ago GFI Group's share price came under pressure and management considered a take-private offer. Given BGC’s current valuation and stock price, would you contemplate a take-private deal for BGC Partners or does this business make more sense publicly traded?

Howard Lutnick, Chairman and Chief Executive Officer

In early May, two months into a pandemic, those thoughts are not on the menu. The answer today is head down, conservative, generate cash, get people back to the office, take care of our people, make sure they're safe, and strengthen our balance sheet. We are not thinking about take-private transactions right now. Our priorities are to strengthen the balance sheet, generate cash, take care of employees, ensure they are healthy and protected, bring them back to the offices when appropriate around the world, and take care of our clients. Those strategic considerations are not being considered at this time.

Patrick O'Shaughnessy, Analyst (Raymond James)

Thank you for answering all my questions.

Operator, Operator

Operator instructions were provided. I'm showing no further questions at this time. I would now like to turn the conference back to Howard Lutnick, Chairman and CEO of BGC Partners.

Howard Lutnick, Chairman and Chief Executive Officer

Hi, I just want to thank everybody for spending time with us this morning. I want to wish you all health and hope you have positive time with your families and that you stay healthy and protected. We really appreciate your time. My management team and I are tremendously proud of our employees, and I just want to finish by saying that we are completely indebted to employees who have worked tirelessly to carry us through to this point. They have done an extraordinary job — our technology people, our operations people. Imagine settling and clearing all these transactions in those last weeks of March — they have been brilliant. The culture we've built and the commitment across the company is second-to-none, and I am grateful to the team at BGC. They are wonderful human beings who care about each other and deeply care about the company. So thank you all, be safe, and we look forward to speaking to you next quarter. Bye.

Operator, Operator

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