Earnings Call Transcript - BGC Q1 2021

Operator, Operator

Welcome to the BGC Partners, Inc. First Quarter 2021 Earnings Conference Call. (Operator instructions were given.) I would now like to hand the conference over to your speaker today, Jason McGruder, Head of Investor Relations. Please go ahead.

Jason McGruder, Head of Investor Relations

We issued BGC's Q1 2021 financial results press release and the presentation summarizing the results earlier this morning. You can find these at ir.bgcpartners.com. Please note you can find additional details on our quarterly results in today's press release and in the investor presentation. Unless otherwise stated, the results provided on today's call are for the first quarter of 2021 compared to 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 also 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. Please see today's press release for results under generally accepted accounting principles, or GAAP. Please also see the relevant sections of today's press release and the back of today's investor presentation for complete updated definitions of any non-GAAP terms, reconciliation of these items, 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 on today's call is available on our website at ir.bgcpartners.com and in our investor 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 and software solutions and post-trade services. These businesses are categorized as Fenics markets and Fenics growth platforms. Fenics markets includes the fully electronic portions of BGC's brokerage business, our data, software and post-trade revenues that are unrelated to Fenics growth platforms. Fenics growth platforms include Fenics U.S. Treasuries, Fenics GO, LouSara, Fenics FX and our other newer standalone platforms. These platforms were designed to build volumes and market share, which we've accomplished over the last two years. We expect to leverage our strong market share gains to drive significant revenue growth from our Fenics growth platforms going forward. Fenics markets and Fenics growth platforms compete with highly valued companies such as CME, Tradeweb and MarketAxess. Fenics overall generated its fourth consecutive record quarter of net revenues, which grew 40% to $105.6 million. Fenics markets revenues grew 36.5% this quarter to $95.1 million and had a pre-tax profit margin of 30.2%. Revenues from our Fenics growth platforms grew to $10.6 million, an increase of 82.1%. As we continue to grow our higher margin businesses, we are well positioned for increased profitability. I will also remind you that the information regarding our business on today's call that is not historical is forward-looking within the meaning of applicable securities laws, including statements about the effects of the COVID-19 pandemic on the company's business, 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 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 statements set forth in these filings and any updates contained in subsequent reports on 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 CEO

Thank you Jason. Good morning, and thank you all for joining us for our Q1 2021 conference call. Joining me virtually for today's call are BGC's Chief Operating Officer, Sean Windeatt; and our Chief Financial Officer, Steve Bisgay. Fenics margins improved across nearly all measures, driven by record Cenex and core revenues, excluding the one-off pandemic-driven volume and volatility that occurred toward the end of the first quarter. Had the pandemic-driven events not occurred, our overall revenues would have grown by approximately $8 million as compared to a year ago. Beginning this quarter, we will categorize our Fenics businesses as Fenics markets and Fenics growth platforms. Fenics markets includes the fully electronic portions of BGC's brokerage business, our data, software, and post-trade revenues that are related to our Fenics marketplaces. Fenics growth platforms include Fenics U.S. Treasuries, Fenics GO, LouSara, Fenics FX and our other newer standalone platforms. These platforms were designed to build volumes and market share, which we've accomplished over the last two years. We expect to leverage our strong market share gains to drive significant revenue growth from our Fenics growth platforms going forward. Fenics markets and Fenics growth platforms compete with highly valued companies, such as CME, Tradeweb and MarketAxess. Fenics overall generated its fourth consecutive record quarter of net revenues, which grew 40% to $105.6 million. Fenics markets revenues grew 36.5% this quarter to $95.1 million and had a pre-tax profit margin of 30.2%. Revenues from our Fenics growth platforms grew to $10.6 million, an increase of 82.1%. As we continue to grow our higher margin businesses, we are well positioned for increased profitability. With that, I'd like to turn the call over to Steve. Sean's line just dropped off. Steve, would you like to jump in now and we'll bring Sean back on as he reconnects?

Steve Bisgay, Chief Financial Officer

Sure. As reported in today's earnings release, BGC recorded its second highest ever total revenues of $567.6 million, behind the year-ago period when the COVID-19 pandemic drove market volatility and trading volumes to record levels. Excluding the impact of those pandemic-related events, BGC’s Q1 2021 revenues would have been an estimated $8 million higher than last year. By geography, Europe, Middle East and Africa revenues declined by 5.2%, the Americas were down by 6.6% while Asia Pacific revenues declined by 7.3%. By asset class, insurance increased 16.8% while rates, credit, energy, commodities, FX, and equity derivatives and cash equities were down by 3.3%, 7.3%, 9.4%, 11.6% and 13.9% respectively. We took steps last year to optimize our front office head count, focused on reducing underperforming and less profitable brokers, which lowered revenues in the short term but increased profitability during the quarter. These measures, along with increased contribution from Fenics, led to a 4.2% improvement in average productivity of our financial brokers and salespeople compared to last year. Moving on to Fenics: this quarter Fenics generated net revenues of $105.6 million as we converted voice and hybrid brokerage into Fenics markets, which drove revenue 40% higher and delivered its fourth consecutive quarter of record net revenue. This was driven by Fenics markets revenues of $95.1 million, an increase of 36.5% and a pre-tax adjusted earnings margin of 30.2%. Fenics growth platforms revenues increased to $10.6 million, up significantly from a year ago, reflecting an 82.1% improvement driven by strong growth in Fenics U.S. Treasuries, LouSara and Fenics GO under the former reporting methodology. Cenex brokerage revenues increased by 49.2% to $83.7 million while data, software and post-trade revenues increased 13.3% to $22.0 million. Corrine's achieved record quarterly brokerage revenues of $52.4 million, growing by 16.8% and generated its second consecutive quarterly profit. Moving on to expenses: compensation and employee benefits expense under GAAP and adjusted earnings decreased in the first quarter of 2021 due to lower commissionable revenues, lower headcount and cost reduction initiatives previously executed. Compensation expense under GAAP reflects $1.7 million and $22.7 million of charges related to cost savings initiatives for the first quarter of 2021 and 2020, respectively. Our non-compensation expenses decreased due to tighter cost control and lower selling and promotion activities; as a result, we reduced professional and consulting fees and decreased commissions and floor brokerage expense. Moving on to adjusted earnings: pre-tax adjusted earnings were $114.5 million, an increase of 2.1%. We achieved post-tax adjusted earnings of $101.6 million, a 135 basis point margin expansion, and adjusted EBITDA of $147.5 million, an improvement of 24.1%. Turning to share counts: our fully diluted weighted average share count increased by 0.6% sequentially to 557.1 million. As of March 31, 2021, our sponsor accounts were 557 million, an increase of 0.7% sequentially. We anticipate our net issuance of shares to be significantly lower than prior periods, as we expect to use relatively more cash with respect to compensation and acquisitions to minimize dilution. As of March 31, 2021, our liquidity was $634.2 million compared with $652.6 million as of year-end 2020. Cash and cash equivalents were $574.4 million versus $593.6 million as of December 31, 2020. Notes payable and other borrowings were $1,313.3 million compared with $1,315.9 million. In the second quarter, we expect to repay our $255.8 million of 5.125% senior notes due May 27, 2021, which will reduce our cash and debt levels. Total capital was $890.4 million compared with $1,028.9 million. Historically, cash has been the greatest in the first quarter, which includes payments of annual bonuses, tax payments and timing differences between commissions earned in the seasonally busier first quarter and commissions collected from business generated in the seasonally slower fourth quarter. The company can continue to explore a possible conversion into a simpler corporate structure. When there's clarity on U.S. federal tax policies, we'll be able to make a decision with respect to the potential corporate structure. With that, I'd like to turn it back over to Sean.

Sean Windeatt, Chief Operating Officer

Thank you, and thank you Steve. Good day, everyone. As I've mentioned, both Fenics growth platforms and core businesses generated strong revenue growth and profitability improvement during the quarter. Profitability across Fenics growth platforms and core businesses improved approximately $15 million from last year, primarily driven by higher revenues, reflecting the operating leverage in these businesses. Fenics reported record net revenues this quarter supported by 40% growth and represented over 20% of our total revenues. Excluding insurance, as had been mentioned earlier, we modified our presentation of Fenics this quarter to more clearly describe and categorize Fenics revenues. These total revenues are equal to the combined revenues of our formerly reported Fenics brokerage and data, software, and post-trade line items. The businesses in Fenics growth platforms are newer, fully electronic and standalone from other parts of our business. These are the fastest growing parts of our overall business and have the potential for very high pre-tax profit margins at scale. Revenue generated from data, software and post-trade attributable to Fenics growth platforms have been included within their related growth platforms. The 82.1% increase in revenues was driven by strong growth in Fenics U.S. Treasuries, LouSara and Fenics GO. Fenics U.S. Treasuries achieved record market share across all U.S. Treasury platforms, growing from 6% to over 9% in March 2021 and represented over 18% of broker-to-dealer market share, up from 9% the same period a year ago. Fenics U.S. Treasury average daily volumes also grew by over 47% in the first quarter of this year across all U.S. Treasury platforms, including CME, Tradeweb, Bloomberg and MarketAxess. Our tighter pricing continues to attract client volumes with nearly 70% of all our dealer trades in the first quarter being transacted at prices only offered on our platform. LouSara revenues increased approximately 73% year-over-year as it won new clients, expanded existing customer relationships and reflected the integration of Alchemy, which was acquired in March 2020. During the first quarter, LouSara launched a new product that combines the functionality of our existing aggregator with LouSara's global bank and buy-side connectivity and rates and credit execution. Fenics GO total volumes increased by over 300% and grew estimated block size and front market share in Euro Stoxx 50 option contracts and other index options by significant basis points. During the first quarter, we launched additional index options and expect to launch more in the second quarter. The key to this technology is our ability to add products with low marginal costs. Our existing success in front market share supports our ability to quickly scale and gain market share across newly launched products. Fenics GO is the only anonymous multilateral electronic platform for listed equity index options that delivers a unique advantage by providing traders best execution as well as benefits to compliance officers who need to validate these requirements. Cenex brokerage revenues grew 49.2% to $83.7 million, setting a new record, with data, software and post-trade contributing $22.0 million. Corrine brokerage revenues grew 16.8% to $52.4 million setting a new quarterly revenue record. During the quarter we saw increased production from newly hired insurance brokers, underpinned by hardening insurance pricing trends. Our voice hybrid business, including other revenues and excluding insurance, generated revenues of $409.5 million with a pre-tax adjusted earnings margin of approximately 22%. We saw strong growth across U.S. and European rates, including inflation products, European government bonds, U.S. equity products and environmental products. This growth was offset by lower activity across Sterling rates products, G10 FX options and emerging market FX products. We remain well positioned to capitalize on accelerating electronic execution trends. BGC's sizable voice hybrid revenue base leaves us uniquely positioned to convert a significant amount of our revenue to higher-margin technology-driven Fenics market businesses. Fenics outlook: our outlook for the second quarter of 2021 is as follows. BGC's revenues were approximately 9% lower for the first 18 trading days of the second quarter of 2021 when compared to the same period in 2020, which included continued higher volatility and trading volume driven by pandemic-related events during April of last year. Therefore, looking forward to the second quarter, we expect to generate total revenues of between $485 million and $535 million as compared to $519.1 million in the prior year quarter. We anticipate pre-tax adjusted earnings to be in the range of $88 million to $108 million versus $92.1 million. And we anticipate a full year 2021 adjusted effective tax rate to be in the range of 10% to 12% versus 11% for the full year 2020. With that, Steve, I'd like to add anything else?

Steve Bisgay, Chief Financial Officer

Thank you, Sean. As you've heard on today's call, we've made significant progress growing our highly valuable Fenics assets. This has helped drive margin expansion as compared to last year. We continue to believe the assets of BGC are demonstrably more valuable than the current market capitalization reflects. Fenics assets have market-leading growth and are capturing significant amounts of market share from much larger market-cap competitors. Our revenue growth also continues to outpace the overall industry. The management team and I are continually thinking about the most effective ways to express the value of the assets of this company. We are focused on maximizing shareholder value. With that, operator, we'd like to open the call for questions.

Operator, Operator

We will now begin the question-and-answer session. (Operator instructions were given.) The first question comes from Rich Rippetoe with Piper Sandler. Please go ahead.

Rich Rippetoe, Analyst, Piper Sandler

Yeah, good morning. Howard, Sean and Steve. So you just said that your management team is focused on monetizing Fenics. I guess the question is, and we've talked prior where you said it was a priority, so can you give us a status update on where that stands?

Howard Lutnick, Chairman and CEO

Let's start with the two businesses. BGC believes that Cenex is the greatest opportunity in front of the company to drive significant and fundamental value improvement for the company. We think our Fenics businesses are wildly undervalued and we are going to be focused on driving that. In that conversation, we've had many conversations about our growing insurance business. We think our insurance business continues to grow and continues to improve. We also think it is a significant value and we are focused on what is the best way to express shareholder value. Things take time — that's just the way it works. Turning to Fenics, we tried this quarter to show you the margin of our Fenics markets business. By separating and showing you the margin of 30.2%, we are describing clearly that our technology-driven businesses are driving up our margins. We have seen our margin grow and it is being driven by the fact that we are producing better economic results from Fenics markets, which drives the economics of the underlying company. Also, we started to show you the Fenics growth platforms and those revenues. These are the businesses that in 2019 we lost $55 million as we invested in those businesses and built them, and then we lost $40 million in those businesses the following year. And you have just seen the revenues grow 82% this quarter. We have an expectation, as we have discussed with you, that these businesses have built market share, have built their volumes, have built value across these marketplaces and will start to earn revenue at significant pace. We will continue to invest in them, but as these revenues grow, they're growing on a fixed cost base. Therefore you will start to see revenues and profits continue to grow. For example, our U.S. Treasury business is highly sought after and highly valued. Our objective is to figure out how to best monetize those things for the shareholders of our company. There are a variety of ways to do that, but I want you to be clear: this is not going to be a long-term event. We expect, in 2021, to be having really interesting conversations about what Fenics can achieve. How that works, we'll see. I don't know the exact timing, but we are going to have conversations because these assets are extraordinarily valuable and, in my opinion, are worth far more than the current market reflects.

Steve Bisgay, Chief Financial Officer

On the question of buybacks and capital deployment, obviously there are legal and regulatory constraints around when we can repurchase shares. We couldn't conduct a buyback immediately prior to this earnings announcement. Once earnings are done, our counsel tells us what we're allowed to do and not to do. As Sean said in his remarks, we expect to use more cash for compensation and acquisitions to have fewer shares outstanding. We do expect to buy back shares to mitigate dilution. We will wait for when counsel tells us it's appropriate to buy back shares and then we'll decide timing, amounts and we'll disclose buybacks each quarter. We don't expect to define a standardized amount per quarter, but the company expects to buy back a material amount of shares this year and to use free cash flow to do so.

Howard Lutnick, Chairman and CEO

If you look back to 2013 when we sold a business, no one believed we would sell it and achieve the kind of economic benefit to shareholders that we did. Our Fenics assets are worth far more in my opinion than the current stock price reflects. For example, our treasury business went from roughly 6% to over 9% of all trading across the major platforms in the last year, and in broker-to-dealer trading it went from 9% to over 18%. Our market share gains are real. Our system is winning. That creates an important competitor to the large electronic marketplaces, and that value is what we are trying to express. Everything is on the table. We'll consider public or private transactions or other structures. We're working on this now and expect to have interesting conversations in 2021 about how to best express the value of Fenics for shareholders.

Rich Rippetoe, Analyst, Piper Sandler

Okay, thank you, Howard. I'll get back into the queue.

Operator, Operator

The next question comes from Patrick O'Shaughnessy with Raymond James. Please go ahead.

Patrick O'Shaughnessy, Analyst, Raymond James

Hey, good morning. Hoping you can comment on the broad competitive landscape at this point. We hear what you're saying with Fenics U.S. Treasuries and the share gains; Tradeweb and MarketAxess talk about success in various dealer suites and streaming quotes in rates. Could you comment on the broad competitive landscape?

Steve Bisgay, Chief Financial Officer

Tradeweb, MarketAxess and CME are world-class competitors and platforms. They were strong last year and remain strong — they are sophisticated and capable. That said, the fact that Fenics U.S. Treasuries went from 6% to over 9% and in broker-to-dealer trading from 9% to 18% demonstrates we are making a fundamental dent in the business. They remain great players, but our increased market share shows that we matter and are changing the landscape. We are not suggesting they're not strong — simply that our growth is meaningful and should be recognized.

Patrick O'Shaughnessy, Analyst, Raymond James

Digging into Fenics U.S. Treasuries, how would you frame the competitive advantage of that platform and how sustainable is that advantage?

Steve Bisgay, Chief Financial Officer

Here's an example to illustrate our advantage. On many platforms, everyone can trade with everyone, which results in a substantial percentage of business being executed by high-frequency trading firms trading with each other. Those sophisticated market makers trade extremely quickly and often create adverse selection for clients who want to trade larger sizes. Our system allows participants to avoid trading with certain counterparties; they can curate and select who their counterparties are. That delivers a better experience for those participants who want to trade larger sizes without being picked off. As a result, average trade size on our system has grown, because it's a safer place to do business. We've grown market share substantially without relying on the high-frequency, ultra-low-latency model; instead we've created a venue that better serves institutional participants who want larger, more predictable execution. We believe this model is sustainable and it's a different, complementary model to what others offer.

Patrick O'Shaughnessy, Analyst, Raymond James

Got it. Thank you. Switching gears to the insurance brokerage business: how aggressively are you hiring into this business at this point? And maybe drilling down into your second quarter outlook, what would your expectations be for insurance brokerage revenue for Q2?

Steve Bisgay, Chief Financial Officer

The insurance marketplace is currently hardening, meaning pricing is increasing, which benefits brokers because commissions are a percentage of premiums written. Our insurance business has good underlying economics. Pricing across the industry has been rising because the insurers experienced significant losses and are raising rates to restore profitability. That dynamic supports continued revenue growth for our insurance brokers. Regarding hiring, we did hire a lot last year, and in insurance it generally takes time for new hires to migrate their client relationships. Often clients do not move immediately; it can take a year for the new broker to harvest their book. So the hiring we did last year had a drag initially but is now starting to bear fruit. We are continuing to hire, but the large hiring spree that occurred last year is now feeding the business and contributing to revenue growth. We expect continued growth and profitability in the insurance business as those hires mature and as market conditions remain favorable.

Patrick O'Shaughnessy, Analyst, Raymond James

Great. That's all from me. Thank you.

Operator, Operator

We have a follow-up from Rich Rippetoe with Piper Sandler. Please go ahead.

Rich Rippetoe, Analyst, Piper Sandler

First question on the insurance business: I believe it broke even in Q4. What were the margins in the insurance business in the first quarter?

Steve Bisgay, Chief Financial Officer

The insurance business is small but profitable now. We reached break-even and are in the black in the first quarter, but it's still a relatively small profit. As more of our brokers pass their first year and bring on accounts, revenue and margins will continue to grow over the course of the year. Our long-term expectation is that the insurance business will approach industry-standard margins of around 15% as revenues scale. We have previously commented that when insurance revenue reaches roughly $300 million, we would expect to approach that industry margin level. For now, the business is growing and moving toward those target margins over time.

Rich Rippetoe, Analyst, Piper Sandler

Next question on Fenics markets margin: it's 30.2% now, and you mentioned the potential to reach 50% margins for fully electronic platforms. Can you clarify what margin range you expect for Fenics markets specifically?

Steve Bisgay, Chief Financial Officer

To clarify, Fenics growth platforms — the standalone, fully electronic platforms — have the potential to reach margins similar to the best electronic systems in the industry, meaning very high margins at scale, potentially approaching or exceeding 50%. Fenics markets, which is the electronification of our brokerage business and includes a substantial sales force and higher-cost salespeople, has a different cost profile. For Fenics markets, we think a more realistic target margin range would be in the mid-30s to around 40% with scale, because we will continue to employ our top brokers who drive client relationships and add value. So, growth platforms can reach higher percent margins, while Fenics markets will have slightly lower but still very attractive margins.

Rich Rippetoe, Analyst, Piper Sandler

Understood, that makes sense. On the intercompany technology services line, you reported $20.7 million in the first quarter. Could you walk through what that revenue is and how it relates to Fenics markets and Fenics growth platforms?

Steve Bisgay, Chief Financial Officer

Sure. That line is the fees paid internally for technology that BGC provides to our brokers and businesses — essentially intercompany technology services. As more business moves into Fenics markets — which are higher-margin and more technology-dependent — we would expect some of that intercompany revenue to migrate into externally reported Fenics markets revenue, resulting in a decline in the intercompany line and growth in Fenics markets. Over the last two to three quarters, you've seen Fenics markets grow and some corresponding decline in intercompany revenue. Remember, there is roughly $20.7 million of intercompany technology revenue in the quarter, and as that technology monetizes externally through Fenics markets, you'll see that shift occur.

Rich Rippetoe, Analyst, Piper Sandler

Would it be proper to view that $20.7 million as a pipeline for Fenics markets and Fenics growth platforms?

Steve Bisgay, Chief Financial Officer

Yes, that's a good way to think about it. It's not a one-for-one relationship, but the intercompany technology revenue represents technology being used internally that can be commercialized externally as we move more of our business to the Fenics platforms. So you can view it as a pipeline or potential that can convert over time into Fenics revenue.

Operator, Operator

That's all I have. This concludes our question-and-answer session. I would like to turn the conference back over to Howard Lutnick for any closing remarks.

Howard Lutnick, Chairman and CEO

I appreciate you all spending the time with us today. The company is focused on maximizing shareholder value and I hope we helped you understand those details. We tried to separate the margins for Fenics markets and show you the revenues of our growth platforms going forward, which we obviously expect will grow materially. We will continue to try to make our company more transparent and make it clear how well we are doing and how we are building our asset value. Our clear purpose is to make sure you understand we have valuable assets and we need to express them to gain value for our shareholders, which we are focused on. I appreciate your time today and I look forward to updating you next time.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.