Cowen Inc (COWN) 2016 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for joining Cowen Group Inc conference call to discuss financial results for the 2016 fourth quarter. By now you should have received a copy of the Company's earnings release which can be accessed at Cowen Group Inc website at www.cowen.com. Before we begin, the Company has asked me to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are subject to risks and uncertainties described in the Company's earnings release and other filings with the SEC.

Cowen Group Inc has no obligation to update this information presented on the call. A more complete description of these and other risks and uncertainties and assumptions is included in the Company's filings with the SEC which are available on the Company's website and on the SEC website at www.sec.gov. Also, on today's call our speakers will reference certain non-GAAP financial measures which the Company believes will provide useful information for investors.

Reconciliations of those measures to GAAP is consistent with the Company's reconciliation as presented in today's earnings release. Now I would now like to turn the call over to Mr. Peter Cowen, Chairman and Chief Executive Officer.

Thank you, operator. Good morning, everyone. Welcome to Cowen's fourth quarter and full year 2016 earnings call. With me today, as has been for many, many years are Jeff Solomon, President of the firm, and Steve Lasota, our CFO. 2016 saw major equity categories post positive gains in the fourth quarter and full year. I think we're all acutely aware of that.

Unfortunately these positive market moves were disconnected from a generally weak market appetite for equity financing which resulted in the IPO market experiencing its worst year since 2003 which is partially reflected in our results. Equity commissions remain under pressure as active managers both long, only and alternative strategies experienced one of their worst, if not their worst, year for redemptions while passive managers had one of their best years ever for inflows. Notwithstanding, however, in 2016 each of our businesses actually performed well despite these headwinds.

The investment management business continues to attract interest in its differentiated alpha generating capabilities and we added to our platform a number of unique strategies. Our investment banking and brokerage businesses both gained market share during the period in their respective markets. We reached a broader audience with our research and macro commentary products while maintaining our focus on providing in depth insights and analysis on the issues that clients care about.

The investment management business continues to attract interest in its differentiating alpha generating capabilities despite challenging investment performance. And we actually raised and grew money during the year. But to be blunt, it's hard not to be disappointed by the bottom line results at Cowen. So I want to put the numbers into context a little bit.

Since 2010 our strategy has been to build a very diversified organization that delivers alpha generating capabilities to its clients in investment management, investment banking, research and brokerage. Businesses and people that we've added over the years have been, at its core, about adding capabilities that contribute to the building consistency of our platform. Parenthetically, I'd add here that while Cowen itself, the Company, is going to be 100 years old next year, our view is the Cowen that we are responsible for is about seven years old going back to when we merged it into Ramius in 2010.

And it's taken a lot of redecorating to get Cowen to the place where it is today. 2016 was no different in that regard. However, the top line performance in investment banking and investment income was significantly lower than 2015 and did not cover the expenses we incurred in 2016 to further build out and diversify businesses, on top of some other, I would say, abnormal events.

As we have consistently said in 2016 earnings calls, we made a conscious effort to invest into the business during 2016 and growing our platform through the slow down in our core markets. Cowen benefited from the ongoing consolidation with the financial services industry, which is something we have consistently said we wanted to be a participant in. 2016 we completed the acquisition of the credit products, credit training, special situations and emerging markets business from CRT. A few months later the policy came from the Washington Research Group joined our platform.

It didn't actually get up and running until August 1st and we are first starting to see the results of their work now, as did the merchant banking and investment banking teams from both Morgan Joseph TriArtisan Partners, which joined us, and several other important recruitment industries such as consumer, industrials and financial sponsors. We also recruited new talent into the investment management platform and launched new strategies. Further, we also instituted an equity finance business which is literally up and running, kind of, as the first of the year but expenses incurred last year to get the people in place, the systems in place which will allow us to finance our Cowen prime services clients, capture margin debit balances and stock loan.

And so if you add all those up, those are fairly substantial investments. All told, we invested $24 million in people and businesses that did not contribute revenue in any meaningful way to 2016's results while at the same time we were pairing costs to reduce head count in other nonproductive areas. We made the decision to invest in businesses and people as we see them playing an important role in diversifying our revenue in the future while bringing greater stability and consistency to our platform in 2017 and beyond.

We believe that additional opportunities will continue to come our way and with $1 billion in total capital we are well positioned to benefit from that ongoing consolidation. Lastly, let me mention that our balance sheet did not perform up to its historical standards, if you will, of what we are capable of doing. Significant contributor to that was the April surprise that we got out of Treasury in Pfizer-Allergan which we have covered -- you know about.

We ended up making all that money back and we were actually up for the year on our balance sheet but not enough to get us to where we usually are. And some of the new strategies in the investment management business also had some difficult periods during the year. We have taken steps to shrink some of those strategies and our capital exposure to them and tighten up some of the risk metrics that were surrounding our event-driven activity so that we can't have a Pfizer-Allergan event again.

For the full year we reported economic income loss of $28.7 million, or $1.07 per diluted share, compared to economic income of $34.5 million, or $1.19 per share last year. Total revenue is $467.6 million which is a 12% decline from the prior year. For the fourth quarter 2016 economic loss was $12.9 million, $0.48 per diluted share, compared to economic income of $15.2 million, or $0.54 last year. Total revenue in the fourth quarter was $128 million compared with $160 million in the prior year.

Before turning the call over to Jeff, I just want to say that notwithstanding our results for the year, we're actually pretty excited about the position we're in and feel like the firm is in a stronger position than it's ever been in before. And with that, I am going to turn this over to Jeff and let him cover topics around the investment banking. And he can talk a little bit about investment management business too.

Thanks, Peter. In 2016 the alternative investment space continued to mature. Several hedge funds closed during the year and the pace of AUM growth slowed to about a 5.9% compound annual growth rate between 2014 and 2016 compared to an 8.1% compound annual growth between 2008 and 2014. So there is no question that maturing of the industry is certainly something that overhangs just about every alternative investment manager.

Industry data indicates that there were about $28 billion in outflows during the fourth quarter in 2016. In contrast, excluding the reduction of assets associated with sale of the alternative solutions business, our investment management business actually grew in total AUM by $774 million to $10.5 billion as of January 1, 2017. In 2016 we raised about $600 million for emerging strategies and those include events, equity long/short, global macro and distressed credit.

Management fees for the alternative investment management segment averaged $5.5 million per month in the fourth quarter of 2016 compared to $5.2 million in the quarter of 2016. Most of the reduction there is a result of the sale of Ramius Alternative Solutions. The average management fee per quarter was 62 basis points compared to 53 basis points in the prior year period. And as we mentioned, we expected to see a bump in the AUM fee -- average management fee calculation because the Ramius Alternative Solutions business was a low fee paying business.

In merger arbitrage we ended the year with a positive return and raised new assets during the year and we're continuing to market the strategy in a UCITS format in a partnership of Bank of America Merrill Lynch which is enabling us to expand the strategies global footprint. The healthcare royalty business continues to attract investors and expects to raise a new fund in 2018. And our global macro offering is positioned as a risk mitigation strategy which seems to be of interest to large asset allocators.

The consumer focused long/short strategy we launched in 2016 secured a mandate for managed account with a multi strategy firm. And our newest affiliate, a long/short equity fund, focused initially on communications technology, media and consumer launched in the fourth quarter of 2016 and is performing well. Its initial investments have increased their allocation so far in 2017 and the team has been approved by top consultants and hedge fund investors. We are really putting together selling agreements in place with a number of top wire houses and are at work with the selling agreements with additional parties as we continue to grow and scale the business.

Real estate successfully completed its raise for a multi-family equity fund and is currently raising capital for its newest debt offering. And at the end of the year, the principal owners of Starboard exercised their right to acquire an additional portion of our ownership in that business. Overall it was a pretty productive year at Ramius and we plan in 2017 to continue looking and developing our emerging strategies as we reposition the business take advantage of the opportunities where we see fund flows.

So I want to thank everybody in the asset management division for all the work and efforts they've made, notwithstanding some of the performance during the course of the year. Really everybody did an amazing job to get a lot of these funds launched and to raise money in a very difficult environment.

After a record year in 2015 for investment banking the market environment in 2016 was a little bit different. I think we talked about this over the course of the year.

But the industry experienced really a muted capital raising environment which lower investment banking fees were across the board, particularly in our areas of focus which are primarily on the equity capital markets. As we mentioned, we have used that down turn to expand the business and invest in key areas as talented individuals and teams and businesses have become available to us. So in the broker dealer we spent nearly $19 million in new business initiatives to scale and diversify.

That $19 million is separate apart from the acquisitions we made and really didn't have any appreciable revenue attached to it for the year. So in investment banking we really had an opportunity to focus in areas such as tech, consumer, industrials and healthcare. We also focused on adding some new M&A capability. So over all we recruited over eight managing directors, including a new head of debt capital markets, a new financial sponsors team and a brand new consumer investment banking capability.

We acquired the credit products and credit research, as we mentioned, from CRT, brought on Washington Research Group to do policy research, which has really turned out to be quite timely, and added the merchant banking team from Morgan Joseph TriArtisan. We also invested a bit in our electronic trading business and staffed a new equity finance business as well as an international prime brokerage unit. So point being, I think if you look at our results it's really important to understand that a lot of the results we had and the losses we incurred with the broker dealer are really investing forward to broaden the platform and create a more meaningful opportunity for us to take advantage of some of the things we are seeing over the longer term.

While we still need to close on our backlog, I would say to you that this year, especially in investment banking, our backlog is the largest it's been since we have been doing this. And we are seeing the diversification both by industry as well as product side. And so it remains very encouraging to see that the investments we made and the teams that we made have not only brought transactions with them but were able to initiate new transactions on our platform that should tee us up to have hopefully a much different 2017.

To review 2016 though in particular, I think it is worth noting that proceeds raised for IPOs in the US in our sectors was about $129 billion which is a 32% decline from 2015 levels. And the healthcare sector, which as you know has been the real driver of equity capital markets, not just in Cowen but across the board, declined 58% during the same period. But even with the decline in healthcare it was one of the two sectors, the other being energy, that were the most active in the capital markets.

And I think we did pretty well in focusing in what was a difficult environment. The ECM business actually posted its third best year since 2009 and in healthcare, despite the year-over-year decline, we actually gained market share. For the year we closed 76 transactions compared to 129 in the prior year period. In 2016 we were a book runner on 55% of those transactions which is similar to what we did the prior year.

As expected, 2016's revenue mix was weighted much more towards follow-ons and IPOs and continuous shelf offerings also emerged as an important avenue for clients who opportunistically raised equity capital in an uncertain environment. And this is a business that we started about four years ago and it's really been showing tremendous traction.

Our debt capital markets was essentially flat year-over-year and we are very confident that with the new DCM leadership in place and new senior bankers that we align quite well and as well as the addition of a fixed income distribution capability from CRT, we are very optimistic on the outlook for this business as we look to expand our capabilities there.

And we think that in doing so over the course of 2017, which is one of our big strategic initiatives, it will grow our M&A business meaningfully and we have chosen to do that organically. So our M&A business actually did grow year-over-year about 11%. We closed 15 transactions compared to 13 a year ago.

And we're showing pretty good improvements in both fees and sector contribution. It's still small so we made several new additions to our team to significantly deepen our M&A effort. And as I said earlier, we ventured the year with our strongest M&A backlog yet since we've been doing this.

Turing to our institutional equities business, which includes equities, prime brokerage services as well as credit research and trading, which we acquired this year, our brokerage business experience year-over-year growth as it benefited from the full-year contribution of prime services formed in 2015 and the contributions from the businesses acquired from CRT in May of 2016. The equities revenue, which includes cash equities, electronic trading, special situations, options and convertible trading, increased 7% in both the fourth quarter as well as the full year. And according to the latest market research, we again grew our market share even as the wallet for US commissions showed a sequential year-over-year decline.

We were one of the very few firms that actually took market share in the year. So it's very impressive to see us be able to do that in a tough environment and really reaffirms the belief that the investments that we are making actually are extremely relevant to the clients we serve. We broadened our coverage to include credit for acquisition of CRT and have added the macro commentaries we mentioned earlier.

So at the end of the year we covered 745 stocks plus 150 in our credit research team. The macro policy area really targets a very different wallet than the one that we historically have done at Cowen and we think this is a tremendous opportunity for us to leverage our distribution network by attracting revenues from people at our existing clients that generally have been paying us. And already the early results we are seeing from both accounts -- with our accounts are encouraging. So hopefully we can get those translated into revenues early in 2017.

In electronic trading we made two important hires which include the new head of training services and the head of market structure which is a new position we created. And our view is that the product road map will really incorporate market structure with these product enhancements as wells as customized solutions. Increasingly, this is a very important part of being able to access the wallet at the buy side and we have already had a number of significant client wins in 2017.

The prime services business continues to develop nicely as the bulge prime brokers have cut back their support of smaller hedge funds. The fee compression at hedge funds means that managers are really seeking different solutions from their prime brokers and we have actually found that we can be an ideal partner for these managers. Our institutional brand adds a lot of credibility with clients and our client base, as it matures, has increased access to Cowen resources such as research, corporate access and things that have become more important as these clients scale.

The pace of new client wins picked up following really a summer lull and customer assets were $7.2 billion at the end of the year which is up 7% year-over-year. Now that does include the natural attrition of accounts that we have either removed or the ones that have closed. But we are excited about the fact that our clients seem to be performing reasonably well in this kind of an environment. We also began onboarding our first international prime brokerage clients. And that's going to be an area for us that we think can be significant growth.

Our credit platform performed very much in line with our expectations. We acquired the platform, as you know, in May 2016 and we focused on distress training in emerging markets as well as special situation equities and trade claims. With the credit platform under Cowen's umbrella for nearly eight months, we generated 19% of the revenue in that organization from the client network.

So it shows that taking the cross selling capabilities and the cross pollination of efforts, the cross asset research and the collaboration is beginning to pay dividends. And so really excited about the possibilities as we head into 2017. And as we plan to further integrate those credit products into our distribution network, I expect that we will see some significant improvement there as well.

So I know that's a lot to digest. So I'm going to turn the call over to Steve who will walk you through our financials more specifically and then I will be back to close it out.

Thank you, Jeff. In the fourth quarter 2016 we reported a GAAP net loss attributable to common shareholders of $3.6 million, or loss of $0.13 per diluted common share, compared to GAAP net income attributable to common shareholders of $28.9 million, or $1.03 per diluted common share in the prior year period. Fourth quarter 2016 GAAP revenue was $122.3 million, compensation and benefit expense was $92.7 million, G&A and other expenses were $52.4 million, net gain on investments was $14.3 million, income tax benefit was $12.5 million and income attribute to non-controlling interest was $9.4 million.

For the full year 2016 we reported a GAAP net loss attributable to common shareholders of $26.1 million, or a loss of $0.97 per diluted common share, compared to GAAP net income attributable to common shareholders of $39.7 million, or $1.37 per diluted common share in the prior year. Full-year 2016 GAAP revenue was $471.6 million, comp and benefits expense was $310 million, G&A and other expenses were $198.7 million, net gain on investments was $23.4 million, income tax benefit was $19.1 million and income attributable to non-controlling interest was $6.9 million for the year.

In addition to our GAAP results, management utilizes non-GAAP financial measures which we refer to as economic income. Management uses economic income to measure our performance and to make certain operating decisions. In general, economic income is a pre-income tax measure that excludes the impact of accounting rules that require us to consolidate certain of our funds, certain other acquisition related adjustments and reorganization expenses, goodwill and intangible impairment and preferred stock dividends.

The remainder of my comments will be based on these non-GAAP financial measures. In the fourth quarter 2016 the Company reported economic income loss of $12.9 million, or $0.48 per diluted share. This compares to an economic income of $15.2 million, or $0.54 per diluted share in the prior year period. Fourth quarter 2016 economic income revenue was $128.1 million compared to $160.7 million in the prior year period.

Investment banking revenue was $35.1 million compared to $36 million in the fourth quarter of 2015. Quarterly brokerage revenue rose 11% year-over-year to $53.6 million. Management fees were $17.3 million compared to $18.8 million from the prior year period. Incentive income was $7.1 million compared to a give back of $462,000 in the prior year period.

And investment income was $4.6 million compared to $43.5 million in the prior year period. Other revenue was $10.3 million compared to $14.7 million in the prior year period.

For full year results the Company reported economic income loss of $28.7 million, or $1.07 per diluted share. This compares to economic income of $34.5 million, or $1.19 per diluted share in the prior year period.

Full year 2016 economic income revenue was $467.6 million compared to $529.7 million in the prior year. Investment banking revenue was $133.3 million compared to $222.8 million in 2015. Brokerage revenue was 29% higher year-over-year at $207 million. Management fees were $67.2 million compared to $70 million in the prior year.

Incentive income was $26.3 million compared to a give back of $1.5 million in the prior year. Investment income was $4 million compared to $62.6 million in the prior year and other revenue of $29.8 million compared to $15.4 million in the prior year. Comp and benefit expense for the year was 64% of economic income revenue compared to 60% in the prior year. Variable non-comp expenses in 2016 were $61.2 million compared to $56.2 million in the prior year.

The increase was primarily related to higher floor brokerage and trade execution cost due to higher brokerage revenue and increased marketing and business development expenses, most of which is related to acquisitions during late 2015 and during 2016. Fixed non-comp expenses, excluding depreciation and amortization totaled $101 million in 2016 compared to $94.2 million in 2015. This increase was due to higher communication and increased occupancy costs both of which are primarily related to acquisitions, again, during late 2015 and during 2016.

Depreciation and amortization expense increased $1.5 million in 2016 to $11 million and this is related to the acquisitions that we made. GAAP stockholders equity decreased by $14.9 million to $773 million at 12/31/16 from 12/31/15. Common equity, which is stockholders equity less the preferred stock, was $671.3 million compared to $688.7 million at December 31, 2015.

Book value per share, which is common equity divided by shares outstanding, was $25.11 per share compared to $26.09 at December 31, 2015. Tangible book value per share, which is common less goodwill and intangible assets, was $21.88 per share compared to $22.90 at 12/31/15. Invested capital was $657 million as of December 31, 2016 verses $731 million a year ago. I will now turn the call back to Jeff for closing remarks.

Thanks, Steve. If you look at our history, the way we have grown the organization has been really quite methodical and we are certainly in a better position today to perform over the market cycle. I think the challenge that we face is always how do we manage for quarterly results versus doing what we think is the right thing to do to grow the business over the long term.

And our view is that if we can invest in and retain and attract really talented individuals to deliver really unique ideas to the clients that matter, that's a winning strategy. And there's sometimes when you have opportunities to invest in those folks at times when revenues are a little bit delayed. And that's certainly really the story for us in 2016. As we said in our third quarter call, it really does take courage to invest in times of market turmoil. While others are eliminating businesses and shrinking themselves, we have had the opportunity to actually grow top line or grow our investment to drive our top line revenues for longer term growth.

And the fact that markets we serve are cyclical in nature has not really deterred us from trying to create long-term shareholder value. We are not where we want to be just yet. We have made good progress despite the bottom line results. But we are more confident in our ability to scale today than we have been in any other time.

And I think I want to echo Peter's comments earlier. The existing results for 2016 I think don't exactly show you the enthusiasm we have as we come into 2017. We are fortunate that our strong capital position provides us with flexibility to invest in the long-term as we look to advance each of our businesses. And we're taking the opportunity to do that across the platform on a very targeted basis as we look at the opportunities in investment management, banking and research as well as equities.

We'll continue to look for businesses that we think can add margin and scale to our fixed cost structure which is really critical for us. But at the end of the day, it starts with hiring and retaining the best talent and driving our core businesses and making sure that when we do, platform synergies like the acquisitions we've made over the last few years that they're accretive out of the gate, which is what they have been. So in a sense, as Peter mentioned, we are seven years into really creating the network effect that we think is going to be the firm of the future. And 2017 is all about nurturing the investments we have made and harnessing our energy towards the areas we believe we can have the greatest impact.

I just want to close by saying to everyone at Cowen who worked so hard to make this place the best place to be on Wall Street, we just want to say thank you. Really without the efforts of you on a daily basis, none of the efforts that really we would do at all matter. And we have so much really more to do and frankly we are just getting started. So with that I will turn it back to the operator and we will open it up for questions.

(Operator Instructions)

Devin Ryan, JMP Securities.

Great. Good morning, everyone. Maybe just starting here, bigger picture, clearly a lot of headwinds in the backdrop in 2016. You guys kind of went through a number of those. But if we are looking into 2017 and you make the assumption that the base case is maybe a more functioning capital markets backdrop and 2016 was more of an aberration and then maybe you start to see some contribution from all the recent hires that were expensive in 2016 and so they're contributing in 2017, how are you guys thinking about where operating margins should be?

Or what are the targets? And wow would you like to see the trajectory for the ROE as well?

I will take a first stab at the operating stuff and then we can tell you what we're thinking about. I think a lot of it starts from your first part of the question. When we talk about the growth initiatives we've made, I think the goal for us is to have a more diverse revenue and be a little bit less dependent on ECM and the challenges and cyclicality of that business.

I think I've said it on numerous occasions, the fact that we are focused on healthcare is a wonderful thing because those companies in particular that we bank have to raise money regardless of the market cycle. And so it really does underpin a lot of what we are doing. The fact that the rest of the ECM market outside of healthcare was so dismal last year, the fact that we still did a reasonably good year suggest that we picked the right industry to focus on and we'll continue to do that.

I think will see M&A be more meaningful. You will certainly see our business diversity pick up across sector, just based on the way that the backlog looks. I think a lot of our margin growth depends on how we also end up doing through investment income and investments on the balance sheet. So hedge fund performance was very difficult last year.

I think our investment income really, notwithstanding some of the challenges and specific things that happened to our balance sheet, investment income should be a more meaningful contributor this year in an environment where this is a lot less volatility, frankly, in the markets given the fact that we don't have an election cycle to worry about. So when we look long term, the investments for us -- this is still very much a high single digits margin business at the end of the day. And I don't know that's going to change much.

This is why we think scale is so critical and so important to us. And that's why we have made acquisitions in the area. We can take out significant costs and add synergies. So long-term, I would say our goal it to be double digit ROE. I think a lot of that is still going to depend on how certain other businesses perform.

But if we end up in a situation where hedge fund performance and, in particular the performance of our funds does well so that our balance sheet does well and we have incentive income, you will see it at the higher end of the margin range on a much higher ROE. And if it turns out that's fair to mid laying and the rest of the businesses kick in and we drive M&A volume and investment banking in other areas, I think you will see some margin expansion.

If it turns out that remains muted, we are still in a position where we'll be able to make sort of mid single digits margins and the ROEs will be a little bit lower. But our goal over the long haul is really to drive double digit ROE on a consistent basis. And as Peter mentioned, really critical for us to be able to drive investment performance on the balance sheet as well as incentive income at the asset manager.

Devin, let me add some things here that won't be easily obvious looking at the numbers. We suffered during the entire sort of election cycle with this very populous notion and I am not picking on Trump here. I am picking on both candidates or all candidates, if you will. One of the great things is drug pricing and they kept harping on that.

And that put a pall over the whole drug industry which made it difficult to bring new companies to market. It had an adverse effect for sure on our merchant banking activities where we have a portfolio that's not insubstantial in pre-IPO and some public biotech companies that we had financed as pre-IPO. That cost us some real money on the balance sheet.

So I think that's behind us now and if you look at grappling with getting control of healthcare costs, one of the things that the administration's talked about is expediting the whole FDA process. That has to happen. That's good for us. Something you will not be able to pick off from the numbers is that our variable non-comp costs related to executing our equity transactions was the lowest this year in 2016 than it's ever been as a percentage of revenue.

So we're getting economies of scale out of that. Another thing you won't see that if you had backed out -- could back out, all the fixed investment we made in other areas, whether it was CRT or getting the equity finance business up and running or the full-year effect of the prime services business on it, you backed out of those fixed expenses -- non-comp expenses related to those, our fixed expenses actually went down during the year. So we are starting to get leverage out of our cost structure.

There are things that whether or not we have a tax bill this year or next year there will certainly be things in tax bill that will be very good for the M&A world, for the financing world, because they're talking about lowering the corporate -- and they will lower the corporate tax rate. There will be some kind of tax holiday for repatriation of overseas liquidity. And that liquidity is not likely to get passed out in dividends because that's what managements don't like to do. They like to buy things.

And so I think that we are in a much better position to participate in the M&A side and certainly from the merger arbitrage side. And I don't want to leave anyone with the impression that our balance sheet is swinging around doing things that aren't related to our business. Our balance sheet is dedicated to our business. So the money that we have aligned with merger arbitrage activities where we took the hit in Pfizer-Allergan is asked to seed and grow that business. And it has grown.

In spite of April's performance, we actually grew merger arbitrage over the course of the year. We on-boarded a very talented woman named Samantha Greenberg to join us in a long/short TMT consumer-based business. I would say from my limited experience over 48 years, the best risk manager I have ever come across. And we have seeded her with a fair amount of capital and she's doing really well. She didn't go live until late in the year.

Everything we do with our capital is to grow AUM or grow a business somewhere. So we do have a fair amount of capital committed to the merchant banking activities of the firm. We have new investment themes that we think we can build fairly robust, I would say, customer assets around. It's going to take some seeding using the firm's capital.

Real estate is an example where we are now -- we just had our first close on our sixth debt fund. We've lent $4 billion over the last 22 years in mezz lending. Our sixth fund is going to be about $0.5 billion fund just closed on the first I think $245 million or $250 million.

One of the things people always want to see is that our money is in there. Finally, because our record is so good, the amount of money that we have to put in is substantially less. We used to put $25 million into those funds. Now this fund we're probably only going to put $5 million into.

And I just -- take this for what it's worth -- don't misread last year's results as being indicative of the strength and depth and breadth of what this firm is capable of.

From my vantage point and -- look I am not happy with last year's results but we have never been in a stronger position. And all the new businesses we have started are really -- they're not growing sprouts, they're growing tentacles. Now whether it is a prime services business, which is really starting to take off and suffered last year with declines in volume and volatility in the markets, or it's our reinsurance business that we have in Luxembourg, which is now a real business and is profitable and growing, or this little business we started in the bespoke aircraft finance leasing business, special mission aircraft, has tremendous potential, was profitable for the full year and will grow I think substantially during the year.

So a lot of the seeds we planted are up through the ground now and I am pretty charged up. I am very charged up about it. So there is a lot you can't see that's happened. And all I can say is don't over read what did happen.

Okay. We appreciate you guys walking through all of that. Clearly a lot of things in the backdrop that you can't control and you hit on the commentary around drug pricing and maybe we're moving into a better backdrop from the comments late last year. But how should we think about the timing? What are you guys looking for to maybe give the signal that the window is reopening?

Because that just is such a big driver of business as we look out over the next year here. You kind of need to see the equity issuance window reopen. So I am curious what you guys are looking for. I know that your corporate clients have a time line around they have to raise at some point. But just what are you thinking about a time line of them actually getting back out and being on the market?

I think that a bunch of them are already doing it. I know what the queue looks like and I know that there is a wave of companies that will need to go public this year through the IPO. So I think we are already starting to see that. I think everyone expected -- maybe people expected 2015 to be repeatable. I didn't.

As I look at the business from healthcare, I think it's a pretty stable business and it has upside potential from it. As far as I am concerned, that window continues to be productive. The thing that I would say we'll see is in technology and a few other areas, consumer and a bunch, there's more companies -- and we're doing more sort of org meetings in other areas for ECM than we've done all year last year.

So I think people are queuing up to take advantage of where the equity markets are for sure. And so we're seeing a lot of activity there. I do think though that for us this is the year in which our M&A business should be in a position where it's meaningfully different. And we haven't really put players on the field to grow M&A franchise. We talked about this over the years.

We've resisted the temptation to buy M&A advisory firms for a lot of cultural reasons. And so rather we have been hiring people organically which is a longer and a tougher row to hoe but it really preserves your cultural integrity. The people that we put in the field last year and this money that we spent last year investing in these other sectors is really to drive M&A activity and financing activity to be less dependent on healthcare.

So to me, if I looked at the backlog and the opportunity, I just think we're less dependent this year on some window reopening in a meaningful way because the backlog is more diverse in industry and more diverse from product. Meaning I expect there to be more M&A capabilities given the people we put on the platform in the last year.

One last thought from me before the next question. Two nights ago SoftBank made this announcement, they were acquiring Fortress. You can read about it in the paper today. That's a pretty significant transaction, not because it's SoftBank and Fortress, but it's indicative of an appetite or a desire on the part of very liquid foreign institutions wanting a bigger window on the United States and a way to deploy capital into the United States.

And I think I don't know whether it is three months or a year from now but you will see more transactions like that occur, in my opinion, as sort of this build up of liquidity in Asia wants to find more efficient way to get into the US and a more focused way. I can tell you just from the inbound inquiry we get that the area of greatest interest on the part of people we speak to is in pharma. People keep coming to us -- how can we engage with you in expanding our pharma business into the US? What can we acquire? What can we bring back to Asia?

So I think there's going to be some very interesting things that will happen around the industry. And there are only really a limited number of places it can happen. It's not going to be the big banks because they're too complicated and there is no coordination. And they all have their own presence over in Asia.

And among the smaller mid-sized banks there is a limitation because of cultural differences that probably are pretty profound. But we have a history of working very well with foreigners, having basically grown Ramius substantially in Japan, having had a presence in China. And I expect some good things likely to happen to us over the course of the next year or two with respect to that.

To Peter's point here, we made a very conscious choice last year to invest in comp and non-comp in areas we knew would not generate revenues. And if you look at our fourth quarter numbers, I think as we've highlighted, the compensation number in the fourth quarter reflects the fact that we made a conscious choice to do that.

Others made a decision to acquire franchises as a way to gain talent on the platform. While we have done that in certain areas as it relates to investment backing and research and some of the things we've done, we have made a different decision which we think is one that over the longer term is less disruptive to the culture potentially and more collaborative. So what Peter is saying --

And protects our capital.

Yes. What Peter is saying is other -- the inbound inquiry that we are hearing from Asian investors and from pockets of capital is coming to us in large part because there is a significant amount of content in this organization that knows where to go to find transactions. We have been angling that content today largely at two markets: ECM and equity commissions. And those, as we have highlighted, have been some of the two more challenging markets.

But as we broaden out our capabilities on the asset management side and broaden out our capabilities in terms of debt capital markets and leverage finance and M&A, that's when you begin to leverage off of this content delivery network that we have been building. And so when you see this -- we could have made some different choices to not enhance that network at the end of the year and our results would have been different. So that's why when we talk about -- when Peter says stuff like don't let last year's results give you an indication of what we are doing, that was a very conscious choice on our part to invest through the cycle. And I have no regrets about it.

I would have liked for certain revenue items to come in in the fourth quarter but I have no control over when some of those things happen. So it just looks like we made big investments in people. But we knew going in that those would not be driving revenues in the short term and that was the conscious choice we made last year.

Got it. That's great color. I really appreciate it, guys. I will hop back into the queue here. Thank you.

(Operator Instructions)

Steven Chubak, Nomura.

Good morning.

Hi, Steve.

Jeff, I was hoping to get a little bit more insight into what you're seeing in terms of the backlog. You noted that for as long as you have been tracking it, it appears to be at a record. The messaging around M&A clearly sounds quite constructive. But as you noted in one of your earlier comments, ECM has really been driving the bus for a while.

And as I look at the revenue trajectory, you had an IB revenue number that was north of 200 -- just a few -- I guess just last year. And I am just trying to think about as given the decline of 40% we saw this year, could we get back to that record level? Is that how you are thinking about it given all the new investments that you've made or is it going to really be a function of the mix?

I would say first of all I am not expecting to get back to the record level because that was largely driven off of probably the best biotech market in the history. So we are not building this firm with the expectation that's going to be the new normal. We have invested in other areas where we see opportunities in ECM and I will say that we've got better ECM backlog outside of healthcare than we have had in a long time.

And that's just indicative of the fact that there is a cycle coming where people want to raise equity outside of healthcare. And we're in position with people to take advantage of that in spots like consumer and industrials and in technology in particular. I think that for me as it relates specifically to the backlog comment, M&A is such a vital part of the universe in sectors both in healthcare and outside of healthcare. And we have to be in a position where we put people on the table who actually understand how to drive M&A processes.

And so when I look at the backlog, what I look at is I take a look at a snapshot at the beginning of the year. We really only roll the backlog six months forward. And we do it only where we have mandates. So when I talk about the backlog, I am talking about mandated backlog, six months forward at the beginning of each year for the last six years. This is backlog that looks the best it's ever looked by a multiple. And we will definitely not close on it all.

By definition you never close on 100% of it. But even if we come anywhere close to closing at the percentages we've historically closed on, it's a very meaningful different number in terms of M&A and in terms of some of the other financings that we would be doing. So my optimism is based on the fact that I can see a very different product mix based on the people that we have hired over the course of the past year.

And we're going to be less dependent on having ECM or healthcare ECM in particular have the kind of year that it had in 2015 in order to drive margins in the business. I will also say this, that option always exists. So the fact that we were able to produce that kind of revenue on this platform suggests that if the market is there for that, the fact that we have all these clients, we are certainly in position to capture that.

And if you look at what we did in 2015, I don't think there was a deal that we didn't do that we wanted to do. So for us, this is about making sure that we are capturing the right kind of market share. And I don't think there was a bank that captured more market share in healthcare ECM in 2015 than -- sorry, 2016 than we did. So I am always looking at -- I can't really control what markets will do. But what I can control is how well we attack those markets and are we in position to ensure that we capture the most of what we want to do.

And even in a year like 2016, we did, certainly in healthcare. And so I would say if it turns out that drug pricing policy is finally put to bed and people stop talking about it and capital flows back on that business, there will be no shortage of companies we see that want to access that market. The new drug applications coming over the next four years are going to be intense. And these companies really want more than ever to be able to be independent longer to develop commercial strategies longer before they sell.

And so I think there can be -- there is upside optionality to the number we did in 2015 just by virtue of the fact that we were able to do what we did in an environment that had massive political over hang and drug pricing debate policy and one in which we took shares. So I am not counting on it. In other words, it is not going to be central to our strategy. But upside potential from what we did 2015 is certainly there if the markets come around.

Got it. And thinking about the capital management priorities, you guys noticed a number of opportunities to invest and where you wanted to maybe enhance your capabilities, how are you trying to balance share repurchase and maybe even inorganic growth pursuits and other acquisitions? Just trying to get a sense as to how you guys are focused on looking to grow, where you are deploying all your additional capital going forward or how it is being allocated.

Let me start by saying I think we have slowed down the stock purchases. And part of that is because we recognize we have more ways to put our capital to work in businesses that are more capital intensive. Our job is to be able to drive margins in the business. And the easiest way for us to drive margins in the business frankly in the short term is to put our capital to work, make money on that capital because that's the highest margin business. The compensation ratios on investment income are the lowest at the firm verses let's say ECM and equity commissions are probably the highest.

So if you can put money to work off the back of your distribution network and you origination network in a way that doesn't risk the firm's balance sheet meaningfully, that drives margins pretty significantly. We are only levered if you take a look at our balance sheet and you rip out some of fund consolidation that has to happen, we're levered like two to one which is really low. And we do that because we are conservative and we want to make sure that we have a solid balance sheet so that we don't ever get ourselves in a situation where people are concerned or employees are concerned.

I think that's been a huge benefit to us in terms of being able to attract and retain talent that we have a stable balance sheet and a stable platform. Growing into the equity finance business is an area where we can continue to, again, leverage off our fixed cost structure and put capital to work. So would defer -- we are opting to do things like that and really drive the return on the balance sheet more so than stock buybacks. Stock buybacks you get a short term bump in that.

You sacrifice your ability to effectively drive margin in the business with some of the more obvious spots. I would say we continue to look at leverage finance as an area for us to expand. And that's certainly given our origination capability, it's an untapped opportunity for us to put some capital to work in areas we can really drive the debt capital markets business more meaningfully. Again, we will do that in a very conservative way and in a way that really leverages our capital base but it requires us to have capital.

And then finally I would say as we have a new head of asset management and as we begin to look at the strategies that we are deploying in asset management, there will be chances for us to either acquire or launch new product that would require us to essentially put capital to work in those businesses. And so as we look to drive margin, I think capital utilization is really critical to that. And we are opting to do that more so than maybe buying back stock in an environment where we really feel like we need to drive margins through the use of capital.

And thinking about that margin focus that you just outlined, Jeff, I know you made some earlier comments about the pretax margin trajectory, just want to get a sense as to what comp target we should be thinking about in a better revenue backdrop where there is still this need to continue to fund some new investments. I know you had talked about low 60s in the past. Is that a reasonable expectation for this coming year or could we see even more comp leverage than that?

So I think we got down to below 60s when we have strong balance sheet years. I think a lot -- really the difference between low 60s and high 50s is largely how well we do on the balance sheet. Again, you can see it really shows through in terms of the contribution margin of investment income. We're still targeting that area.

I think it's really critical for us to make sure -- and we communicate this internally -- really critical for us to be able to be around that area long term. Obviously this year in the broker dealer segment was much more significant because we made these investments in individuals that didn't drive any revenue. And I feel like it is very, again, a conscious decision.

So I think we are not looking at making organic investments the size and the scale of what we made in 2016 in 2017. Now it's not like we didn't reposition and take costs out. We continue to do that.

But I think as we look at our business, to be as an overall firm to be in the low 60s, if we do better on the balance sheet I would say probably increase into the high 50s -- that's kind of the range. If it lags a little bit I can see it moving a little bit higher into maybe the sort of mid 60s but I don't see it being much higher than that long term because that's just not a place where we want to be.

Got it. And just one question relating to your tax policy changes and looking at the balance sheet, the DTA still comprises a pretty substantial portion of your overall book value. I think it's around 20%. There has been discussion around possible write downs in the event we do see a reduction in the US rate. I didn't know if you guys could give us some numbers or put some numbers behind it in terms of what the potential write down could be if we see maybe 10% reduction in US corporate tax write.

If the rate goes down to 25%, it would be about a $35 million adjustment. And if it goes down to 20%, it's about a $50 million adjustment.

Perfect. That's it for me. Thanks for taking my questions.

Thanks, Steve.

Thank you. That concludes our Q&A session for today. I would like to turn the call back over to management for any further remarks.

Well I think we have said it all. Again, we're disappointed but at the same time we feel very good about where we are. So we look forward to speaking to you after the first quarter and hope we can demonstrate that a lot of the things we talked about are going to bear fruit.

Thanks, everybody.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone, have a great day.