Cowen Inc (COWN) 2017 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for joining Cowen Group, Inc. Conference call to discuss the financial results for the 2017 first quarter.

By now, you should have received a copy of the company's earnings release, which can be accessed at Cowen Group, Inc.'s 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 concern forward-looking statements.

These statements are subject to the risks and uncertainties described in the company's earnings release and other filings with the SEC.

Cowen Group, Inc. has no obligation to update the 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 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.

Reconciliation of those measures to GAAP is consistent with the company's reconciliation, as presented in today's earnings release.

Now I will turn the call over to Mr. Peter Cohen, Chairman and Chief Executive Officer.

Thank you, operator. Good afternoon, everyone. Thank you for joining Cowen First Quarter Earnings Call. With me as always is Jeff Solomon, President of the firm; and Steve Lasota, our CFO.

In the last earnings call, we said that in 2017, we would begin to see the benefits from the investments we made in 2016. We'd look to create scale organically and through acquisitions and opportunistically deploy capital towards opportunities that support our core businesses.

We are definitely making progress on each of those fronts. The investment management business continued to attract new assets, and we are incubating new capabilities by cross-pollinating expertise across Cowen. Investment banking activity rebounded, and we are continuing to see the revenue and diversification; benefits from newer banks, newer bankers added to the platform. And the brokerage business performed well in a very difficult environment for equities.

And with the Convergex acquisition, which we announced in April, we expect that our increased scale will unlock significant economic benefits by providing greater top line resilience and financial performance through market cycles and improve profitability from cost synergies.

Investment income had a productive quarter as our various strategies performed well in the quarter, and the announcement in March of a strategic partnership with China Energy Limited known as CEFC China, which includes a $275 million contribution of capital to the firm, is expected to accelerate growth in our core areas of expertise: banking, equities research and investment management. CEFC China's investment is subject to approval from the committee on foreign investment in the U.S. and certain other customary regulatory approvals, which will take some months to achieve as there is a process that has to be gone through.

Now for a summary of our First Quarter results. Cowen reported economic income of $5.5 million or $0.19 per diluted share compared to economic income loss of $4.9 million or $0.18 per diluted share in the prior period last year. Economic income revenue was $129 million, which compared to $106 million in the first quarter of 2016.

Now reviewing the results of the investment management division. In general appears that outflows from hedge funds, which reached $106 billion in 2016 have slowed a bit in the first quarter. According to industry data, investors redeemed approximately $5 billion in January 2017 compared to $19 billion in January of 2016.

The HFRI equity index was up 3.8% for first quarter of 2017. In the first quarter 2017, our investment management business grew total assets under management by $170 million, $10.7 billion as of April 1 last year. That number excludes these assets which were sold when we sold our solutions business, RASL, to Sanford Bernstein.

Our long/short equity fund focused initially on the communications, technology, media and consumer sectors continues to gain traction from investors. Just after the end of the first quarter, the fund was approved and became available on the Morgan Stanley and Merrill Lynch wealth management platforms with a combined capacity that we've allotted them of over $300 million between the 2 firms. The merger arbitrage we delivered strong results and saw modest inflows in the quarter.

Real estate had its first close in February of its 6 mezzanine debt fund offering. We expect the second close in second quarter of this year.

Our health care royalties business had a record quarter for the amount of capital committed to new deals, putting them in a position to probably raise a substantial amount of new money next year, which will grow their business base substantially. Our consumer-focused long/short equity strategy is developing a separate managed account business even as we close the comingled fund due to a lack of interest.

And during the quarter, we exit our partnership with State Street, which is really a managed features platform that had literally no assets under management. So, it made no sense to continue it. We're unable to gain traction on the State Street platform. So we exited the business.

In coming weeks, you're going to -- you will see us rebrand the firm from Cowen Group to Cowen Inc. You will see us change the name Ramius to Cowen Investment Management, and the purpose behind all of the rebranding we're going to do is to unify the view of the firm, integrate investment management and to the broader Cowen organization and utilize a lot of the resources that are available more efficiently. We really want to put forth the one brand concept here.

We believe this effort will better reflect opportunities among all of our businesses, especially as we develop capabilities and investment offerings that leverage the expertise and resources of the group.

Moving to the investment management part of our business, investment performance part of our business for the quarter, we generated $21.6 million in investment income compared to $1.9 million in the year-ago period, and this was achieved kind of broadly across all of our strategies.

If you have been following us for a while, you have seen our platform grow organically and through acquisition over the last 2 years, something we said we would try and do. In 2015, we acquired Concept Capital and Conifer Securities to create Cowen Prime Services. In 2016, we acquired CRT's credit products, credit research and special situations and emerging markets units, which is doing very well under the Cowen platform. And in addition, last year, we welcomed the team from the Washington Research Group and the merchant banking and investment banking teams from Morgan Joseph TriArtisan to the platform.

And thus far, in 2017, we announced the acquisition of Convergex, as well as the strategic partnership with CEFC China. With this broader, larger platform, we are focused now in driving profitability and cost effectiveness as we think that we have substantially enhanced the critical mass of the firm.

Before I turn the call over to Jeff as always, none of this would happen without the hard work and dedication of our colleagues, and I want to again thank them, as I always do, for what they do to help make a big difference in Cowen, a place we all love to work. So with that, Jeff?

Thanks, Peter. Following a muted capital-raising environment in 2016, investor appetite for new issue was much improved in the first quarter of this year. The increased activity largely centered around follow-ons, while IPO activity outside of a few marquee public deals were still relatively modest.

Total equity proceeds raised in the United States for IPOs and follow-ons in our core sectors is about $25 billion, which is a 68% increase in the prior year period.

134 transactions were completed across these sectors compared to 63 in the prior year period. And with the generally improved market conditions, our ECM business was up 42% year-over-year, recording its best quarter since the third quarter of 2015. In total, we closed 23 transactions compared to 12 in the prior year quarter. We were a book runner on 61% of those transactions compared to 50% in the year-ago period.

Our revenue mix, which is weighted towards follow-on offerings, reflects the current environment and in addition, our clients are utilizing continuous shelf offerings as an avenue to raise capital opportunistically, and we've seen revenue grow meaningfully in this area.

Our mergers and acquisitions business continues to experience good momentum. And the bankers that we've invested in over the past 2 years are beginning to season on our platform and are contributing to 2017 revenue, especially as we head into the second quarter.

To give you a sense of the momentum, in late March and early April, we advised 2 M&A transactions totaling $1.3 billion in transaction value, and these are the 2 largest deals we've advised in many years, and will represent significant fees for the firm when they close later in this year. So they're not in the first quarter numbers.

Our M&A backlog remains quite strong, and we replenished -- more than replenished our execution over the past month. And we need to obviously convert those that backlog into fee, but it remains very upbeat for the remainder of the year.

Turning to our institutional brokerage business, which includes equities, Prime Services and credit. With respect to the general environment for equities, volumes have been lower across the industry than they were in 2016.

For a point of reference, New York Stock Exchange NASDAQ composite volumes for the first quarter were down 18% year-over-year, and the preliminary figures for the first quarter of '17 from a leading market research firm point to double-digit year-over-year declines in commissions for the entire industry. And we've been saying for a while that we expected to be continued fallout from smaller competitors, and there clearly has been. We are aware of at least 4 research providers who've exited the business thus far in 2017, and we estimate collectively that they represented about $100 million in annual commissions.

Our platform, which is a fully scaled research focused business providing active managers with sophisticated insight and domain expertise had translated our brokerage business into a brokerage business that has performed much better than the industry average. Our total brokerage revenue declined only 1% year-over-year, aided by contributions from credit and research trading businesses acquired last year.

Our core equities revenue business, which includes cash equities, special situations, electronic trading, options and converged only decreased by about 8% in the quarter versus 18% for the listed volume decline mentioned earlier. This environment reinforces our rationale for the Convergex transaction, which will provide us not only with meaningful scale but a platform where we will have a created a unique equities franchise offering high-quality research and sophisticated nonresearch-based agency execution capabilities on the same platform.

There are very few firms our size that offer similar value proposition to clients. As the buy-side continues to consolidate their broker commission towards the most important providers, we believe we'll be a major beneficiary given our strong research capabilities as well as our position as an important liquidity provider.

Our strategy's playing out as expected as we continue to gain share with key accounts. In many instances, we are already a top broker for important buy-side accounts. Based on a research footprint, we do have room to grow with them on the trading wallet. And with Convergex, we'll be in a position to further penetrate existing and new accounts as there is very little overlap in our existing client base.

In Prime Services, client assets in custody and clearing firms exceeded $7.5 billion, and our newly launched international prime brokerage already has begun to show some traction as we've gotten important client wins. This credit-rating business through acquired last year, and it specializes primarily in distressed emerging markets and special situations and trade claims remains episodic in nature but is performing well in this environment. It is something that we think will be -- continue to improve as we see increasing volatility.

And then as we approach the 1-year anniversary of the acquisition of these businesses from CRT, it has clearly been accretive to our operating performance as we've been able to eliminate cost meaningfully, and I think that's important as we look forward to the consolidation of Convergex into our organization. This is clearly a management team that understands that in an environment, in which we don't expect the markets in which we operate to expand meaningfully, we have to be acquiring growth inorganically and taking out cost structure. Certainly, we've been doing that with the acquisitions to-date, and I think with Convergex being our largest one to-date, we have a significant amount of opportunity to create margin through synergies.

So I'm going to turn the call over to Steve, who will review our financials, and I'll close out at the end of the call.

Thank you, Jeff. In the first quarter of 2017, we reported GAAP net income attributable to common shareholders of $1.3 million or $0.05 per diluted common share compared to a GAAP net loss attributable to common shareholders of $5.4 million or negative $0.20 per diluted common share in the prior year period. First quarter 2017 GAAP revenue was $115 million. Comp and benefits expense was $76.7 million. Non-comp expenses, excluding interest expense, were $48.8 million.

Net gain on investments and net gain from consolidated funds were $39.4 million. Income tax expense was $1.9 million, and income attributable to noncontrolling interest of $9.1 million.

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 first quarter of 2017, the company reported economic income of $5.5 million or $0.19 per diluted share. This compares to an economic income loss of $4.9 million or $0.18 per diluted share in the prior year period.

First quarter 2017 economic income revenue was $128.6 million compared to $105.6 million in the prior year period. Investment banking revenue was $36.6 million compared to $26.1 million in the first quarter of '16.

Quarterly brokerage revenue declined 1% year-over-year to $52.3 million. Management fees were $13.9 million compared to $16.9 million from the prior year period.

Incentive income was $3.1 million compared to $6.9 million in the prior year. Investment income was $21.6 million compared to $1.9 million in the prior year period.

Other revenue was $1.1 million compared to $1 million in the prior year period as well. Comp and benefits expense for the quarter was 58% of economic income revenue compared to 59%. Variable non-comp expenses in the first quarter of '17 were $16.4 million compared to $15.2 million in the prior year period. The increase is primarily related to a higher pool of brokerage and trade execution costs and increased marketing and business development expenses.

Fixed non-comp expenses, excluding depreciation and amortization, totaled $23.8 million in the first quarter of '17 compared to $24.4 million in the prior year period. Depreciation and amortization expenses were $2.6 million in the quarter compared to $2.8 million in the first quarter of '16. The decrease is primarily related to a decrease in depreciation expense from fully depreciated fixed assets, partially offset by an increase in amortization on intangible assets related to acquisitions during late '15 and during -- in '16.

GAAP stockholders' equity increased by $5.6 million to $778 million at March 31, '17, from $773 million at 12/31/16. Common equity, which is stockholders' equity less the preferred stock, was $677 million compared to $671 million at 12/31/16. Book value per share, which is common equity divided by shares outstanding, was $24.79 per share compared to $25.11 at 12/31/16. Tangible book per share, which is common equity less goodwill and intangible assets, was $21.67 per share compared to $21.88 at 12/31/16. Invested capital was $645 million as of March 31 versus $657 million at December 31, '16.

I'll now turn the call back over to Jeff for closing remarks.

Thanks, Steve. Our business, as you all know, is about intellectual capital and our ability to provide high-quality services to clients who are really looking to outperform, and I think it remains our primary mission and goal to cater to active managers, and that's what we do best here at Cowen. We remain steadfast in our commitment to maintain a healthy capital base, which provides us with a strong foundation for our platform. It enables us to do what we do best. With $1 billion in total capital, we have the flexibility to optimize that capital, later on and -- but we do believe that it will fuel our shareholder value, whether it's investing in our existing businesses, acquiring businesses or buying back stock.

In our core business, our investments in 2016 are really beginning to manifest themselves, and we have had some newer activities underway such as the development of a securities finance business, on self-clearing for certain portions of our Prime Services business, all of which will be augmented by the Convergex acquisition. And of course, that acquisition, as we mentioned earlier, really scales our platform by leveraging our cost structure and generates significant operating efficiencies for us, as well as scale.

The partnership with CEFC China will facilitate future growth in our core competencies by providing us with capital to scale businesses that are more capital intensive, like securities lending and eventually leverage finance. It will also provide us with long-term initiatives such as asset management distribution in China and more opportunities for us to bring to bear our products and services that we have here in the United States to an audience that's really the fastest-growing economy in the world.

So we've great confidence in our ability to scale in a more diverse way by elevating the revenue capabilities to the organization and by driving margin expansion, and that's really what's going to be our focus for the remainder of 2017. We really do think that we've created something special at Cowen, and we've got a lot more to do. And obviously, we want to thank our colleagues for that. You all do an incredible job, and we could not be more proud of the team that we've built here at Cowen.

So with that, I'll turn it back over to the operator, and we can open it up for questions.

(Operator Instructions)

Our first question comes from Devin Ryan with JMP Securities.

This is Brian Mckenna for Devin. So, I guess, just on M&A advisory, I know it sounded like the backlog was up significantly at the same time a year ago, but does it still feel as good today? And then just how are you thinking about the timing of the completion of it?

So, I feel pretty good actually. From our standpoint, we think that the backlog and our ability to close on that backlog is still very high. We did close on -- we signed a record number of engagement letters in the first quarter. Some of those are buy-side as well as sell-side opportunities, and obviously, those transactions have to close. But just being able to see the efforts of the backlog and the conversion rates we saw from last year, if we do on a percentage basis anywhere close to what we've done historically based on where we were or at the first quarter, our numbers will be up pretty significantly. And we did announce that 2 pretty significant transactions I mentioned both in the semiconductor space right at the beginning of April. One of them is likely to close in this quarter, the other one is subject to CFIUS, approvals will be later in the year, but these are the kinds of things you work on for a really long period of time, and then they happen. So I'm just pleased to see that even though we have deals that are closing and coming off backlog and M&A that the backlog in M&A has been bigger and with higher quality stuff. Some of the areas also are worth noting -- it's the M&A backlog is primarily in technology and in consumer, and we've got a few things that are in healthcare as well. So it's a much more diverse industry mix than our equity capital markets business, and that's I think a function of the fact that the bankers we have in those areas are more focused on M&A, because the ECM opportunity in those sectors is more limited and more -- and less robust. And so I think again, we've opted to build our M&A business organically as opposed to do acquisition, and those things just take time. So I think I'm pleased with where we ended the first quarter, which is an improvement over the last year in the first quarter, and I look out at the rest of the year and see that we can make meaningful progress over in our year-over-year numbers there as well.

Great. Appreciate all that color. And then just a quick follow-up. How much of the gain income was from the Linkem investment? And could you remind us where that investment stands right now?

In the first quarter, there was no gain from the Linkem investment, very little. When you say where's the investment stands? The company continues to grow very rapidly, with what's going on broadly around the world and in the appetites of spectrum, we get a lot of inquiry. It's a company about partnering, joint venturing, distribution arrangements because we have the vast majority, about 70% or 65% of all of the 3.5 GHz spectrum in Italy. And we think that the outlook for Linkem is quite good.

Our next question comes from Sharon Leung with Nomura Instinet.

I'm filling in for Steven today. So, my first question is just on the ECM outlook. Obviously, had a really strong quarter this quarter. Looking forward, like what are we seeing in terms of the backlog right now? Is the strength expected to persist? Or like just what's your outlook from here?

So on ECM, I actually feel really good on that as well. I think the lack of volatility in the marketplace has certainly encouraged people to come to market. We certainly see that we're in the right sectors. Being in the healthcare sector is a great spot to be. Those companies need to raise money, no matter what. So even if you have a period of time in which they may wait because of some market volatility, invariably, they come back to market and raise money. So we certainly are the beneficiary of that because we've got a bunch of clients that we've done really well by over the course of the past half a decade plus, and so that backlog is actually continues to be robust. There's a bunch of new IPOs that we're actually on the road with a few of them as we speak. We've actually landed a few IPOs outside of healthcare, which I think is encouraging. Some of those are lead-left IPOs and consumer and a few others, a few other areas. To me, we are doing -- we're positioning ourselves extremely well to take advantage of the places where we should be winning and where the wallet is available to us and making sure that we're sized appropriately from a staffing standpoint to execute on them as well as we can. So I still remain very bullish as long as we have the kind of environment where there's not a lot of -- where the markets don't seem to care too much about geopolitical challenges, the markets are open, and investors are actually sitting on a fair amount of cash. And many active managers have missed the run-up in equities, and that usually makes for an environment in which they'll chase those returns through new issue, which is I think still the best and easiest way for active managers to outperform their benchmarks. If you bring companies to public into the public market and investments, you get the chance to participate in a leg-up after an offering. That's a -- that's usually a pretty good and healthy sign. So, so far, so good into the second quarter, and we'll see how things continue, but I feel pretty bullish about it.

Okay. That's really helpful. And then on your 10% ROTE target that you've talked about in the past, can you give us any actions that you've taken, especially with the upcoming Convergex deal and the China equity investment? What should we think about as a reasonable timeline to getting to that 10% target?

So I think what we've tried to do is balance both the need to create scale on the businesses, as well -- through revenue growth as well as drive cost reductions. I think we've done a very good job at making sure that we've got a robust enough platform to bolt businesses on. And so our challenge has been the infrastructure of the organization is built to be a much bigger revenue number, and organic growth has been slow. So when we start to look at the numbers, particularly post the Convergex integration, and we always give ourselves a couple of quarters to get that right, our view is that we should be in a much better position to achieve those targets on a more consistent basis as we head into 2018.

Now we always have optionality associated with the performance off the balance sheet and investment management with the performance fees, where we could be driving ROE if we have positive investment performance in our funds, which have either significant exposure in capital or significant exposure to investment performance or investment income. So I think we can certainly be achieving those -- that target prior to 2018, but I think our goal here has been to take this great infrastructure that we have and scale meaningfully or build it, so that we can bolt on businesses as meaningful in size as Convergex and eliminate duplicative costs. So over time, we can be more consistent in our ability to provide those targeted returns. So totally possible for us to be hitting those numbers at any time in 2017, but I think the way we think about it is how can we make sure that we're getting that kind of consistency without having to rely on investment performance -- outsized investment performance on the balance sheet or investment performance in the funds to drive that margin. So that when that actually happens, the margins will -- should expand to greater than that. Does that makes sense?

Yes, that's perfect, and then just one final quick one. Can you give us an update on the gains embedded in Healthcare Royalty Partners that are in your P&L right now?

Yes, I mean, it's still -- fund 1 is still tied up in a couple of investments, and it's still -- we won't book those incentive fees until the capital is returned to the investors plus the preferred return and then we get to book that incentive fee. So it's just when those 2 investments are realized.

I think -- so one of the things that we, frankly, hadn't focused on just to be clear, several years ago when we started talking about this is it just never really occurred to us that 100% of our carry would be tied up in the last 2 or 3 investments in the fund. I mean, I'll just say as somebody who grew up in the hedge fund business and really didn't focus on the GAAP accounting associated with private equity, I just -- we can see the gains, we know they're there, but the realization of those is all dependent on the last few names in your private equity portfolio. And the team is working to monetize them. They're doing just fine. It's just a matter of time. Those are private companies, and they need to be monetized at some point, and they will be. And I just think it's hard for us to know what the optimal time is for that. All I can say is that the team is well aware of the fact and is adequately incented from their standpoint as well as from the company standpoint to monetize them at the appropriate time and as soon as possible. Just I think as we've been talking about it for a long time, and that's just I think a reflection of maybe 4-5 years ago, our sort of really lack of appreciation for how much of the carry would be tied up in the last few investments.

(Operator Instructions)

Our next question comes from Nick Brown with Zazove Associates.

Just have 2 questions. The first one is on the brokerage business. Can you give a little more color on why that was weak this quarter? I mean, given what the markets were doing would have seemed like you have better growth there.

Well, I mean, I think certainly, Nick, you're familiar with what's going on in the volatility markets, I'm sure, given what your portfolios look like. You can see VOL collapsed and people are sitting on their hands and honestly when VOL collapses like this, people are just -- I'd say investors were generally tentative to move into the market wholesale. I think there's a lot of investors who believe that the rally in the market has been very narrowly focused on a couple of really high profile stocks, particularly in the tech sector. And I would say a lot of folks have just been reluctant to put money to work on the active side, and this is I think, by the way, I think we're doing way better than most others, frankly. The other -- many of our competitors have suffered I think way more meaningfully than we have just from a lack of volume, and so I'd say this is a market-driven, more than anything else. On days when we see little spikes of volatility, or people get concerned about geopolitical issues, the volume picks up, and we certainly see our fair share of it. I mean, we see more than our fair share of it, and I would say the metrics I focus a little bit more on for us, Nick, are like are we moving up in terms of our votes at long-onlys and at hedge funds meaningfully both on a research side as well as on the trading side? And to me, like that's the thing that's well within our control. We continue to move up and get a bigger share of the wallet at each of our individual -- at each of our clients individually than collectively when volume returns to the market, which it will eventually, we'll be in a much better position than we were several years ago. So I think it's more just a lack of volatility. People are just sort of sitting on their hands and not necessarily putting money to work.

Volume.

That's helpful. And just my one other question, more of a housekeeping question. Given that you're further along since the announcement of the CEFC deal, I know in the press release when you announced it, you expected it to close by the end of the third quarter. Is that still your expectation? Or is it taking longer than that?

No, I think we're on track with the processes we have to go through to meet that objective.

And our next question comes from Weston Wilkinson with Perella Weinberg.

Just a quick question on inorganic growth on the investment management side. What are -- as you guys look to grow that business organically or inorganically on the inorganic side, what are the types of structures or economic structures arrangements in general frameworks that you guys typically look to build around or will look to build around going forward?

Yes, I think that first of all, good question, certainly one that given where you are, you're probably thinking about as much as we are. I think we've got a bunch of platform products that we see, and we've got a bunch of distribution that we know we can access. We're always looking at new product types that meet the liquidity profile of the strategies that we're pursuing, which is to say that we're trying to match liquidity profiles with the investments we have. We do have platform distribution. We are distributing in Europe. I'm not going to get into too much detail today because a lot of things that we're working on are a little bit proprietary in nature and as much as they are, I don't want to share on an open call. But all the structures that we're looking at revolve around the fact that we have real strategies that we think are differentiated. And as you can see, when we think we have strategies that are a little less than differentiated that we see no traction, we just we've been much more aggressive at shutting those down and moving them off the platform pretty quickly. So I don't know that there's any deep insights that we are willing to share on an open call on structure. Suffice it to say though that when we look at our growth, it's coming from individuals and from institutions collectively, and it's just really depends on the channels in which we're selling into.

Well said.

I'm showing no further questions at this time. I would like to turn the conference back over to management for any closing remarks.

Operator, thank you. This is Peter Cohen again. Just thank you all for dialing in and asking questions. We look forward to making a lot of progress in the future, now that we've got these 2 major transactions almost under our belt. And as I said earlier, have got the firm to a level of critical mass that we think we can really build on. So thank you, and Happy Bring Your Children to Work Day.

Talk to you all next quarter.

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