Cowen Inc (COWN) 2018 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for joining the Cowen's Conference Call to discuss the financial results for 2018 second quarter. By now, you should have received a copy of the company's earnings release, which can be accessed at Cowen'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 contain 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 has no obligations 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 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. Reconciliation of those measures to GAAP is consistent with the company's reconciliation as presented in today's earnings release.

Now I would like to turn the call over to Mr. Jeffrey Solomon, Chief Executive Officer.

Thank you, operator. Good morning, everyone, and welcome to Cowen's Second Quarter 2018 Earnings Call. This is Jeff Solomon, and joining me today on the call is our CFO, Steve Lasota. Building off of a record Q1, our second quarter results added to the strong momentum we've been experiencing recently in our businesses. We are benefiting from a continuation of some favorable trends, including a robust capital raising environment and elevated equities trading volumes. In addition, a number of the strategic actions we have undertaken have helped to improve operating performance. More specifically, we are gaining noticeable traction in scaling businesses, driving margin through cost cutting, diversifying our revenue streams and harmonizing our balance sheet activities with our operating businesses, all in order to generate more accretive returns for our shareholders.

As I stated before, though, we view our recent accomplishments as a work-in-progress. I'm proud and encouraged by the robust improvement in our results for the first half of 2018, but I also want to stress that we are in the early innings of Cowen's transition into a simpler, more consistent, more transparent and more profitable company. That being said, Q2 represented another solid milestone for Cowen compared to Q2 of last year. Economic income grew 88% to $21.7 million on a 36% increase in economic income revenue of $234.3 million. Economic operating income, which represents economic income excluding depreciation and amortization, was $24.7 million for the quarter versus $14.2 million for the second quarter of 2017 and was $51.7 million for the first 6 months of 2018 versus $22.3 million for the first half of 2017. Economic operating income is a metric we have begun to use as we believe it enables us as managers to better measure how our businesses are performing across the platform regardless of whether we scale and profit are coming from organic growth or through acquisition. It is also easier for us to establish targeted operating returns and margins for each of our businesses as we look to improve our return on capital. Finally, we are trying to be more transparent with our shareholders and potential investors by making it easier to compare our operating results with other publicly traded financial services companies who exclude costs related to acquisitions from their equivalent of economic net income.

Turning now to our results and progress in each of our specific businesses. In banking and capital markets, while we continue to take advantage of a robust capital raising environment particularly in our leading health care franchise, we also made inroads in some of our other areas of expertise, including technology, industrials and consumer. Investment banking revenue grew 25% from the second quarter of 2017 to $80 million on an economic income revenue basis as investors continue to show interest in IPOs and follow-ons during the period and companies chose to finance themselves. As our results for the past few years have shown, health care equity capital markets have been our biggest growth driver in this segment. We made strategic decision almost 7 years ago to embrace and focus on equity capital markets and in health care in particular as it is long been a core competency at Cowen. As a result, today, we are one of the leading capital raising investment banks in the sector, which demonstrates the consistent need for equity capital raises. Thus, it remains a solid foundation for our business even as we look to diversify.

Following what was a record quarter, first quarter of 2018, health care ECM had another strong quarter marking our strongest first half since the formation of Cowen Inc. While the first 6 months was conducive for the health care sector to do capital raises in general, it is worth pointing out that this period is actually second to the first 6 months of 2015, which was the last major period for health care new issuance. However, in the first 6 months of 2018, it is a record for us at Cowen, which points to how much share we have continued to gain from our competitors. Aside from the success we have been experiencing in health care, we are continuing to invest in our nonhealthcare verticals and advisory activities to diversify our revenue mix and we are making good progress on this front. Non-health care revenue on an absolute dollar basis continues to grow. In the quarter, our non-health care revenue was $26 million, a 64% increase from the second quarter of 2017. As a percentage of revenue, it represented 32% of banking revenue compared to 25% in the second quarter of 2017. We are clearly making progress on our goal of diversifying banking revenue on a percentage basis though it can sometimes be hard to see that in periods where health care ECM is also experiencing strong growth.

In the quarter, merger advisory revenue was up 81% from the prior year quarter to $14.5 million, with transactions coming from health care, industrial, technology, information services and special situations. In fact, this was one of our most diversified quarters as it relates to industries underlying our M&A revenue.

For the first half of the year, M&A revenue was $28.9 million, which is a record for Cowen since its formation in 2009. It's worth noting that the majority of the growth in M&A has come from organic hires over the past 7 years as we set out to rebuild the franchise methodically.

As we have said previously, diversifying our business towards higher-margin activities is a multiyear process. We plan to continue investing in our advisory capabilities both organically and inorganically in order to drive long-term margin growth. In spite of the pace of investment banking transactions in the quarter, in the first half of the year, our backlog has held steady throughout the period as we have been mandated a number of transactions even as others have closed.

Now turning to our markets businesses. Our brokerage revenue grew 69% on an economic income basis compared to the second quarter of 2017. As a reminder, the prior year quarter included 1 month of Convergex. Total brokerage revenue averaged $1.8 million per trading day compared to $878,000 per trading day in the year-ago quarter. Over the years, we have made significant long-term investments to elevate both our research and brokerage franchises. Our efforts are paying off, enabling us to gain market share especially in a post-MiFID II environment. Clients value us because of our sophisticated and differentiated approach to research and our position as a key market liquidity provider on a nonconflicted basis. For purposes of this call, we will broadly describe the individual units within the markets business as institutional brokerage and institutional service. As a reminder, institutional brokerage includes cash equities, special situations, electronic trading, options, convertibles and credit. Institutional services includes prime services, global clearing, securities finance and commission management services.

Starting with the first component, institutional brokerage. We have doubled from the second quarter of last year. Much of this is due to the acquisition of Convergex, which closed in June of 2017. With the addition of Convergex, we were able to build on our competitive position by leveraging our larger platform to gain further market share with clients and begin to drive down cost due to our improved scale. Our institutional services business rose 127% from the second quarter of 2017, with much of the growth once again reflecting the diversification in the business following the acquisition of Convergex.

With respect to MiFID II, it is still early in its implementation and we continue to experience a muted impact, though we continue to see improve market share among our MiFID II specific clients.

Moving to the investment management business. As of July 1, we had $10.9 billion in assets under management, which was a $40 million increase from April 1 of 2018. Our private health care strategy, which is our first Cowen D&A investment platform, we are exploring the potential launch of a complementary public market fund that will leverage our market position. Our health care royalty business is currently 75% committed to third commingle fund and the business had the strong first half of 2018 having deployed $315 million across all active vehicles.

Merger arbitrage outperformed the HFRX mergers arbitrage index as it successfully navigated an investment landscape made increasingly volatile by the geopolitical environment and decisions made by the Department of Justice in certain landmark cases. Real estate held its final close for its third equity vehicles. Our long short equity strategy, which invests primarily in the communications technology, media and consumer sectors, produced positive results, which compared favorably to the long-term S&P 500 Index and the HFRX equity hedge index.

But the investment management business is still a business in transition. Last year we eliminated products that did not show an ability to scale and brought the total number from 10 last year to 6 today. We are continuing to value each of the remaining businesses based on their ability to be accretive to our targeted ROE objective over the near term including their utilization of capital. We will continue to make decisions based on each strategy's ability to scale with our client base thereby fostering improved margins and returns on equity.

As we discussed on prior calls, going forward we're focused on developing alternative investment products that leverage Cowen's expertise in certain domains, such as our private healthcare strategy which we launched last fall. This is what we term Cowen D&A.

We also made a shift in how we launch these strategies going forward, whereas traditionally we would incubate strategies internally first before raising outside capital, today, we are focused on raising external capital first and putting our balance sheet to work simultaneously. And for new strategies, we are focusing our efforts more towards private equity style strategies versus traditional hedge fund strategies on which Cowen had been previously focused. Over time, we expect the combination of these actions will result in a more focused and profitable platform that is better aligned with the broader Cowen platform. We will continue to make adjustments to this business to better leverage the broader franchise and in our deep domain expertise to drive higher returns for our shareholders. Having gone over our individual businesses, I will now spend a moment or two expanding on some of the strategic initiatives we've been talking about for the past few quarters. The first is simpler, fewer, deeper, which you've heard me address in portions of my prepared remarks today. Simpler, fewer, deeper is not some sort of catchphrase we throw out there to be -- describe what we're doing. It is actually a roadmap for taking Cowen to the next phase of our evolution, which we call the value creation phase. Evolution started of course with the merger of Cowen and Ramius in 2009. And since that time, we've undergone a rebuild and position phase to reposition the platform around our core competencies and position ourselves for increasing growth and economic income. Now the challenge and opportunity rests squarely on laying out the framework that will guide us to driving greater shareholder returns. Simpler, fewer, deeper is one of the core pieces of that framework, and you'll begin to hear us talk more about it as we share some of our progress in executing our initiatives.

One of the initiatives we've been working on is improving our capital allocation process to drive higher returns on equity. Our view is that capital allocation should be balanced carefully to achieve the appropriate long-term objective, which are to drive stronger growth and returns to the business, while also returning capital to shareholders when the right opportunities present themselves. I think it's evident that we would not have experienced the strong results in the first half of 2018 had we not judiciously allocated capital to the areas of our business with the greatest risk-adjusted opportunities. But at the same time we recognize there are opportunities to reward our shareholders along the way with buybacks, which is why we repurchased 3.3 million of our common stock during the quarter, leaving approximately 14.1 million available to repurchase under our current program. That is to say we plan to return capital in addition to growing the business, not at the expense of growing the business. Of course, complementing this balanced capital allocation view is an overall longer perspective of the business, which comes with the territory. We can't deliver value creation and simultaneously return capital when taking a shorter-term view, which means that we're comfortable sub optimizing returns in the short term sometimes by closing down on some of our underperforming funds in order to scale returns over the long term. In this fashion, we believe we will be in a better position to drive more sustainable returns on equity.

We'll also be continuing to optimize our balance sheet activities to align them more closely with our operating businesses. As you've heard me say before, this plays into our philosophy that balance sheets are meant to be seen not heard. In addition to making further reductions in our quarterly investment volatility by derisking the balance sheet and growing the contribution from spread businesses, we are also working on a road map to monetize some of our private investments. It is clear to us that this is a legacy area of our business that has confused a lot of investors, so I'm going to take a few minutes to explain it in more detail. If you look at our investor presentation, we break down the components of invested capital. For the quarter ended June 30, 2018, invested capital totaled $716 million, of which $119 million is tied to our private investments as well as a noncore real estate investment. During the first 6 months of the year, those investments did not contribute anything to investment income. That is to say our economic operating income and economic net income was generated with very little coming from a large portion of our balance sheet. I will leave it to you to do the math on the true ROE of our operating businesses over the quarter.

So with that said, I will turn the call over to Steve Lasota for a brief review of our financials and then we'll close it up. Steve?

Thanks, Jeff. For the second quarter of 2018, we reported GAAP net income attributable to common shareholders of $3.7 million or $0.12 per diluted common share compared to $5.7 million or $0.19 per diluted common share in the prior year period. Note that our GAAP stockholders' equity increased by $45 million to $793 million at June 30, 2018, from $748 million at December 31, 2017. I'll discuss this further later on my comments.

Our GAAP revenue was up 46% year-over-year to $234.6 million compared to $160.5 million in the prior year period. The increase, as Jeff touched upon earlier, was due to continued success of our businesses especially banking and brokerage, which benefited from a healthy market demand for capital raising as well as higher trading volumes. Compensation and benefits expenses were $131.8 million. Noncomp expenses were $88.4 million and D&A was $3.2 million. In addition, other income from gains on investments was $47.1 million. Income tax expense was $4 million and noncontrolling interest expense was $24.6 million for the quarter.

We adopted new revenue recognition guidance as of January 1, 2018, which has impacted several components of our GAAP income statement. For one, revenue on our investment banking business segment is now recognized on a gross basis rather than net of any associated underwriting expenses as it had been presented before. This change, however, has no impact on our GAAP net income.

Moving to the investment management business, the majority of fees from certain funds that we previously presented as incentive fees are still being recognized but are now being presented as equity investments in the funds with associated gains or losses in the income statement. Only a portion of our previously recognized incentive fees will be deferred for GAAP to a future period at the point that they are crystallized. We'd be happy to address questions related to these changes later in today's Q&A section.

Now turning to our non-GAAP financial measures, which we refer to as economic income. As a reminder, we use economic income to measure our performance and to make certain operating decisions. In general, economic income is a pretax measure that eliminates the impact of consolidation -- of our consolidation [of] consolidated funds and excludes goodwill and intangible impairment, certain other transaction-related adjustments or reorganization expenses, certain costs associated with debt and preferred stock dividends. Economic income revenue also include incentive income during the period when incentive fees are not yet crystallized with GAAP reporting. The remainder of my remarks will be based on these non-GAAP financial measures, but before I get into the actual economic income results for the quarter, I'd like to take a step back and walk through our rationale for using this metric and why we think it's important to focus on when evaluating our true underlying performance.

Economic income strips out one time our accounting-related items that are not core to our business or our profitability and cash generation. We do make sure that our adjustments are transparent as possible so that investors can exercise their own judgment to arrive at an appropriate valuation or investment decision. With that being said, let's take a look at our economic income results for the quarter.

We reported economic income of $21.7 million or $0.71 per diluted share for the second quarter of 2018. This is nearly double the $11.5 million or $0.39 per diluted share of economic income we generated in the prior year quarter. $0.26 of the GAAP to economic income reconciliation is related to the loss from the embedded option feature associated with our convertible notes. Prior to our June 26, 2018, shareholder meeting, the embedded conversion option feature was recognized at fair value in accordance with GAAP as a derivative liability. Subsequent to receiving shareholder approval for share settlement, the embedded conversion option was reclassified to equity and will no longer result in profit and loss movements.

Economic income revenue increased 36% year-over-year to $234.3 million compared to $171.9 million in the prior year quarter. Similar to the increase in GAAP revenue, the increase in economic income revenue was due to strong performance in equity financings as well as growing contribution from the advisory and nonhealth care sectors. Investment banking revenue was up 25% to $80 million from $64.1 million in the second quarter of 2017. Quarterly brokerage was up 69% year-over-year to $113.2 million. Management fees were $12.5 million compared to $14.4 million from the prior year period. Incentive income was $9.4 million compared to $11 million. Investment income was $20 million compared to $14.2 million in the prior year. And finally, our other revenue was a loss of $721,000 compared to revenue of $1.3 million in the prior year.

Now turning to our expenses. If you look through our acquisition of Convergex, our comp to economic income revenue percentage was lower than prior year levels. Comp and benefits expense for the quarter was 56% of economic income revenue compared to 58% in the prior year period. Fixed noncomp expenses totaled $34.9 million in the second quarter compared to $29.8 million in the prior year period. We're continuing to reduce noncompensation cost to drive margins and reach a more efficient cost structure. We're also continuing to reap the synergistic benefit from the Convergex acquisition by working to integrate and streamline our collective technology operations and corporate practices. Variable non-comp expenses in the second quarter of 2018 were $37.2 million compared to $21.9 million in the prior year. The increase was primarily related to higher floor brokerage and trade execution cost related to the Convergex acquisition. Economic operating income, which is economic income before depreciation and amortization was $24.7 million compared to $14.2 million in the prior year quarter. As Jeff mentioned, economic operating income is a metric we've begun to use. Depreciation and amortization expenses were $3 million compared to $2.7 million in the second quarter of 2017. And similar to the prior quarter, the increase was due to an increase in amortization of intangible assets and depreciable fixed assets related to the acquisition of Convergex. GAAP stockholders' equity increased by $45 million to $793 million at June 30, 2018, from $748 million at December 31, 2017. The increase is related to our 6 month 2018 earnings and a reclassification to equity of the embedded conversion option associated with convertible debt, which I previously spoke about. Common equity, which is stockholders' equity less preferred equity, was $692 million compared to $647 million at the end of 2017. Book value per share, which is common equity divided by total shares outstanding increased to $23.37 as of June 30, 2018, compared to $21.82 as of December 31, 2017. Tangible book value per share, which is common equity less goodwill and intangible assets grew to $20.40 as of June 30, 2018, compared to $18.77 as of December 31, 2017. And lastly, invested capital was $716.1 million as of June 30 compared to $695.3 million as of 12/31/2017.

This completes my financial summary. I'll now turn the call back over to Jeff for closing remarks.

Thanks, Steve. So there's a real momentum in our business and it's not just captured by our strong financial results. It has to do with a collective entrepreneurial mindset here at Cowen to achieve great new things and outperform in every sense of the word. Our client share this vision and mindset, which is why we believe they choose to partner with us. Our intent is to continue to the string of successes that we've been experiencing only in a much larger and more sustainable scale, one in which our clients, employees and shareholders can all be proud. So I'll say it again because it bears repeating. The first half of 2018 was the most successful start to a year that we've had since we formed Cowen nearly a decade ago. The results we accomplished so far will serve as a blueprint for evolving the company going forward. But we're not extrapolating these results out into the rest of the year. That is to say we will remain judicious in how we continue to invest in our growth.

While we're seeing real progress towards our objective of a more transparent, predictable and sustainable results, we're still not at stage where a standout Q1 and Q2 by default translates into an exceptional year, but everybody here is working super hard to make sure that, that happens. What I hope you can from today's call is a sense of what our future can look like if markets are okay and we execute on our plan. Objectively, we are making great strides towards achieving that plan, and I want to go through the objectives that we discussed here at Cowen as we execute.

One, we are looking to scale businesses that will drive margin. Two, we are focusing on opportunities where we have strong domain expertise and can leverage the Cowen D&A. Three, we are improving revenue diversification. Four, we are maintaining and growing contribution from recurring revenue businesses. Five, we are harmonizing balance sheet activities with our operating businesses. Six, we are implementing the philosophy that balance sheets are meant to be seen not heard. Seven, simplifying our balance sheet by exiting noncore investments in noncore strategies. And eight, improving the capital allocation process. Over time, we believe the successful execution of these objectives will translate into increased earnings power, greater operating consistency, lower volatility and improved transparency results. The ultimate outcome, of course, is higher and more sustainable shareholder returns.

I look forward to joining the talented partners and teammates we have here at Cowen in taking the next steps towards making this vision a reality, and I want to thank everybody here for all the efforts that we made so far this year. And with that, we'll open up the call for questions. Operator?

(Operator Instructions) And our first question comes from Sumeet Mody from Sandler O'Neill.

Looking for a little color around the recruiting environment in investment banking and where you guys see opportunities for continued diversification that you mentioned earlier on the call in kind of more non-health care sectors? And what's your appetite there before you kind of reconsider any pace change?

A few things, we laid out the core strategies in the industries in which we're looking. I think, obviously, we recognize that building out merger advisory revenues is a much higher-margin business. As we've noticed, the equity capital markets outside of biopharma and health care are just different and not as robust. And so as we continue to look for talented individuals, we certainly are looking for folks who have the ability to not only win but execute on merger advisory business, debt capital markets and other things. The goal is to bring people who understand the value of the domain expertise that we have. And I think that's a really critical differentiator. As we have been out talking with a number of people, either teams or businesses that may be for sale that we may look to acquire, one of the things we talk about is the value of the content we have and the domain expertise we have in the industries we cover and research. And so we're very much interested in bringing people onto the platform who see the value and figure out how to monetize that value in investment banking, not just through finance, but through advisory services as well. And so I mean, I think we've announced a few individuals over the past few months, and you can see these are really senior individuals who are choosing to come here from the places where they are because they see an opportunity to apply what we do to their clients and bring their clients to an organization that really understands exactly how we can prosecute the business and effectively build a great long-term partnership. So maybe, that's a little too general but we're being extremely selective in who we bring on because we want to make sure that as people come into the organization they hit the ground running.

Helpful. And then secondly, what would you say are the most important metrics for people like us to track from the outside to get a good feel of how Cowen progressing as you simplify the business?

Well, I think from an operating standpoint, certainly there's enough out there in the public domain about how financings are going. That's still a primary revenue driver. I would certainly see on the markets business, you can take a look at volume and advertise volume. It should give a pretty good idea of as a proxy for how well we're doing relative to other non-conflicted trading shops or other independent shops. I would say as it relates to that, it would not compare our equities business at all to the bulge or anybody who has a dark pool. That's not an effective comparison mechanism. Those are different businesses. I would also say that we recognize that the very large banks are using their balance sheet to trade and position. That's not what we're doing. So I think we can help you offline to sort of think about who we compare ourselves to. But we look at those metrics all the time internally, and that's probably a pretty good comparison. On the investment management side, I still think it's helpful to look at hedge fund indices as a way to try to get a sense for how performance is going. We are increasingly less dependent on market directionality, and we try to squeeze as much of that out of our organization as we can by running our balance sheet to be relatively, I wouldn't say, market neutral, but we're not necessarily looking to beta ride on our investment. So that'd probably be a pretty good way to assess how well the health of the market is doing. Of course, we put out I believe quarterly AUM numbers, and I think there's probably anyone of a number of ways you could determine in how our funds are performing because I think we published those, so that would be a thing. And then last thing I would say is increasingly we are really managing our business through economic operating income, and that's one of the reasons why we are highlighting this metric today. Depreciation and amortization rules are very convoluted and it can make you make bad decisions if you're looking at margins after those. We've made some acquisitions as you know, and making sure that we're driving operating margins and really putting the tools in the hands of front-line managers to drive their targeted margins. It's a really important thing that people own -- senior managers own the responsibility for driving margins in their individual businesses. And as we've said certainly with integration of Convergex some of the things that we're looking to do in the merger advisory business, our business managers understand exactly how to drive margin both in revenue and in cost. And we are rewarding them through a compensation mechanism for doing so. And so economic operating income is more what we're using internally here. And so we've added that as a metric for you to look at because that's what we're looking at. And if we can drive economic operating income, over time that will drive ROE. We know that to be the case, and so it's working for us. And 6 months in that's why we decided to share with you all so that you can begin to track that in much more meaningful way because of that's what we're doing. So I hope that answers your question, Sumeet, but you'll let me know.

Yes, that's very helpful. And just one real quick one, last question for me. Regarding the roll off some of your noncore investments in invested capital, just maybe on a high level, how are you guys thinking about using the capital for monetization especially for maybe the larger investments like Linkem?

So we haven't said and the reason is timing-wise, I would love to figure out how to monetize those, but we have partners in all of those investments and so we are just working to monetize it. We'll assess at the time what we can do with the capital. If there's a way for us to deploy to grow the business we will. We'll be looking to return some of that capital to shareholders. There's a number of things we can be thinking about. But I think the point of our highlighting it as carefully as we have on call today, and in our subsequent meetings with shareholders, is to say that we recognize that those investments are not driving our core operating business. And we can have discussions and debates about how to value them, and I'm happy to go into that with anybody who wants to spend time. People want -- we think they -- they're absolutely mark-to-market so their valued fairly by an independent third-party, but we can debate whether or not there's future growth or whether or not people have concerns about them. The bottom line is, it's not core to driving what we think is going to be ultimate value creation engine here, and so we'll be looking to figure out ways to monetize and as it is we'll take a look at the landscape when that happens and we'll make some determinations as to how best to deploy that capital.

(Operator Instructions) We have a question from Devin Ryan with JMP Securities.

So I guess, first question here. I heard the comments on increased market share in brokerage kind of early days MiFID II, but I think the results you guys have been putting up speak for themselves. I guess, the question here is what are you hearing from clients as to why they're consolidating their wallets and why you're winning at Cowen? And then kind of the second part of that is, within Convergex, revenues have been coming in ahead of at least our model. It sounds like there's still some expense synergy still to come there. So I'm just trying to think about kind of the margin outlook and kind of operating leverage within the business. I know you don't specifically break it out to that granularity but I'm just trying to think about the potential margins moving forward if there is some more expense savings.

Okay. So first question. So let's just break this into 2 component pieces. There's the MiFID II regulated accounts. I want to remind everybody that we don't have a very large European equities business. We do have 1 but it is a relatively small percentage of our overall markets revenue, it's less than 10% of our revenue. And there's no question that MiFID II is impacting those folks. As it relates to our research payments, we're up year-over-year with MiFID II accounts in part because I think they're absolutely going through and consolidating their counterparties, and we're on the winning side of taking market share. I do think there are number of firms who are not on the winning side of that and they're being eliminated. So we've talked about this for a long time. The market surveys that talk about the impact of MiFID II, are broad market surveys to talk about what the likely impact is going to be on the aggregate commission dollars paid to The Street. But we long-held the view that most of those declines are going to come from people going to 0. And that the rest of us will end up actually gaining share, gain a bigger share of a smaller pie. And that's what's happening to us with our MiFID II accounts. Now we still have some work there to do. We're looking at becoming a systematic internalizer in London. It's a small amount of capital that we had to put up to do that. That will enable us to be able to provide more liquidity on an upstairs basis to European accounts. We're doing that because our accounts are asking us to do that, so they can actually do more with us. So we've been reacting to the feedback we're getting from clients knowing full well that when we engage there we actually have more flow we can take. The second part of MiFID II is really what I would call the global players are doing in response to MiFID II. So they may not be specific MiFID II compliant entities, but a lot of the global players are either ringfencing their MiFID II or adopting what I call MiFID II light, which is to say unbundling. And I just -- we've been saying for a long time there's no news there. Everybody's unbundling. They want to know that for their commission dollars, what they're paying for research and what they're paying for trading are clearly distinct. And that's actually an advantage to a firm like Cowen who can really compete head-to-head with anybody either in research, content quality or in trade execution quality. And so the purpose of doing the Convergex acquisition was precisely to give us at that market heft and scale to in order to be able to sit down with buy side trading desks and offer them heads up, highly competitive liquidity options for them to do business with us. This enables us to effectively to reaggregate the wallet. So that if certain of our clients are facing pressures on commission dollars but have an opportunity to pay us with trading, and they're unbundled, we'll reaggregate it and make sure that were permissioning them adequately to look for -- to enable them to continue to get the best of what we do at Cowen. Now we have an internal optimizer around how we're using our resources. And so it's very clear that we have to be extremely judicious with how we're spending our time and our energy both in research and in trading for the clients that match up best with us. So our -- we're going to process where we're looking at how to do more with the clients we have. Certainly, acquiring Convergex gives us more clients. The reason we're experiencing I think better than we anticipated top line revenues is because 1 plus 1 actually has equaled more than 2 for us. These are clients that were not doing business with Cowen ahead of time and the Cowen clients weren't really doing business with Convergex, so bringing the 2 together has enabled us to really scale our business in a much more meaningful way. And so that's part of what we're seeing there. As far as operating margins, we haven't given specific operating margins for the markets business, and we're not going to start now. But I will say that we look at it, we look at it hard and when we look at our quarter-over-quarter numbers and our year-over-year numbers, the margin expansion has been better than we anticipated. We continue to find ways to wring out cost from our vendors because of the size and the heft that we have now. Certainly, there are more venues that are soliciting us to drive business to their particular venues. I love that because it means that we actually matter meaningfully to market liquidity, and that's a very powerful position for us to be in for our clients. It allows clients to know that they can come to Cowen and actually get outstanding execution because of the demand and attention that we're getting from the people that ultimately end up executing trades. So that margin has been much more -- much greater than it had been historically for us and is really is been quite impressive for us. So I'm not going to give you specifics, Dev, but suffice it to say, it's something that we're very proud.

That's great color, Jeff, appreciate all the detail. And I guess, second question. Heard the comments loud and clear not to annualize kind of great first half for investment banking purely because it can be lumpy. But as you look into the back half of the year and you just think about kind of the environment that we're in right now, you should have some visibility, I guess, into the M&A pipeline. So it would be great to get some perspective there in terms of expectations. Then maybe at a higher level in equity capital markets where results have been great, there wasn't anything unusual that you would point to in the first half in the kind of market tone or environment that drove the outside results that has changed. So I'm just trying to get a sense directionally if it still feels as good and it's just -- it's a lumpy business so let's not promise we can repeat this every quarter.

Yes, you hear the caution in my voice always because I'd rather manage people's expectation. It's been a good environment. I don't want to minimize it. But the underpinnings of that or the drivers of that market remain intact. So let's talk about ECM first. It is a very good time for biotech companies to be raising money. New company formation has increased significantly. We've been saying for a long time when these companies exit, when there's M&A in the business, 2 things happen. One, that capital gets returned to shareholders. And as long as there's not massive withdrawals from the health care funds, that capital needs to be redeployed. And they're limited places to redeploy that capital. The second thing that happens -- so basically they're looking for new investments. And that is what opens up opportunity to find the best investments and to create new companies. The second thing is, those management teams often go on to start new companies. So they've had a success, they understand a therapeutic area really well and they've got the ear of a lot and the trust a lot of investors in the space. So they go and they find really new exciting sciences they can bring along. And so private company formation off the back of really successful public company exits is absolutely happening. And so the dynamic is such that they sell the businesses for billions and billions of dollars and then they come back to the market and they raise hundreds of millions of dollars. So when you think about that dynamic, as long as we can have good science and a conducive FDA, there are teams who are being formed, really well heeled teams are being formed, with good track records of having successfully negotiated or navigated exits for their prior companies, that are now looking to raise capital. So when you make a list of the banks that you want to spend time with, who have the best connectivity and the best research and can really actually weed through what's likely to be successful and what isn't, it's a shortlist. And we are absolutely positively in that. If you're bringing a company public in the biopharma space, and you're not talking to us, you're doing yourself a disservice. And so we are being selective with who we bring on. And so that dynamic continues into the back half of the year. I just can't tell you what's going to happen with the overall geopolitical environment or markets in general, and we do know that if markets get a little bit uneasy, people will pause and wait for a better time. But they're definitely going to raise money eventually because that's what they do. And the fundamental underpinnings of this market suggest that, that could continue for a while. On M&A, our pipelines have been refilled. So one of the things we measure is if we're just burning off pipeline or we're replacing. And I think I've said on the call that our pipelines continue to be at the same level that we saw them at the beginning of the year, even though we've closed on a little less than $30 million of revenues. And we've already put up a couple of prints in the month of July that would suggest that things are moving apace. We have pivoted our business in M&A away from the big cross-border Asia-based acquisitions where it seems to get hung up in CFIUS. And so that was something we recognized from our own experience last year with CFIUS, which you'll remember. And our calling effort and in our advice we're giving the companies, we've been able to find our clients the right kind of investors that are likely to have successful exits. So it's not just announcing transactions, it's getting them closed. And that's something our bankers are extremely attuned to doing because we've got to get stuff over the goal line. And so I would say all in all, it's a steady state, I'm not -- we could certainly see a pickup as we add new people and I don't expect that to happen, but I don't see anything currently from a macroeconomic standpoint that would undermine the momentum that we've had.

One for Steve, just you had mentioned the accounting impact on incentive income and that accrual. Can you just maybe give a little more detail on that? And then I just want to make sure that, that does not impact the carried interest accrual accounting for health care royalty.

It does not. It's just as I said, certain of our funds that the incentive fee has not crystallized, so in looking at our earnings release, Dev, it's $0.05 this quarter that they uncrystallized what they should be crystallized by year-end. So for GAAP purposes you'll recognize them by year-end. For economic income purposes, we recognize them currently. So it's a small minority piece. The majority of them, as I said, moved -- gets moved for GAAP purposes to equity investments whereas this piece is, it has to be crystallized before it's a real incentive fee. In our view it will be crystallized so we reflect it in economic income.

Got it, okay. And just last one kind of bigger picture. It's a little bit difficult to probably go through in a lot of detail, but if you take the first half earnings, which clearly are strong and you annualize that, that's about $3 a share of ENI. And if I look at the stock price this morning, nearly $15. You're still -- it's less than 5x kind of the ENI of the annualized first half. And so at what point -- I know that you're kind of like setting the bar here and the success is kind of building upon itself, and so hopefully the market starts to appreciate that to the extent there's consistency in the results. But at what point do you say kind of the enough is enough? You can obviously buy back more stock and that's one kind of method to potentially try to take more control of that. Is there anything else you guys thinking about doing or just kind of that you feel like could be done to help the valuation? Because it does seem that if for the success you've had over the first half, it's not being reflected in the share price at a sub-5x for multiple, for the mix of businesses that you have.

Well, so one thing we'll definitely be doing is asking our research analysts to take us on the road, introduce us to new investors who can appreciate the new story. So that's one place where you could be helpful. And Sumeet, 100%. I think -- I don't think people understand the story yet. And I think that's we've been trying to take great pains over the past few calls to really lay out our objectives, repeat them, be more transparent, talk about the parts of our balance sheet that we're going to be migrating away from and where we're going to be migrating to. We're not just going to financially engineer ourselves to book value at the expense of making sure that we have a business that's sustainable. We understand that if we don't have places to put money to work to drive our mid-teens ROE objectives, and we've said publicly that our goal is to be able to, in a normal environment, to be able to drive mid-teens ROE by the year 2020 in a more consistent basis. So we're clearly able to do that today, but sometimes it may mean that 1 particular sector outperforms, and so everybody says, well, what if that sector doesn't outperform. And our answer is, well, this is why we're diversifying our revenue base because we're not counting on the for 6 months in health care ECM to be the same all the time. But as you can see, other businesses are beginning to pick up momentum that will fill the revenue bucket for us when there's a little bit of softness in that area. So again, this is why we're taking this longer term view. And we think that on an earnings basis alone, clearly, the business is very inexpensive relative to what our peer group looks like. And so we understand the allure and the attractiveness of buying back stock, and we're continuing to do that, we certainly are. But a lot of it is making sure that we're doing it in a way where we're not -- if we do have any sort of softness or we do have any sort of downturn in the market, that we're not going to be similarly capitalized and putting the franchise at risk. So we'll continue to do with over time. Certainly as we monetize some of these assets, we have a lot more financial flexibility to do things like that.

And our next question comes from Justin Hughes with Philadelphia Financial.

My first question is just on the buyback, obviously, it was down significantly from 1Q and I know it could be a timing -- just wondering is that a timing issue? Is that where the stock price was at in the quarter, black out period, et cetera? What should we expect for the second half?

We'll continue to buy back stock out of operating earnings. I think we certainly had a shortened quarter this quarter because we did the debt raise, and so we knew we were going to do a debt raise so we lost 1.5 weeks there. I just feel like we've been picking away at the stock pretty consistently. I certainly think we've also in the quarter -- we buy back stock from employees on a net sale basis. We are going to be cleaning up over the course of the next 9 months, we'll be cleaning up the remaining outstanding converts we have from the first deal so we've got some things to consider there. But yes, we're going to continue to buy back stock at these prices. We see how the business is going, and we have a lot of confidence in our ability to execute on it. So why wouldn't we. It's super cheap and relative to the earnings power of the organization and we'll continue to do it. Are we going to chase it higher? I think everyone would love for us to do that, but we're going to be smart about it and make sure we're doing the right thing from a cash flow standpoint to ensure that we're not going to put ourselves in harm's way. We have the flexibility to do it. We have -- we do have enough buying power here remaining. And when we burn through that we'll go back to the board and ask for more. We talk about it at the board level. The board is happy with the pace that we're going at and understands and that we have the flexibility to do what we want to do as we see opportunities to do it. So hope that helps you with the answer.

And then you've identified about $120 million of kind of noncore assets from like, the core profitability of the business. If $50 million monetized in the cash tomorrow, what would your top 3 priorities be to use that $50 million of cash?

That's a good question. I would say -- somebody else asked that question a little bit earlier and I punted on it, because I think I don't expect to have the monetization of those assets in the next 6 months. We're working on it but there's just some things that will -- that need to happen that are not in our control before we can actually have the monetization events occur. So I'm not going to commit to doing it -- to giving you a top 3 list. I think we've laid out very specifically capital optimization. There's businesses that we're likely to buy. There's also opportunities to buy back stock. All of those are at play and when we monetize those positions, we'll take a look at where we are and what we've already accomplished and make the decisions accordingly. I just -- I am not -- I don't want to commit to doing anything specifically over the next 6 months. I don't expect to be able to have meaningful monetizations in those businesses for reasons that are outside of our control. I would just say we're working super hard to make sure they happen, but I don't expect to have between now and year-end and next year is a different year and we'll take a look.

Okay. And then what are the -- it was a very strong quarter overall, but one of the most encouraging was the pickup in M&A advisory. And you said you have been adding headcount there. I was just wondering can you give us a little more specific numbers on what your MD count within M&A versus a year ago or 6 months ago? So we can get a little bit of a sense of how much this is organic growth versus just a strong market, and kind of what your pipeline is for M&A MD recruitment.

So great question. So I don't think that the success we're seeing now is the result of recent hires. So as we discussed and we discuss this, it takes a while for people to put on the Cowen uniform, go out and win and execute business. So the success that we're seeing in our M&A franchise is a result of people that we've hired in 2011, '12, '13, '14. Certainly, if you look at our 2016 results, we made some significant hires in the back half of 2016 when there was a lot of softness. And those people have contributed mightily to our performance over the first half of this year. It does take a good 18 to 24 months for people to start to print in a meaningful way though. I will say, several years ago it would take like 3 years, and so there is an element of momentum. But when you're printing and the more qualifications you put up, the more brands you build, the more likely it is that you find yourselves and finals competitions and more likely you are to win. So we do know that as we approach $100 million in annual M&A revenue when that starts to happen, your brand just becomes pervasive in the industries in which you cover. And so we're going to continue to look to do that. The environment is actually pretty robust for recruiting for us, and that's because there's just a lot of unhappy people in places that where, honestly, they come to work every day and not having fun. I don't want to make it seem like we're -- it's a party over here every day. But the reality is we try to create a culture where people come to work and do what they do best and enjoy it, enjoy being with everybody and make it happen. In an environment like that, there's just very few of those places where you can do that on Wall Street and not have a lot of political blowback. And so what we're seeing is people are like, "I'm sick and tired of working here. I'm good at what I'm doing, and I want to go work at a pace that has amazing content and great culture where I can be who I am and do better. And I'll take maybe a half a step back in this year or next year's earnings, because I think over next 5 years, this is going to be a place where I can really make a big difference." That for us at the size, it could be 2 or 3 or 4 critical hires in a year that could be enough to really make a meaningful difference if they're successful in the following year. So we'll continue to do that. I think we can be careful to make sure that the people that are here and put up numbers that they get paid. That's obviously something we're super mindful of. And so as we look at funding new organic growth, we'll just make sure that we're doing it judiciously so that the people that are being successful on this platform are being well compensated and well taken care of for essentially putting up good numbers.

Okay. Anyone who has been an investor in Cowen has shown that you have the virtue of patience. So if you have to hire people now and wait 18 months to see the results, I think that's fine with most Cowen shareholders.

Well, I appreciate that. I'll just say, you and I we talked about this, there are very few people like you who understand how long it actually takes. And, obviously, that's something that we know firsthand and so I appreciate that, and we'll continue to do that because we're getting good results. Great. Thanks, Justin.

Thank you. And I'm showing no further questions at this time. I'd like to turn the call back to Mr. Jeffrey Solomon for closing remarks.

Well, thanks, operator. And thanks, everybody, for dialing in this morning. I know it's lengthy, but we wanted to take the time to really lay out our strategy a little bit more. And so we appreciate everybody's patience and attention, and we look forward to coming back to you next quarter with our results. Have a good day.

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