Piper Sandler Companies (PIPR) 2016 Q4 法說會逐字稿

Good morning, welcome to the Piper Jaffray Company's conference call to discuss the financial results for the fourth quarter and full year 2016. During the question-and-answer session, the security industry professionals may ask questions of management. The Company has asked that I remind you that statements on this call that are not historical or current facts, including statements about beliefs and expectations are forward-looking statements that involve inherent risks and uncertainties.

Factors that could cause actual results to differ materially from those anticipated are identified in the Company's earnings release and reports on file with the SEC, which are available on the Company's website at www.piperjaffray.com, and on the SEC website at www.sec.gov. This call also will also include statements regarding certain non-GAAP financial measures. Please refer to the Company's earnings release issued today for a reconciliation of these non-GAAP financial measures to the most comparable GAAP measure. The earnings release is available on the Investor Relations page of the Company's website, or at the SEC website. As a reminder, this call is being recorded.

And now I would like to turn the call over to Mr. Andrew Duff. Mr. Duff, you may begin your call.

Good morning, thank you for joining us to review our results for the fourth quarter and the full year 2016. We finished the year on a very strong note, generating record revenues in the third quarter, and then exceeding that record by almost 10% in the fourth quarter. This drove record revenues for the year, which propelled us to an adjusted return on equity of over 9%. I want to thank all of our long-term partners, and the many new partners who have joined us in the past couple of years, for their hard work and dedication which produced these results for our shareholders.

In 2015 we invested for growth, and in 2016 we executed for growth. Expanding into energy and financial institutions, and adding products across many parts of the firm, contributed to the growth and notable results we produced this year. The best way to discuss our performance in 2016 is in the context of our stated objectives to increase shareholder value. First we intended to increase our earnings and improve ROE. We made significant improvement in both this year, as our investments continued to season. We grew adjusted earnings by 11%, and made solid progress in our path to achieving a ROE that exceeds our cost of capital.

An explicit element of our strategy is to remix the business towards activities that attract higher multiples in the market. For us, this translates to advisory, public finance, and asset management. Over the past five or so years, we have doubled the revenue contribution from these areas to almost two-thirds of our total revenue today. Most of our revenue growth has been in these activities. Our diversified business mix has provided some earning stability, and we continue efforts to further diversify the business to produce strong results across various market conditions. This year provides a good example of the benefit of diversification. Strong growth in advisory and public finance more than offset the challenging market conditions we faced in equity capital raising and asset management, to drive overall growth in revenue and earnings for the firm.

A key metric in building shareholder value is gaining market share in our primary markets. We have done just that. With significant market share gains in both our advisory business and public finance. Finally, we are utilizing our capital effectively for shareholders. This includes both investing to drive growth, and returning capital to shareholders. In terms of investing, we closed on the Simmons acquisition early in 2016, and continued to fund our expansion into FIG throughout the year. With respect to returning capital to shareholders, we have actively repurchased shares over the past couple of years. Also as we announced this morning, we are pleased to initiate a quarterly dividend, and remain confident that we will have adequate capital available to continue to invest for growth.

Now I want to spend a few minutes briefly commenting on each of the business areas, before turning the call over to Deb to discuss our financial performance in greater detail. Our equity capital raising faced the worst market for IPOs in over a dozen years. The year got off to a very slow start. Contributions from our new initiatives in Energy and FIG could only partially offset the dramatic drop-off market-wide in capital raising experienced in healthcare-related areas of biotech and med tech. Strength in our advisory business, which set record revenues for both the fourth quarter and the full year, more than offset the weakness in equity capital markets. Our advisory business has been an area of strategic investment over the past few years.

Meaningful contributions from our Energy and FIG groups, supplemented with additional revenue growth from our healthcare and consumer teams, drove a nearly 50% increase in advisory revenues over last year's record level. Our debt advisory team also contributed significantly to these outstanding results. Our public finance business which has been another target for our growth strategy, again produced remarkable are results driven by the depth and breadth of our platform. 2016 represented another year of record results, as we achieved market share gains on top of market issuance that was at an all-time high.

Since 2010 we have doubled our market share in this business with the majority of gains coming through organic growth. Our equity brokerage business in 2016 was up 12% versus 2015. Bouts of heavy trading post-Brex and post the election spurred the activity. More significantly our expansion into energy with the addition of the Simmons research team is having a very positive impact on the entire platform. We firmly believed that Simmons had a first class research team, but the response from our clients exceeded our expectations. The addition of the energy research team is lifting the profile on our overall research platform, and we would expect increasing revenue from the combination due to the recognition of the increased value we are bringing to our clients.

In fixed income, the addition of the GKST late in 2015 brought gains to our customer flow business, which were offset by fewer opportunities from a trading P&L perspective. Discussions of potential tax changes had an immediate negative impact on valuations in the municipal bond market. Given our large public finance business, our inventory is relatively more concentrated in this asset class compared to most firms. Our asset management business endured a difficult year. The persistent wave favoring passive over active management was particularly detrimental to our net asset flows, and coupled with significant declines in MLP valuations revenue was significantly lower. We remain committed to the business, and are diversifying our product mix to position us for positive asset flows, as market demands shift from time-to-time. We added an aggressive growth equity product in 2016, and more recently added a global product through hiring of a new team that we will roll out this quarter. I will now turn the call over to Deb to discuss our financial performance in greater detail.

Thank you Andrew. As context, my remarks will be focused solely on our adjusted non-GAAP results, unless otherwise indicated. We reported record revenues of $218 million for the quarter, an increase of 9% sequentially, and 12% year-over-year. Earnings growth was attributed to both higher revenues and the inherent operating leverage in our model, as our non-comp ratio declined to 17.5%, and our operating margin expanded to almost 19%.

For the full year we generated record revenues of $736 million, an increase of 11% versus the prior year. Realizing the returns on our recent investments in Energy and FIG plus another year of market share gains in public finance drove the growth in revenue. Advisory and public finance have both been targets for strategic investment over the past few years, as we sought to weight our business mix towards these areas. To give you some perspective on our progress, from 2009 through 2013 our advisory revenue averaged about $75 million per year. In 2014 and 2015 we averaged just over $200 million. In 2016 our advisory revenue exceeded $300 million.

In public finance, which largely shows up as debt financing in our segment reporting, 2016 revenue of $115 million was up 26% over 2015, and up over 70% versus 2014. Our product breadth, geographic reach, sector expertise, and a scaled distribution platform, have all contributed to the success in this business. Our compensation ratio which was slightly under 64% for the fourth quarter, finished the year at 64.4%. Our comp ratio which began the year around 66% in Q1, improved compared to the first half as our FIG and debt advisory teams continued to ramp their revenues.

Going forward, we would expect the comp ratio to trend lower, but keep in mind the ratio is influenced by a number of factors, including revenue levels, business mix, and the degree to which we are investing organically in the business. Given our success of investing through the P&L to drive organic growth, we view this as an attractive use of resources, and will continue to invest opportunistically. However we would expect to invest at a more modest pace compared to the major effort we undertook to expand into FIG.

Our non-comp ratio improved throughout the year as revenues grew, reflective of the operating leverage in the model. We believe exploiting the operating leverage is a key element of our proposition to drive increased earnings, and value for shareholders. For the full year, the non-comp ratio of 20.4% was within our targeted levels, despite significant investments we have made in our business over the past couple of years. As part of our ongoing effort to optimize capital usage and reduce costs, we made the strategic decision to move our trading operations from a self-clearing model to a fully disclosed model. We are estimating that it will cost us approximately $3 million between 2016 and 2017 to execute this conversion, with a payback of less than a year. We have included these expenses as a separate line item in our financials.

Moving to a fully disclosed model, will meaningfully reduce clearing capital and expenses in our trading business, as well as remix part of the cost base to be more variable. I would now like to make a couple of comments on the goodwill impairment that we have recognized in our asset management segment during the fourth quarter. The combination of the current trends favoring passive investing, the decline in MLP valuations, and the underperformance of some of our strategies created strong headwinds for the business. We feel that each of these factors are likely transitory in nature. We believe that the macro environment for active managers may be improving, as we transition out of the market dominated by low interest rates. We remain committed to the business, and while we took a non-cash write-down of our goodwill, the charge did not reflect a restructuring or reduction in the scope of the business.

Finally as Andrew mentioned, we continue to be careful stewards of capital for the shareholders' benefit. To this effect we are pleased to announce that we reinitiating the payment of a quarterly dividend, starting with a dividend of $0.3125 per share. We believe this is an important additional element to our management of capital which includes use of capital in the business, investing for growth, and returning capital through share repurchases, and now dividends as well. While deploying capital to grow the firm remains our top priority, our ability to generate excess capital based on the stability and level of our earnings, led us to initiate a dividend as an additional means to return capital to shareholders. Now I will turn the call back over to Andrew for a few comments on the outlook for 2017.

Thanks Deb. The election has certainly affected the markets thus far, as investors assess the impact potential, or likely policies coming out of the new political landscape. Investors have demonstrated a belief that policies will be favorable for financial firms, especially banks, brokerage, and private client-related companies. Generally, we believe that the policies if achieved should be positive for our business. Lower taxes and a less onerous regulatory environment should spur economic growth and increased valuations. We feel this favors our equity capital raising and advisory activities, particularly if CEO confidence remains high.

We would expect faster economic growth to lead to higher interest rates, and we have seen this expectation start to play out already, with rates moving up after the election. Higher rates should be favorable for our fixed income brokerage business, with higher rates we could also see less of a singular chase for yield, and greater dispersion returning to the markets. This should provide a more favorable environment for active managers, and should help both our asset management business and equity trading, as funds flow back to active managers. We also believe that the outlook for public finance business is likely to be favorable in the mid to long term, but could be less constructive in the short term, as higher rates disintermediate some refunding activity, before greater economic growth spurs new issuance.

As a summary, we believe conditions are beginning to align for more favorable markets. We are still mindful of exogenous risks which could be detrimental to our growth. Political uncertainty, domestically and instability overseas, could trigger periods of market volatility which may have an adverse impact on our business, at least in the short run. However, on balance, we feel positive as we enter the new year. We will now open up the call for questions.

(Operator Instructions). Your first question comes from Hugh Miller. Please go ahead. Your line is open.

Hi, good morning. Thanks for taking my question.

Good morning.

Good morning, Hugh.

Thanks. I guess a couple, start on the Capital Market side. You gave some interesting perspective in terms of CEO confidence, which is obviously strength in media post the election. I was wondering within the healthcare side of your business, with some of the recent comments we've heard from the President just regarding lower drug pricing, manufacturing drugs in the US, have you noticed a shift in sentiment with regards to the discussions you're having with corporations, is there any change, coming about in terms of the outlook with that particular segment, just with some of those new commentary?

It's really early to see any real shift. I would add though, however, our healthcare practice is very diversified, and if there's an impact in one area, it's likely that more broadly, both of our advisory capital markets should be in pretty good shape.

Okay. And then I guess just turning to the energy side of the business. You provided some guidance when you guys did the Simmons acquisition, looking, if I remember correctly 10% to 15% accretion in year 1 in that transaction. As we start to head into year two of the deal this year, how are you guys thinking about the franchise, the outlook for that vertical, and the potential impact on the Company's business?

I would say a couple of things. We clearly had slow start to the beginning of last year, but both the quality of the people, their relationships have truly exceeded our expectations. Q4 was their strongest performance on our platform. And the first ten months did exceed our expectations. As we turned into the new year, business is performing very well, and we expect it to perform honestly above our model. And a big part of this that I think we're particularly pleased about is the synergies being on our platform. A lot of activity on the debt capital markets and in Q4, there were seven ECM transactions. Both were the benefit of the combination.

Got it. And aside from just, looking at the movements in commodity prices within that sector, are there any other things that you guys view as key catalysts coming up in 2017, that could meaningfully change the pace of advisory activity for that business?

Yes, there was a significant amount of capital raised last year in the US markets where we are focused. And US energy companies have gotten more efficient in the downturn, making them even more attractive investment targets. So we're positioned nicely to benefit from both of those trends.

Okay. And just given some of the commentary you guys made about the ECM markets in 2016, how challenging they were, how are you guys feeling about your pipeline for ECM activity as we head into 2017, and do you expect sentiment to kind of change, or what could the sentiment to change to kind of see a greater pace of industry activity?

So, it was in fact a challenging year, and as the year trended towards the back half, it improved substantially. But it's still really, the year ended up well below prior years maybe by 30 to 35%. But absent extreme volatility, the recover should continue to perform. You've got all of the right ingredients. Some modest but improving economic growth, relatively low volatility, capital needs. It looks like a good start to 2017.

Okay. Thank you. And then just in terms of you guys made some commentary about the municipal inventory levels, and I believe that any marks there would have been run through the brokerage income for fixed income. Is that correct?And what impact did it have on the quarter?

Yes, you are correct, Hugh. That is exactly where it would run. As we look at the quarter overall, obviously it was challenging especially in the municipal market. We were able to navigate through that given our extensive knowledge in that business, and we still had modest training gains, so we did not recognize a loss in that business. I will say we had a decent increase in customer activity in that business as well during the quarter. But you are correct, they would flow through that, and they were actually modest trading gains.

Okay. All right. That's helpful. And then just given some of that volatility, how are you guys feeling about the demand for both trading in that, just given some of the uncertainty about tax rates, and then also just the underwriting demand from the issuer side?

So, a couple of comments. Again, as we've said previously, increased interest rates on a positive yield curve are beneficial to our fixed income brokerage. And the client activity, even post election really indicates that's the case. From an underwriting municipal underwriting, as I made the comment earlier, mid and long term more economic growth, a lot of discussion about infrastructure should be beneficial to the business. Now there could be a gap here, if in fact rates go up very quickly, then you're going to disintermediate. Refundings may be faster than when you get to new capital. On balance we expect it to be positive, and we're very well-positioned for it.

Got it. That's helpful. And then a question just on the emerging banking portfolio, I noticed some of the gains that were booked there in the quarter. How should we be thinking about kind of that platform and portfolios, potential sustained gains at that level. Is there anything kind of outsized of the quarter?

Yes, I wouldn't say there's anything outsized in the quarter. I think that is a business where looking at it more on an annual basis, than a quarter-to-quarter, makes a lot of sense. We do mark the portfolio on a fair market value, so we look at that on a quarterly basis. During this fourth quarter, we had some marks on a couple of different positions in that portfolio. So I guess in summary I would just say that we continue to be pleased with the platform. We will be actually outraising a second fund, and really looking at that on an annual basis is probably the best way to do that.

Okay. Got it. That's helpful. And then just a couple of questions on the asset management side of the business. Just one on housekeeping. If you would just give us a sense of what the breakout was for AUM between the two strategies, for equities and MLPs?

Yes, I can do that. So at the end of the quarter, we ended at $8.7 billion of AUM. $4.6 billion in MLP and $4.1 billion in the rest of the equity value and other products.

Okay. Got it. And just in terms of how you're seeing things with MLP, given kind of the rise in oil prices, a compression in some of the credit spreads in that area. How would you describe kind of investor demand for investing in MLPs at this point?

So what we've seen in the more near term, is less institutional interest picking up but more on the retail side, the yield again is quite attractive, and the prospects for energy. So we're starting to see some signs of retail interest.

Got you. And is there a difference in terms of the fees you guys may generate between institutional investing and retail investing in MLPs?

Yes, I would say, I mean a little bit it depends on the structure of the retail investing, right?So if it's through closed end funds in that case, right, there's a slightly lower fee, but a lot of our assets are coming through mutual funds as well, and those do have a higher fee structure. I think there's about $1.5 billion or so in the MLP mutual fund structure.

Okay. Got it. And just a couple on the capital allocation priorities. I mean obviously you guys now initiated the dividend. How should we be thinking about that dividend going forward?Is there a payout ratio that you are targeting, obviously your business can be lumpy in terms of earnings in one quarter versus another. So is there, should we just assume a static level at this point, given that it's a new initiative, or how do we think about that?

I would say, Hugh, that our objective over time is to balance investing and growth with growing the dividends over time. Now the exact pace of that is going to depend on a number of factors, including what opportunities present themselves for our use of capital for growth. So it's difficult to be real specific about that at this time.

Maybe I would just add to that, Hugh, that we were certainly mindful of initiating a dividend, that we were very comfortable that we pay on a quarterly basis, and the objective would be to grow it over time.

Okay. And if you could just give us a sense as we end the year last year, what's the level of excess capital that you guy really have on the balance sheet at that point?

One of the things as you probably know, we haven't disclosed necessarily exact level of excess capital, because it's something that's quite dynamic for us, where and how we use capital within the business. I will say even if you think about the significant investment we made in Simmons, which was an all cash transaction at the end of the day after the we bought it back. We have a decent amount of excess capital, and our earnings are obviously increasing that, and that all really gets into as Andrew was mentioning, the comfort we had paying this dividend too, given really the level of our earnings, and more stability of our earnings now.

Okay. That's helpful. And then just a modeling question or two. You guys did talk about giving a little bit of insight to seeing the comp ratio coming down from this year, but mindful of being opportunistic with investments that you could make. Is there a targeted range we should think about in terms of 2017 for the comp ratio. And on the non-comp side, is there a level in 1Q or in 2017, in terms of an aggregate amount, or for a ratio that we should be considering?

Yes, so let me start on the comp ratio. Just to give you a little perspective on that overall. So you saw the comp ratio decline in the second half of the year, which is something that we had talked about and anticipated. Just to give you some perspective, we talk about investments driving our comp ratio, but another thing that we often refer to, is just business mix as well. Just to give you an example of that, our advisory revenues increased from 32% of revenue, if you go back to 2015, to 41% this year, and on the flip side our asset management revenue decreased from about 11% to 7%. And that mix of business is going to have an impact on our comp ratio. So it's something that also is somewhat dynamic, and makes it a little challenging to get real specific. Obviously as you alluded to in our comments previously, we have been pleased with the success that we have had investing through the P&L, so we will continue to look for that. Now our focus, our focus is on driving growth and increase in margin, and the way we're going to do that is invest in the business. All that said, we do believe that our comp ratios should trend down modestly. You saw where it was in the fourth quarter here a little below 64%, and I think that's in a general range of where we expect to be. Again, knowing that we will continue to use our comp ratio as a way to invest in the business.

Okay. That's e helpful. And then on the non-comp side, any commentary there?

Yes, on the non-comp side, for the quarter we were at just over $38 million, which is a low end of the range that we had guided to when Simmons had come on board, we said we would be between about 38.5 and 40.5, and absent any material growth initiatives, I think that's still a reasonable range. I would say that's even a reasonable range including the back office conversion costs in 2017, that were never part of that original range. I mean obviously in quarters where we have some of those costs hitting, it's going to put us more towards the top end of that range than the bottom, but I still think that 38.5 to 40.5 range is the right range and from a non-comp ratio, we continue to target driving that down towards the 20%, and that 20% to 22% range, even with the conversion expense I think is the range that we're really targeting, and of course as you know that's a large driver of that, that's where the revenue comes in in any particular quarter as well.

Okay, great. That does it for me. I'll back off, and step back in the queue. Thanks.

Thank you.

(Operator Instructions). And there are no further questions at this time. I turn the call back over to the presenters.

Thank you for joining us today. It's been a remarkable year for the firm, and I want to express my gratitude to our 1,300 partners at Piper who achieved these results. I am excited about our prospects as we enter 2017 significantly stronger, larger, and more diversified than a year ago. Have a good day. Thank you.

This concludes today's conference call. You may now disconnect.