BGC Group, Inc. (BGC) Earnings Call Transcript & Summary

So welcome back to the Piper Sandler's Global Exchange and Financial Technology Conference, virtual this year. So we're pleased to have BGCP's Chairman and CEO, Howard Lutnick, as our next speaker. Howard and I go way back, I think he took over the original -- brought the original eSpeed public back in 1999 and -- which I knew him back then. So first, welcome, Howard.

And then next, I'll start with my first question. It's about your whole transfer over to the stay-at-home work environment globally. It appears it's gone pretty flawlessly with you.

Well, what's surprising is you have your business continuity plan and you think it's flawless, but you never think you're going to institute it everywhere in the world on the same Tuesday, so -- but it went okay. Our sale -- our brokers take their turret home, they have computers at home. They have their VPN, they connect it and they're on. And they press the button, and they can transact with their specific clients. So it went pretty well. And obviously, we would have done better if we were at the office because our clients would have done better and everything, but it went okay.

So you had to transfer people across the globe to work out of the office at home, and you've done that successfully. But could you also give us sort of an indication of how the banks made that transition and how do the inter-dealer brokers -- you went through the 2008 financial crisis. So how do the broker dealers -- how had they made that transition? And how was it different from the global financial crisis of 2008?

Well, I think the banks started a little slower, meaning that people went home, and they were just taking risk from home in a way that the banks were uncomfortable. And the banks got more and more comfortable. They got their systems in place. They got it all working. And they got it to a level they were okay with, but they -- and it was never perfect because you have people taking risks at home where the banks were not particularly comfortable. And they started -- been reducing the amount of risk that they will allow their traders to take from home. And so now they're pushing their traders -- you're not going to see that much from the press, but they're pushing their traders to get back to the office because the risk controls are just better in a more controlled environment where they know where everybody is, and they can watch them more credibly. So I think our volumes will be better, all else equal, when everybody is in their offices because the traders will take more risk from the bank's perspective. And they'll use more of the systems. But we are seeing a dramatic demand pull from our clients to embed our electronics systems in all of their systems. Whereas before, they were only taking the easy-to-use stuff, now they really -- even through this whole COVID period, they are integrating our full suite of electronics across their full suite of platforms. And I think that you'll see that come online over the next 4 quarters in a material way.

So that should help the Fenics business, hopefully.

Oh, yes. So you'll -- so what happened is -- I'll give you an example. So we have a product -- we have these products called Volume Match or Credit Match where on an illiquid instrument, people, without displaying how much they want to buy or sell, can meet in the middle. So let's say the market is 14, 16. Someone's got a deeply illiquid instrument, we say we'll transact at 15, in the middle. Someone comes in as a seller, but they don't tell our brokers, they don't tell anyone, it's just the system knows. And if someone comes in as a buyer, they transact to go, right? So in mayhem, people didn't want to sit around and do that. They just said sell at 14, sell at 13, just sell and sell. So that goes to the voice broker. Now you're seeing them not only want that meet-in-the-middle model as the volatility ended, but our systems allow you to sell it at 14. If you can't find it at 15, sell at 13. But people weren't using that. Now they're going to take them in and implement our full suite of technology in. And so what I think you're going to see -- this quarter still had a lot of mayhem from April; obviously, less in June. So you're going to see sort of the ramp-up will begin in June. But what you're going to see is, in the next 4 quarters, I think pretty steadily, you're going to see Fenics, the integrated side of Fenics, the electronic side of Fenics, start to grow nicely and go back to really growing nicely as that -- as those businesses convert from the full voice into our electronic system. And the way we're going to describe electronics going forward is we're going to say our voice business got the 60% payout like we've talked about over the years. But on integrated, we will say -- we will make it very simple: it's got a 30% or better margin. Simple. So the system either drives a better margin or it's voice. It's black and white, right? The system is helping the voice brokers. That doesn't count because they get paid 60%. If the system is the proximate cause and it's a driver of reduced compensation so that the net result is we have a 30% margin, we're going to call it Fenics integrated. So it will be easy to see when something moves over from voice to electronic, you got to pick up 15 points. Black and white, 15 points. And I think you're going to see that march starting in the third quarter -- at the end of the second quarter, of course, but starting in the third quarter, you're going to watch that march higher, and that's going to make a clear difference to our bottom line.

Okay. Interesting. You talk -- we'll get more back to Fenics. But I did want to get to the massive Treasury issuance that you've talked about on the prior earnings call. We've been through this cycle before. I can remember your comments about waking up and reading the Wall Street Journal and being happy over massive Treasury issuance. I guess it's a repeat. So could you go over some of the expectations and how that could impact your business, debt and issuance?

Sure. So you have the world's record issuance of government bonds around the world, the world record issuance of corporate bonds or credit around the world. Every week is going to be a new record, and then that's just going to be beat by next week and the week after and the week after because the scale of companies that will need to borrow is just -- it's awesome. You have, mitigating that, the central banks of the world buying everything they can, literally buying and buying and buying to keep the credit markets tight, and they've done a brilliant job. So that's the offsetting [ variable ]. But the scale by which this issuance is going to emerge is hard to imagine. It's just hard to imagine. So what you're going to see is -- there's only so much the Fed and the central banks can protect. And the net result is going to be -- you saw it just briefly now with the long bond, which is just -- the Fed said it's not going to protect the long bond, We're going to protect the 10-year and the 5-year and the 2-year, so those spreads are going to stay tight. But the long bond is going to drive out. And then what you're going to see in a couple of quarters, you're going to see the 10-year start to drive out. And then, ultimately, you're going to see the 5-year start to drive out because there's only so much balance sheet the Fed needs to protect, and they have to protect the short end of the curve where there are trillions of dollars of deficit issuances going. So what you're going to see is, as that breaks over, that volume will go into our platform. And you'll see, over time, there's just enormous volume growth. But not today. Today, you're seeing the Fed is just buying, buying, buying to keep rates down. But that mathematically has to end. If you just take out your phone's calculator and do the math, there's only so big the balance sheet can get to the Fed and eventually -- and this is true for European central banks and Asian central banks, as that breaks away, the benefit to our business will be awe-inspiring, really awe-inspiring. I mean you saw a trend -- like Treasury volumes were down because the Fed's buy $75 billion at a clip. But now they're tapering that to $22 billion at a clip. And eventually, they're going to say, you know what, the 10-year can trade in the 30s. Well, I'm not buying 10s in 30s. And remember, they're issuing an extra $2 billion every month, like $2 billion more every month, like every month. That's just -- it's going to be huge. And so it's a groundswell. It's not here today, but it's coming. It's like a freight train coming. And the raw material underpinning our business will really be there for probably the rest of my life. Man, this is the greatest event, the fundamental foundation of bonds that can ever be, could ever be.

I hope you saw the fire while we're at it.

I did see the fire.

So we're really doing a fireside chat again. This may be the 15th one we've done or so. I guess the next question is, so compared to when we chatted, I think it was March 30, the world seems like it's more -- there's more boundary, there's some frameworks around it now, not completely forecasted but some framework. The doomsday scenario looks to be a bit more limited now. Is that -- would that be your assessment as well?

Sure. I mean the central banks of the world have done a great job constraining the credit markets and not having them go to where they naturally would have gone but for the central banks. So for sure, the world's got a sort of balance to it, for sure.

So that -- then the question is, when do you move from a more -- the very conservative stance, which is understandable, protecting the firm, which was, at the end of March, when do you move -- when can you move from or feel comfortable moving from a more conservative stance? We're not saying anything about the dividend, it's just, I guess, your...

No. But I think -- look, we're together, so let's talk about it, which is -- so my and my Board's sense was that we wanted to have a stronger balance sheet, just the world -- and we'll talk about the world. The Fed can help spreads and the central banks can help spreads and stimulus can help push people to take risk in the equity markets, which they've done, but they can't help revenue. They can't help revenue. And the scale by which there will be defaults of companies in the world, come the fourth quarter or the first quarter, will be unprecedented. It will just be unprecedented. And that will create -- and we can talk about the creation of opportunities for us to trade CDS, credit default swaps, and interest rate swaps that start to spread and widen, and the opportunities for us as a business will only get better. But my sense was as following. We drew $300 million of our revolver, pay off that revolver but keep the cash. Don't spend the cash, keep the cash, have our balance sheet be just $300 million stronger, paying it off over earnings, and that should take plus or minus the 1 year and then go -- and then announce a capital return policy, whether that's dividend or stock buybacks, but have a percentage to say, look, this is our capital return policy and set a dividend and buy back stocks and examine it then. So that's $300 million over the course of the year. So I would say it's the course of the year. Then that's our cash flow, using our cash flow to pay down the revolver, and we've already paid $75 million already. So this is sort of a work in progress. Pay down, keep that -- those facets on the balance sheet and strengthen the balance sheet. That can be accelerated by this transaction in insurance. So we -- then we had the big groups of people we've hired join. We can underwrite or we can evaluate what we expect the revenues to grow to. We did about -- we did $45 million in revenues in the first quarter, so a substantial insurance growth. We'd expect to continue that growth. And I think people will pay us for our insurance business. We've invested between $150 million and $200 million. I think we will express substantial profits above that and use that to pay off like -- so if we do a transaction in insurance, if we can get the right valuation for it, that would take the $300 million and move it in. And then so we can address this dividend policy sooner and the capital return policy sooner. So my goal is the $300 million and then capital return policy. So that will take about a year or, with insurance, we'll just accelerate it. So it could be shorter. I don't expect it long.

And there's some debt that is due in early, I think it's -- was it $350 million, I believe, that's due?

Yes, it's about a year from today, May of 2021. And that can be -- when the credit markets open, that can be refinanced. Part of our decision to reduce the dividend was to show the rating agencies that we should remain investment-grade and to try to do that. And they reaffirmed us. So I think our ability to go out and refinance that is something that's worthy of consideration [ to take our profit in ]. So I think paying off a revolver and taking the May '21 and sort of refinancing them away, I think we'll show everybody back to a world where we are going to be a very healthy capital return policy company. And the sooner I can get back there again, the better. You know I'm the largest shareholder. I [ wrote ] that policy. So I think -- I was just being prudent. And I'm a scarred individual. I mean I lived through 9/11 and the '08-'09 crisis and rebuilding the company through that. And I just want to make sure the company is strong because the rest of our conversation is going to talk about the spectacular assets this company has and had it growing. And I'm really excited. I've never been more optimistic about the long-term view of the company and its outcomes. And I just want to make sure that we're strong to get there, and we don't skimp on our investing because the outcomes are going to be soon.

So the investment -- a lot of investment has been -- well, in a couple of areas, in Fenics and in the insurance side. So Fenics, can you talk about -- dig in more into the topic you already talked about? The behavioral changes that came about from the pandemic period, do you think that accelerated the growth of Fenics? Because we've heard both that some asset classes benefited from that period where people sought liquidity in electronic venues where electronic market share grew; others, not so much. So where do you think that your platforms came out in that volatility period?

Well, MarketAxess and Tradeweb, which are in both credit and rates, did very well because they're B2C companies, right? They are the banks doing business with their clients, and so they gained market share over their sales forces, where they moved more electronic over -- versus their sales force and the way the clients did business electronically versus calling the bank. It really wasn't about us. So people think, oh, you guys -- what happened with us was what I just described is that the violent volatility pushed people to use voice versus the electronic in our integrated models. But in our stand-alone models, like our U.S. Treasury business, we saw our volumes explode higher, and we participated in the way you would expect us to participate: as a winner. So I think what's happened is it has accelerated the demand pull for our integrated electronic business, moving our business from just voice to voice electronic where the computer is a dominant player and, therefore, the compensation ratio declined. So you're going to see that over the next 4 quarters materially grow, materially grow. So that's number one. So we'll go from where you said, "Gee, the fourth quarter, Howard, you were kind of slower than you thought." In the first quarter, we never really got to see because of the pandemic at the end. Second quarter still includes April, right? But now you're seeing June, and what's happening? And the answer is demand pull by the clients for the electronics, which means that in the third and in the fourth quarter -- I'm not guiding, I'm just saying, what's -- that the pull is there. It's coming. You're going to see our numbers, we expect -- or I expect our numbers to grow as things move from voice into the electronic medium of that in [ liquidity ]. One liquidity pool, 2 ways to get in. You can get them by voice or electronic. And then our other electronic businesses, we've done -- we have a new product called Fenics GO, Global Options. It has 2 options on it now: it has Eurex 50, and it has the Nikkei 225. And that's just equity options. There were numbers of days where we're the #1 broker in the world, a new electronic system, #1 broker in the world, and the demand pull for that system is on fire. The amount of banks calling us wanting to get on the platform, wanting to transact with the platform, wanting to use the platform, it feels really, really good. So our Treasury business -- so what we've done is we took a deep look into all of our investments. And we had a lot and a lot that, obviously, we can talk to you about even because it wasn't ready for prime time. But what we've done is we are doubling down on the winners, and we've got a whole bunch of ones that just weren't there yet. And we know the winners. So treasuries are going to go into off-the-runs, they go into tips, they go into bills. Those are all coming, and we're investing, bringing and really extending that because our Treasury business is winning. Our foreign exchange business, MidFX and Foreign Exchange, Foreign Exchange Options, these are all winning. And then, of course, going to our Fenics GO and our Global Options business, taking that out into more and more equity products and then into fixed income for options, these are things that are winning, and we're going to expand and extend. And I think they're going to create tremendous value for my shareholders because, as you'll remember, Rich, once upon a time, in 2013, it didn't matter what I said about eSpeed, it didn't matter how many times I said it. And what I said, I would say, "Gee, eSpeed is worth more than the value of the company," and the stock would go up $0.01, our Fenics electronic platforms are growing. They're succeeding. We expect -- we spent $55 million last year, under $40 million this year. We expect breakeven next year, right? So what we're doing is we're changing which ones -- we're investing more in the winners, less in broad scope. And I think we're going to do it again. I think basically, the asset of Fenics is going to be worth such a large amount that it's not being valued by the company, and we'll -- our objective is to create value for our shareholders, and we will do it. And I think our Fenics venues are leading the way.

And I'm remiss because I -- when I asked the question about electronics, you had already warned back in March about a modest pullback in electronic activity and told us about it back early on, and it did come out on the earnings call. So I guess the question -- and you really answered my conclusion question, it was you're frustrated with the stock price. And we know a number of investors that are, and I'm sure you are as a major shareholder, I guess, the Fenics, is there any other ways to unlock value? Or is this -- I guess with Fenics and the insurance business, we're still at that sort of decision point.

Well, yes. I mean I think -- look, I think we -- I need to do a better job of articulating Fenics, and we plan to have an Analyst Day. And we're going to have growth, and I expect us to have -- Fenics integrated to be on a growth path starting in the third quarter. And that's my expectation. I'm feeling it in the end of May, early June. So it's -- I can feel that -- I can only do what the market is telling me, but that's what I see. And the company feels good about that. Our venues will continue to grow. The fact that our Treasury -- U.S. Treasury business does more business than needs to be done every day, materially more every day, that's good. We're going to extend it out into more and more products. We're rolling out our system that allows market makers, banks to trade with their clients, right, to make prices -- to use our system to make prices to their clients. We have Lucera that we don't really talk about much, which we have an aggregation platform that does things like [ Ion ] does. And we're installing that in one of the biggest banks in the world right now. We've won that client as a contractor. We're going to install that in one of the biggest banks in the world as an aggregator. Then we bought this company, Algomi, to be an aggregator of the buy side and sell again for subscription. So just take all these feeds and all these venues, just bring it in for subscription, do that through the buy side. And this is pretty much what I do for my brokers all day, so we're good at it. And then third thing is you use the rails in between. Let the banks stream prices to the buy side, right, and just do that on a subscription basis, not unit economics, trade with each other, just use us as infrastructure in rails. And I think what you'd find, if you talk to banks, is you'd see they're so excited about breaking unit economics in their transactions between them and their clients. And MarketAxess and Tradeweb are brilliant client companies because they get to trade -- charge unit economics per million when a bank trades with its own clients. So we think sort of 2.0 will be a subscription-based model. And we're getting lots of demand to pull for the banks in that business, and that's called our Lucera business. So now that's -- the problem with that business is that I have electronic trading agreements, BGC has electronic trading agreements with virtually all the banks of the world. Then we have -- but we don't have a master service agreement. We're not a vendor to it. So we have to go through these vendor connection agreements, which takes some time, sometimes 6 months, sometimes a year. Once you get that through, we can go product, pick a product, pick a product. And so I'm very excited about the 1-, 2-year horizon for Lucera. And I think the combination of our market data growing, our venues growing, our integrated growing and Lucera's growth, I think, will really show Fenics in a deeply attractive side. And then as you've seen in the past with me, eventually MarketAxess, Tradeweb, the exchanges of the world, will start coming knocking at the door, starting to look because they need to grow, and we've built assets and tools that are complementary to them and work really well on their platform. And so I think what you'll see is the value of the company will be expressed. And last time when I did the transaction, and you were with me then, the stock went from $3 to $15. And now it's strange that we're there again, but we'll do it again.

Thank you, Howard. Unfortunately, we're done on time. But we appreciate you taking the time out of your schedule. We're pulling for BGCP and Fenics and your, like, electronic trading and unlocking the value. So we'll see how the next several quarters to a year play out. But thank you for your time. And hopefully, we can do this face to face again sometime soon.

I look forward to it, Rich. Thanks.

Thank you. That's it. We'll take our dual wrap there. The next, 2:00, in about 2 minutes, is Virtu. So thank you, Howard. And we'll see everybody at the next session. Thank you.