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

This is Craig Siegenthaler from Bank of America, and I'm joined on stage by Eli Abboud, who covers the exchanges with me, and we're pleased to introduce Howard Lutnick. Howard is the Chairman and CEO of both Cantor Fitzgerald and the BGC Group. And today, Cantor Fitzgerald is a leading U.S. investment bank, and BGC was just brokerage arm, which had spun out in 2004. BGC is not only one of the largest interdealer voice brokers in the United States, but its Fenics platform is rapidly becoming a leader in electronic treasury trading. Fenics has doubled its volume in the past 5 years and electronic trading now accounts for 1/4 of BGC's revenues. Howard has spent his entire career at Cantor and BGC. After joining the firm out of college in 1983, he quickly rose to the ranks and became CEO in 1991. Howard, thank you for joining us.

Great to see you.

So maybe we'll start with a quick question on background, but you spent 40 years at the company. This included 9/11, which was a horrible period for the company and the country, but you bounce back stronger. So can you spend a minute on how BGC got to where it is today and how busy you must be being the CEOs of 2 separate companies?

So BGC is the wholesale marketplace for financial services and commodities in the world. So pre-9/11, we were the dominant player in that space. then obviously got crushed on 9/11. And then since then, we've rebuilt the business, and we're back to being the most valuable wholesale player in the world. So BGC, which is Bernie Cantor's initials, spun out of Cantor Fitzgerald. And it is the wholesale market for financial services and commodities everywhere in the world. Think of it as an exchange for everything that doesn't trade on an exchange. So you'd say government bonds, foreign exchange, corporate bonds, interest rate swaps, credit, all those kind of things. Those are our markets we sell market data the same way. It's pretty similar intellectually. And so we've rebuilt it after 9/11. And it really -- it has the most extraordinary assets because it's an exchange, but the world doesn't really understand it yet as an exchange, but they're going to now because we've announced and we're going to talk about it, that we're going to compete with the Chicago Mercantile Exchange, and we are competing with them now. We have our treasury business, which you've said it's called FMX, and it now has 26% market share in U.S. treasuries. It's taken over 20 points off the CME over the last 2 years. So it's really been very successful against the CME, and we've said, we're going to launch FMX futures opening this summer, got full approval from the CFTC, done and dusted, full exchange, full approval, all in the bag done, finished, announced. We're going to open this summer. And we plan to announce, who our partners are between now and the next quarter, and we're going to announce all the banks and trading firms, who are going to be our partners, and there's going to be a whole slew of them. We expect -- and then we're going to launch a competitor to the Chicago Mercantile Exchange. So it should be really, really fun and then people will truly deeply understand, who we are in the marketplace. And I think it will be really helpful to understanding our growth and our scale and how successful we are.

So you have a lot of exciting things you're working on in terms of the long term of the secular, but let's talk about the cyclical for a second. How do you see the macro backdrop unfolding with potentially rates coming down, maybe equity markets moving higher? -- and volumes? And how do you see that impacting BGC?

So we had a very strange 14 years from '08 to 2022. Interest rates going to 0 is really bad for secondary market trading, right? Imagine I call you up and say, do you want to trade and you'd say, well, where are rates? I'd say 0, where are they going to be next year 0, where they going to be the next year after that 0, how about year after 0. So everybody who's young, like Eli has never actually seen a rate their whole life, right? So I said on television a couple of weeks ago that the odds of the Fed cutting rates 6 or 7 times in the next year was fanciful. I mean that's just young people who've never seen a rate think, oh my God, it's 5.25. It's been 0 my whole life. We're going to -- okay, that's -- I find that silly. But let's go to BGC for a second. When interest rates were 0, that is bad for secondary market trading, it broke the natural relationship between issuance and secondary market trading volume. The ratio has always historically been 60%, which means if I double the issue in size, secondary market trading will grow 60%, right? It's just a bigger issue, right? We do a $1 billion IPO. The secondary market trading is going to be bigger. If you do a $2 billion IPO, right? It's just simply bigger, bigger secondary market trading. That broke when interest rates were 0. So now if you compare to '08 credit issuance is 3x the size. Rates issuance is 5x a size and secondary market trading is about flat to '08. And so what you're going to see happen is core fundamental growth of BGC's business. Every business, every quarter going forward, I said that in June of 2022 when -- and it's nominal rates, do we care, if they're 5.25, 6.25, 4.25, don't care. In fact, I like when people are uncertain, where they're going because that's just good for trading. But the fact is a notional rate means our business is good, less than 1% really bad, some number bigger than 1% really good. So where are we now? Really good. What is really good mean, 5% growth in the first quarter, top-line revenue growth, then 10, then 12. Last quarter, 18% top-line revenue growth of our core business, just a regular business, which divisions are growing, all of them. Really, all of them? Well, how could they not, right? Credit was only up a little bit last quarter. And they said, well, why is that? I said weAlmar Latour, this quarter, we'll be up 10%. So 10% is our outlook. It was our outlook last quarter, we grew 18%. So the macro model is very positive. It changed. And I understand why people haven't gotten comfortable with it yet. We had 14 years of 0 interest rates. That's a really, really, really, really long time, but that is not true anymore. And our core growth, our fundamental growth across all of our businesses is now repairing, growing, and it will continue to grow as we go forward. So it's really -- it's an interesting world that we've changed, and everyone can understand that 0 interest rates has gone. But they just don't realize they should go look to BGC because they haven't seen the business in 14 years. And now the business is back, and it's growing based on issuance and repairing the broken relationship between the issuance and trading buy.

Got it. And moving on to the secular themes. Could you maybe walk us through the impact of electronification on your business? I think there might be some misconceptions there.

Sure. So we take marketplaces that are messy, voice-based and make them pretty and electronic. So where sort of we turn straw into gold, right? Now when the business is voice, compensation ratios are high, they're in the 50s, right? And as they go electronic, it drops into the 30s because we would then have the best sales people in the world -- and so they go in the 30s that we pick up between 20 and 25 points as the market electronifies. And then every once in a while, we'll sell something through an exchange at a very high multiple and create enormous value for our shareholders. So we've done that twice. We sold eSpeed for the market cap of the company, and then we sold Trayport for $650 million. And so each of them were north of 10x revenues and our company trades at 9x earnings. So these are just wildly different values. So we convert voice businesses into electronic. We're about 25% of our business. So of our $2 billion in revenues, about $500 million is electronic. And those points are we earn 20 points more a bottom line earnings when it's electronic, 15 to 20 points more and the rest of the business. So we're moving that over, and that Fenics business is one of the largest electronic platforms in the world with $500 million in annual revenues. So that is completely undervalued and 9x. Think about it in a world where I take pieces of it and sell it at 10x revenues. It's trading inside a 9x earnings company that's whose core nonelectronic revenues are growing strong double digits. So it's really an extraordinary opportunity that as the company grows, Fenics is going to continue to grow. Fenics is widely more valuable than the overall business, and its margins are, as I said, 15, 20 points higher.

Howard, let's move on to the -- probably the most exciting part of the business, now the launch of the futures exchange. So you're in the process of launching FMX, which in addition to offering cash treasuries and FX includes a rate Futures exchange, which will go to head-to-head with CME's monopoly. How do you plan to take share from that?

Okay. So what's required to be successful in a competitive futures exchange is you need 2 things. You need to have a fully integrated front office electronic system because you can't build 1 from scratch. You can't start calling the Bank of America and say, can I install this now? I mean -- and then imagine calling JPMorgan and Goldman Sachs and Morgan Stanley. I mean, it would take forever. And so you need to have a fully installed operationally superb front-end clearing -- front-end trading system in place now, which we have in U.S. treasuries. And so it's rates already installed and our rates platform, our treasury platform is growing either 1% or 2% market share sequentially per quarter. So every quarter, like last quarter, we grew 1%. The quarter before that, we grew 2%, right? So now we're at 26%. Two quarters ago, we were 23% market share, and we just keep growing. And that is continuing. I would say I expect that to continue this quarter as well. I see nothing in the horizon that would stop that. So we have an installed front-end trading system and to do Futures competition, you need to have an adequate clearing mechanism that will give gross margin, right? Because you can't have someone long the CME and short FMX and they have to post margin on both. So by having an arrangement with the LCH is our 1-pot clearer, SOFR contracts, which is the #1 contract of the CME will have its natural perfect offset in cash, which is interest rate swaps, which clear at the LCH. So it is a superior model to trade SOFR contracts on FMX with its perfect cross-margining to cash swaps than it would be on the CME. And so if you couple that together with the cross margining to treasuries and their cross margin is so for treasury Futures and there's 2 pot system with the DTCC. What you end up with is we are competitive and adequate on the first day of gross margin. And so, if you have those 2 things together, you have all of the ingredients to build a competitor. Now if you said, okay, but the CME is an extraordinary enterprise, incredibly successful. How do you expect to take market share? Well, when we launched our U.S. treasury platform, the CME at 85% market share, Tradeweb, dealer web was called a NASDAQ at eSpeed, had 15%. So 85% and what I call cats and dogs have 15%, right? Today, we have 26%. The CME has 64%. Cats and dogs have 10%, okay? So if someone says, how do you take it off of them? We have proven quarter-after-quarter sequentially, that having a faster system, pricing it for your clients and having a tighter spread are the 3 components necessary to grow market share. So if they are in a quarter, we're at an 8. If they were to say they're going to react and go to an eighth, I'm really good at that, seriously. I am amazing. When I graduated the eighth grade, I killed it. So if you go to an 8, I'll go to a 16. And if you go to 16, 32 and 32 to 64 and the 128 and 256 and 512, I'm so good at that stuff. Really, I don't -- so I'm going -- and we have said we will be at a tighter spread than you are. And so it doesn't matter, if they were to react we'll just go to the next notch lower. And all of our banks and market-making trading firms understand that, and they are all built and integrated to be able to do that. Whereas the CME would have to announce it a year in advance to get people to write software that will allow them to change the spread, Ours was natively built to do that. And so I think these are the advantages we have. This summer, we're going to open for business. And I think -- over the course of the next 3 years, just like we did in treasuries, we will become a very, very capable, competent and valuable competitor to the CME and you can attribute tens of billions in market value to that, but we're between $3.5 billion and $4 billion franchise, growing our core business, 18% last quarter. Having FMX, which is think about it right now, we have a fully approved futures exchange waiting at the starting line, costing us money. How much nicer is it when you open, right, revenue and market data. And so I think the business coming for BGC is very, very attractive.

One follow-up on that, Howard. How do you think about the market share trajectory drift or the volume pickup because it might take years for some of this to have help. So just so we don't get ahead of ourselves. How should we think about that kind of share grab? And also on that last point, what are the incremental margins as volumes and revenue goes up.

Well. Okay. So the incremental margins for BGC are perfect. When you're eating all the expense and they're already in your numbers today, fully integrated in our numbers today. We lost the money. We spent the money, setting up this futures exchange. It's ready to go. When the first time someone pays us $1 million shoot to the bottom line. I mean, that's you're still losing money, you just losing way less. But our margins, which seem ordinary are not ordinary. They are better than that because we're spending this big investment over here. So from an incremental marginal standpoint, that was just too easy. Thanks for the softball, that was really kind of you. Market share. On our treasury business, it was 3% to 5% first year, 10 to 12 the second year. And now at the end of the third year of '26, '25, '26. So that's what we've done. So I don't think that is out of the -- that should be these goals that we have. Whether we can get there, we'll see. But that would be I mean imagine, if we had 25% market share in cash treasuries and Futures, and we'll have more than that in cash treasuries. We have that now in cash treasuries and now we're going to have all these partners. Imagine what value you'd attribute to that exchange. Another way to look at it when we do a deal with all the banks, what value do you attribute to the exchange post investment of all the major market participants strategically investing in the Futures contract? It wouldn't be the value put on in the first day, which was a strategic value. It would be multiples higher. Kind of like when George Clooney invested in a tequila company, right, became -- Casamigos became way more valuable after George Clooney. And so I think Bank of America is like George Clooney.

He might be a little cooler.

I don't know, to me, Bank of America is so cool.

Now Howard, you are, of course, the first person to electronify the U.S. treasury markets with eSpeed. Could you talk a little bit about that experience and maybe how those lessons learned have helped your efforts with Fenics and now FMX?

Yes. I think the model started capturing data and getting it into a system, then making the system able to transact as well, if not better, than the way the prior market operated, right? And that model was really interesting and different than because it was the beginning when people were uncomfortable with that model. Now everybody is comfortable with the model. So it's really, how do you do it faster? And how do you do it better. And one of the ideas is we always have to have the fastest system. So remember, we don't build what to buy. We just build how to buy it, right? What's the fastest system you can build, and we operate the fastest system in U.S. treasuries in the world. So that if a trader puts in an order, we time it from the time they put it in the order to us and back to them. With whatever network and connection they have in between just outcome-based not, oh, I do it really fast, but you do it really slow, not always. It's just outcome point A to point A period. So that has to be the fastest. And then imagine building into the system, the spread between cash and futures, so that they naturally -- you can put into the system buy A and sell B, and the system can execute that spread trade without regard to the outside world. It can do it faster, it could do it more perfectly and it can never make a mistake. So having a native built system to do that is what is special and extraordinary. And you can't do that from some other places. So the CME has broker tech, which is excellent and has mid-60s market share. And they have the CBOT U.S. treasury system right? And then they have the CME SOFR future system. Imagine having 1 system built native to go back and forth to all 3 built into the matching engine and to be able to say, if A, then B. If A, then B, then C. Put them all together, do in any combination you want. And it will never miss, and it will be exactly operated as fast as humanly technologically possible, right? That would be what you'd want to roll out, and that is what we are rolling out. And that's why our treasury system works really, really well. It's just -- it gives people -- I'll give you another example. Let's say, you're a big professional trading firm, market maker and you're just making prices all the time. And you keep matching with another professional market-making firm. And neither of you were getting the right outcomes you were hoping for, right? So you dial back your volume because you're not getting the outcomes you're hoping for because you keep matching with another sharp-edge sword. So we allow them to mathematically determine is their counterparty you're having a bad experience with and you can mark them out. And so then you can come in with bigger size because you're not afraid. And therefore, our average trade size is larger. How do you do that? You either know to build it that way or you can't. You cannot modify your system to do that. That is not a modifiable event. That's a complete and total other rewrite from scratch or not. So I don't think the CME can come up with that, right? That's just sort of a shrug because even if they wanted to come up with it, it would take them years to make it. And then you'd have to reinstall it to everybody and get everybody to rewrite every connecting system, Oh my God! And -- but that's what we did over this period of time, and someone says, why is your treasury business successful? Well, if I can say to you, if you're having a bad experience, right? We can do a mathematical calculation and see, is it someone who looks like you? And if it is, let's mark them out. They won't trade with you, you won't trade with them. They'll be -- you'll both be happier, right? And therefore, you both can come in with bigger volume to do business with everybody else. And that's just good for the system. It doesn't present our market share as high as it could be, right? Because if I let these guys trade with each other, we'd do more volume. So think about it. We have 26% market share without letting big professional trading firms trade with other big professional trading firms because they don't want to. Once they're owners and they say, "Oh, we don't mind, let's just do it and gain market share" right? Because that's probably 20% to 25% of the market we don't do now at all. Just interesting nuance of how do we get there. Remember, I've lived and breathed and our company has lived and breathed the deep understanding nuance of having built the best treasury system in the world, got knocked out on 9/11, sold it with the #1 business, right? Sold it, granted, it was a variety of problems with it done by the new owners. And then we went back in the business, and now we're back again. So we clearly understand it. And I think you would all put some real good, reasonable probabilities on our success across the REIT's franchise.

Got it. Backing up a minute, could you maybe talk about the differences between your dealer-to-dealer market and the D2C treasury market and how that market structure has evolved over time?

Sure. So we are wholesale, right? Meaning pros -- so you're a trader -- if you're a trader were to leave and go to a Millennium or sit it out, they'd still be doing business with us, and you'd be doing business with us and anyone else, who wants to act like a pro, who knows what they're doing, right? But the buy side is used to having service, right? So let's say, our market is -- we have a really tight market on the 5-year, $52 million bid, $87 million offered. PIMCO is going to call the Bank of America and say, offer me $500 million. And you're going to offer to them on the [ offered ] side, right? So they get perfect offer at the [ offered ] side for free. So that's a good business that is slightly different right? So that's the buy side to the sell side, right? That's what we'd say, business to customer. But it's not really a customer, it's really institutional investor, right? And that's a business that Tradeweb and MarketAxcess. MarketAxcess and credit and Tradeweb in rates have automated, right? So you can ask buy side firm can ask 3 or 4 banks to make a price on X, right? Everybody wants to trade wholesale. Because in that market, you can just be a taker, right? If a buy-side firm wants to hire a maker who says, I don't want to pay in the [ offered ] side, I'll put a bid in, then they need to trade with us. But they are then forgoing, right, the business of calling you and saying, offer me $500 million. So you were happy to have someone ask you, but sort of the fair balance with the banks are, if you ask me to provide you with liquidity, I don't want to see you on the playing field. If you're on the playing field, just tell me you're on a playing field like Millennium or Citadel, and we'll form whatever relationship we want, but at least we know who each other are, right? So that's the model. So the buy side would like to do business with us. But we provide a different product than the sell side provide them, which is I'll make you happy on your size at a fair price, right? So that Tradeweb and MarketAxcess is B2C business, right? But when you try to go all to all it's not going to work. Because that's why I just told that story. Then the bank says, so I don't understand. So am I providing you liquidity? Or am I seeing you on the playing field? If I'm seeing you on the playing field, don't ask me for liquidity. And I'm happy to see you on the playing field, right? Go bid and offer like everybody else. But don't ask me to provide you nice liquidity, so I can see the other side of your trade and I can use it in my business. So all to all, I think eventually, everyone is going to figure out. It's just not a winning model because it just goes in the face of customer service for money in exchange for something, and it has to be because you're my client. So all to all, you're going to watch, it's not important. Wholesale is important. B2C is important, right? We do a little B2C, when a buy side firm hires a trader, right? They can do a little D2D, they can't really do D2D because that would -- the dealers would zap, listen, you do business with my clients, which is it, right? And so there was that separation. And I think it's a great business. Everybody wants to trade wholesale, right? If you want to buy a car, you would like to buy it from wholesale. So I'm very popular with the buy side. They all chat with me, and they all talk to me. But the answer is, when they say, should I do business with you, the answer is, do you buy and sell 500 at a clip. Yes. No. I would have a product that makes you happy, I have 82 offered. If buying 82 works for you, great. But if you want 500 while you're asleep, call the bank. And that's why we have such a good positive relationship with all the banks. They know that each step we take is one that is logical to them. And we would never just say, just bring it all to all. It's just dumb, but that takes such deep fundamental understanding and nuance of the business. That someone who doesn't deeply understand it is trying to say, I'm going to say something nice to YouTube, so I can move my stock up. We're doing all to all. No, no, no. No, you're not. You're just saying it, but you're not actually going to do all to all. Because all to all is not in the best interest of the market participants. And if you understand it, you will just pound forward the way we do with a great relationship with all the banks, who then want to be your partners in everything you do because they understand sure, parts of the business should be with customers. And you know which ones to do and when we're going to talk about it together, and we're going to do that to. And that's what's very exciting about our business.

I guess a quick counter point would be in equities, you've seen direct market access and the D2C model kind of coexist and in credit market access has open trading, which has gained some popularity. I guess why is rates different in that sense?

Because the banks provide huge liquidity without charge, right? So if in equities, I could call a bank and you would offer me 1 million shares of the stock at the offered side, right? But you wouldn't. You would say, I'm not offering 1 million shares. I need a 5%, 6% premium because of the risk, right? So once I put a price premium on it, then the model changes. But because of the scale of liquidity in rates, the banks can offer a great service at too lower price in exchange for customers, and that's the difference.

Howard, with that, I just want to look at the audience and see if we have any questions. So please raise your hand, and we can get you a mic, if there's any questions.

You used to be a pretty nice dividend payer a few years ago. Just curious what your thoughts are there?

So capital return policy. If our stock is going to trade at 6 or 7, which it was before when before rates move, and now it's 9x earnings, we're going to buy back shares because it's a good capital return policy, which is let's buy back shares. Let's buy by lots of shares. And that's what we have been doing. We bought back over 15% of the shares of the company, and we're going to continue to buy back shares. And then the company earns lots of cash and it doesn't need the cash to operate its business. So therefore, we'll do share buybacks until such time as the stock is more balanced in price and then we'll reinstitute a dividend that's healthy. But the cash flow remains beautiful. So it's really a matter of, you would say, at 9x earnings with the story we just told buyback as many shares as you can. And the answer is. Yes, I agree with that. If we're going to buy back as many shares. In fact, I had a bunch of my shareholders we had a dinner. And they said, if you have a couple of divisions that are in Fenics then you can sell at 10x revenues. Would you be willing to consider selling them at 10x revenues and buy back shares at 9x earnings? And I'd said that sounds smart. So that's why I said in the last call, that sounds smart. And when I say stuff like that, that's not because I'm just like talking, right? So the company is thinking about that we have some divisions that are smaller that we could sell it, we think, at 10x revenues, and we can buy back shares at 9x earnings. It sounds deeply accretive in the understatement of the week for my show.

Any other questions in the crowd? I have one more operating margin question up here. So your margin is depressed, you're investing a lot into FMX. But strategically, how do you think about investing for growth versus operating leverage on a longer-term basis?

I think we're just opportunistic. I think the right answer is if acquisitions are really easy for us, bite-size acquisitions, meaning nonstrategic sort of plug-and-play kind of acquisitions or bolt-on acquisitions. Because if you think about it, we find a company, let's say, it does $100 million of revenues and makes $10 million, right? And we can buy it, let's say, we -- they'd say, I'll sell it to you at your multiple 9x and you'd get loss -- they're not us. We'll pay you 7x. So we buy the company for $70 million. We immediately take out their tech spend and their back office spend. So all of a sudden, it makes $20 million, and we've burned at 3.5%. Okay. That's pleasant. How often are you going to do that as many times as I can, right? So we're always buying little companies that sort of the big fishing, little fish kind of model. So we do that all the time. Example, we just went back into Japan. We have all our licenses. We kept everything going, but come on. Interest rates were 0 or negative in Japan for 25 years. So I'm glad we exited when we did because it's just too painful for 25 years. But now that we think rates are going to come back it's time to get back in, and so we'll invest. We'll hire lots of people. I think they will be profitable in the fourth quarter. So they're a drag today, but they'll be profitable in the first quarter, fourth quarter and thereafter. And then when rates come back, we think it will be a $100 million business. So we're going to do things like that. We're going to invest in electronifying interest rate swaps, building an interest rate swaps options business. Those are good businesses for us. But when I say they are near-term investments, which means they may be a drag on earnings for 2 quarters. But then that's it, by the end of the year. And for 3, 4 quarters, it turns profitable and that we never discuss it again. And I don't discuss those are drags. They're just explanations to why we didn't have the full gearing we expected to have. But that's it. I don't talk about foreign exchange at these things. This company is going to outgrow all of it. So it doesn't actually matter year-on-year. I guided that we expect our top-line revenue growth to exceed 10%. We should have nice gearing, which means at least 15% earnings growth, right? We're north of that, maybe between 15% to 20%, let's say. And we expect that to continue because there are nominal interest rates that the issuance and credit and the issuance of rates are so big that we will continue to grow, that our commodities business, which is -- which grew 40% the last couple of quarters will continue to grow because it is undersized as compared to how big it can be. It's our second largest business. So it's not small. But it's just the scale by which the world is gigantic in commodities. We can grow for the long distant future at very high rates. And so those -- all of these things combined really mean we're in a wonderful business. And the reason we're not more popular is because there was 14 years, where there were 0 interest rates, which was weird and strange and torched us. But that's over. And so we've had a beautiful year. We're going to have a -- we just guided 10% revenue growth. So we're feeling very positive. And we think things are very, very good going forward.

Great. Well, I think, Howard, with that, we are out of time, so we will wrap it up. But Howard, thank you very much for participating in the conference.

Thank you for having me. I appreciate it, guys.

Thanks, Howard.