Galaxy Digital Inc. (GLXY) Earnings Call Transcript & Summary

Good morning, and welcome to the Galaxy Digital's Second Quarter 2020 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. At this time, I would like to turn the conference over to Galaxy's Investor Relations team. Please go ahead.

Good morning, and welcome to Galaxy Digital's second quarter earnings call. Before we begin, please note that our remarks today may include forward-looking statements. Actual results may differ materially from those indicated or implied by our forward-looking statements as a result of various factors, including those identified in our filings with the Canadian securities regulatory authorities on SEDAR and available on our website or in future filings we make with other securities regulators. Forward-looking statements speak only as of today and will not be updated. In addition, none of the information on this call constitutes a recommendation, solicitation or offered by Galaxy Digital or its affiliates to buy or sell any securities, including Galaxy Digital securities. With that, I'll now turn it over to Mike Novogratz, Founder and CEO of Galaxy Digital.

Good morning, everyone. It's actually a beautiful day here in New York. We're going to do this a little differently than we've done in the past. In the past, I've read a script. Damien and Chris and Alex have all chimed in. But today, we thought we'd take a different tack. I'm going to kind of put you on the quarter back to helmet and try to give you some sense of how I'm seeing the world, how I saw the first half of this year, the opportunity set and how I think about our company. Listen, no one likes to look at a red $550 million number and try to feel good about it but I want to put this in context of the journey we've been on and the journey we're going. January 2020, partners equity in the firm or our book capital was roughly $350 million. And at the end of Q2, we were over $1.8 billion. What goes into that number? It goes that gains we've made in our portfolio, less expenses we paid, rent, salaries, bonuses, taxes. And so it's a hard number to grow that quickly and so in some respects, I feel pretty awesome about the stewardship of that capital. Listen, I don't take a salary, I don't get options, I don't get shares. And so for me, I'm a big shareholder, the focus is our book equity and our stock price. And so you hear today a lot about risk management and how we're going to drive book equity higher, we're going to drive our stock price higher because that's where my real focus is. So put the year in perspective, if you took our losses this year, plus our gains last year, we still made over $1 billion in a growth business, while we're investing a ton. And so in the big picture, I feel pretty good about things. When I break our business into the 2 hawks, we have 4 operating businesses or really 8 operating business if you want to take the intermediation business and break it up a little bit. And then we have a balance sheet that we manage. And I look at the operating businesses and I've got a grid in my face. I am proud of how they operated. I think in each of the businesses, and I'll get to them, we did really well. We didn't make the same mistake some of our competitors did. Our risk management, both from security selection, our token selection to counterparty selection to credit management, all was top notch and we think should be a model for how this industry self regulates. And so I feel pretty great about that. On the balance sheet side, high to low, this year, were down 29%. Luckily, July and beginning of August have been much better months. And so that number is smaller today than that month quarter-end trend. But that's in context with the crypto market down 65%. The good news is last year, we sold over $1 billion of stuff or last year in the beginning of this year. I guess the bad news is we should have sold more. Managing a big balance sheet is tricky. Some of it's big illiquid positions. In the private side, those have been marked down. Some of it was liquid positions that we either didn't hedge fast enough or held on to too long or had the wrong market call. And so the great thing about trading or investing is the numbers are the numbers. You see them there, you can compare them to our peers. But I feel like, listen, we're sitting here at the end of the quarter with over $1 billion in cash, $1.5 billion in liquidity and operating businesses that I feel pretty good about. What else happens in big bull markets? Your cost structure gets a little bit heavier than you'd like. And that's just, I think, a natural in any bull market. And so what we've done in the last 8 weeks has been to take a really serious look at each of our businesses, in essence, re-underwrite each business and look at our cost structure. We've taken out over 20% of vendor costs. That's from marketing and tech spend. And so that's just going through 500 line items at our sheet and making smart decisions. The biggest cost in this business is people. Luckily, for us, we've got a variable comp structure. A lot of our comp comes in bonuses. In a year where we make $1.7 billion, those bonuses are pretty high, in the year where we're losing money, those bonuses are less high. And so adjusting the comp pool down, we took some selective shrinking of our team. Those are usually in areas where we had underperformers or where we thought we could find synergies by combining a few businesses. And so we took a few people off the field but we're adding people. We started the year less than 300 people and we're about 375 right now and I think we'll finish the year over 400. And so while the crypto landscape is less certain than it was, my confidence of where it's going in the medium term hasn't waned a bit. We are a growth company. We are investing in people, in products and engineering teams for not the next 6 months, but for the next 6 years. And so I think that's the message I really want you to hear today. Listen, we've taken our cost structure. If I look at a normalized 12-month go-forward cash outlay down to roughly $175 million, $177 million and if you add the equity comp that would go along with that, it's about a $200 million number. I feel very confident that our operating businesses will make that much in revenue. And so I'm looking at a company that should be cash flow positive and have a very big and well-managed balance sheet and an opportunity to be offensive. And so as bad as that 553 headline number feels, I don't fear nearly as bad as I thought I would. And I hope it's the worst quarter this firm ever has. Listen, let me real quickly touch on each of the businesses. When I think about our sales trading credit derivative business, like I said, I feel pretty great. In credit, you've probably seen the competitors monster losses in lots of places from retail credit to institutional credit. We've had an unbelievably well-managed business. Chris Ferraro came from a credit background, Luca, who runs our credit business, they've been conservative, they've been over-collateralized. We did have our first loss in credit in the firm's history this year. It's filed publicly. We put a claim into 3 Arrows. That's in their filing. It was, within the context of our balance sheet, small. It was hedged, so the losses were mitigated. And it was frustrating. You don't like to lose money anything but to lose $8 million, $9 million relative to the hole that it created in other people's balance sheets was something we swallowed. The business was still profitable in the quarter. We liquidated or shrunk our balance sheet in a really managed way with lots of other counterparties. And I think we've got market share to gain there as most of our competitors have been wounded and we're not. Our derivative business continued to make money. Hat's off to Rob Bogucki and his team there. It's a business that we think, again, we've got the right to earn more market share as competitors got wounded. Our OTC businesses, our quantitative trading business from Andrew Karos used to be called Blue Fire, all continue to be profitable. And so I flip to asset management, we are raising capital in a tough environment. We've launched a good product. We have an alpha fund that is just getting launched by Chris Ryan, that I think is going to be a wonderful product. The interactive fund is doing their second close. And so we got AUM back to $2.1 billion at the end of this month. We think that's a business we should do well in. We've finally got, I think, the right product. And so that's a pretty easy one for us. Mining is a business that we had invested a lot in. You're going to see our mining revenues start to grow pretty rapidly. There's no magic to that. We had invested, we finally are plugging in our mines that we bought at low power places. And so that's going to add to the revenue going forward. In our Investment Banking business, run by Michael Ash, is just doing a great job. We're in the middle of a ton of activity. We're benefiting from a couple of years of investment in developing domain expertise in that space. And so again, when I look at those businesses, I'm pretty optimistic on each one of them. On the balance sheet, like I said, we marked down our private positions pretty aggressively. We are liquid. In our liquid positions, we have less diversity. We've got bigger bets in the more liquid tokens that we think will go higher. And we feel pretty good about where we sit. Listen, with BitGo, we're in constant contact with Mike and his team. We're evaluating what's best for both businesses, it has been frustrating that it's taken as long as it has. With the listing in the U.S., we continue to plow ahead. And there's a long queue of other firms that are not are with the SEC, we remain hopeful and doing the best we can there. I want to stop before we go to questions and just talk a little bit about crypto. Crypto is not going away. And as much as it feels when the whole market went that 80% that people got really nervous, I didn't, and there were a few different reasons. One is, I look at the 15 analysts that we just hired, and I scratch my head and say, "Geez, I couldn't get a job at my own firm, if I was 22 years old. From great universities, diverse group, all over the place who know more about crypto that a lot of our more senior people. These are young people who believe in this revolution. When I look at our meetings with institutions, while retail really got hurt in this, institutions were just starting to get in and so we see nothing but forward progress there. There was a big announcement this week with BlackRock opening up their Aladdin platform to crypto for the first time. That is actually a monumental shift. And it just tells me that more and more access to crypto is coming. The total addressable market, the TAM of crypto, is much bigger than people think it is. And so we're going to invest accordingly. With that, I think I'm going to leave it for questions. I'm going to bring in Alex Ioffe to just run you real quick through the facts of our numbers but I want this to be interactive. I want you guys to ask as many questions as you want. Alex?

Yes. Thank you, Mike. We'll keep this short. In the tough market conditions of the second quarter, our business performed well. We ended the quarter with $1 billion in cash on the balance sheet and $1.8 billion in equity capital after reporting a loss of $555 million, most of it from unrealized marks to market. In the quarter, we marked down our principal investments from $1 billion to $750 million and unrealized marks on digital assets were negative $230 million. Our total liquidity was $1.5 billion at the end of the quarter, consisting of $1 billion in cash, $220 million in net liquid digital assets and $250 million of stable coins we used for exchange settlements, predominantly USDC, issued by Circle. With that, I will hand over the call to the operator to take questions. Thank you.

We have a first question from the line of Chase White with Compass Point.

So a couple of questions. So in general, do you guys see your prudent risk management in the face of the recent crypto market events kind of leading to Galaxy taking additional market share going forward and when could we start really seeing that come into force?

Yes, I'll take that one, Chase, and welcome, and it's great to have you covering the company. But let me hit on a few fundamental components of our risk management and credit and then I'll get to your market share question. As we think about our overall portfolio, the key things that we are very focused on are concentration risk. And so if you think about our concentration limits that Chris and Luca and the team manage our book towards, no counterparty concentration is above 1% of partner capital. And so you can reverse engineer that, that the largest loan that we have out there is $40 million. Some other key things for you to know are over 60% of our loan book is directly to TradFi service players, so think about family offices, traditional hedge funds, high net worth individuals. And the book itself offers a lot of diversification benefits at different market segment levels across both TradFi and crypto players. And so our ability to manage our asset liability components extends well outside of the crypto-native environment and I think that's an important component to think about to answer your question around market share. And so as you can probably appreciate, in the back end of 2021, our sales force, we're giving Chris, Mike, myself and others are pretty hard time about our conservative loan agreements that we wanted to put in place and some of our competitors stepped in and took that market share. That lending market share, often like it does on Wall Street, comes with trading market share. And we took a back seat and we felt a lot of pressure. That's reversed substantially as we've come out of the other side of this tradable bottom in crypto. And a lot of those customers that were choosing our competitors in the back end of '21 are now doing business with us. The terms of these loans, not only are they at higher collateralization levels than we had implemented throughout 2021, there were slightly higher NIMs. And we anticipate being able to enjoy an environment that has both of those things, safer loans at higher NIMs for the relatively near term and potentially the medium term.

One thing I'd add is, listen, I think the credit business can be a big business. The cost of capital for the overall space has gone up. And so we are working really hard to figure out ways to be a better borrower. I mean if we could borrow cheap and lend expensive, we've got a pretty good business at infant item. And so that will be the real governor to how fast this business can grow will be access to good financing.

And by the way, we are borrowing cheap. We have $0.5 billion at 3% 5-year term on the balance sheet.

And then you mentioned in the release that there was a prominent shift towards M&A in the market right now. Can you help us kind of size that opportunity up and how quickly could this kind of M&A shift take place? Like is it happening very quickly and then it will be over quickly or is it kind of a prolonged environment, do you think?

Yes. So let me give you a little bit of color around that and some data. The answer is, we don't know. A lot of the contributing variables to the answer to that question are linked to capital and whether or not it will continue to flow into the sector. If you look at the data that we use in our advisory business, M&A in '21, where you look at least one company in the crypto sector being part of that transaction, we saw 180 transactions. In the first half of this year, that pace exceeded last year with 92 deals looking at the same metric. If you look at what Sam and the FTX team have done in the very recent past, they've been extremely active in this down market. You referenced BlockFi, [ BitM, Bitvo, MVAD ], just in the last 2 months alone. And if you look at assets raised or capital raised by companies in the sector, in July alone, $1.3 billion continued to get raised. That was across 89 deals. And so year-to-date capital raise is just over $21 billion. And so the capital raising side in terms of financing has slowed a little bit. That's reflected in what our bankers are working on. We have been very active on the buy side for some of our customers, that continues to be the case. And I think you're going to see a lot more M&A than the run rate suggested in '21 in the back end of this year and the first half of '23 but I think the increase will be largely led by TradFi players who are able to participate now in the sector of valuation ranges that are a lot more digestible than they have been in 2021 in the first part of this year. And so the activity that we're working on reflects that type of dynamic.

We have next question from the line of Deepak Kaushal with BMO Capital Markets.

I've got 3. I'll try to make them brief. First, just on the U.S. listing process, I know it's hard for you guys to talk about it. Any other color that you can give us, Mike? I mean, is there still some back and forth going on or is there a stall or is there a bit of a summer pause here until we get back in the fall? What's kind of the activity level and how is that changing?

I would, I guess, hone you to the other companies that are in the same process. If you think about Bullish and Circle and eToro and there's a bunch that have been in the same queue. And just looking at those, it doesn't seem to be great progress. I think when the market sold off as aggressively as it did, it probably took a lot of key sources and a sense of caution. We're hitting a new equilibrium, things have kind of balanced out the players that were getting washed out and so I'm hoping it gets back to normal and we make that progress. But I can only tell you what we're seeing and things continue to be slow.

And then just on the competitive side, obviously, BlackRock and Coinbase have your partnership and helping Coinbase's stock a bit. Are you finding that your handcuffed from a prime brokerage perspective, that you haven't been able to close BitGo yet? Is that affecting you guys competitively at all? How is that side of the market shaping up?

Let me give you some color around that. And I think it's really important to ask the question of, what does prime brokerage mean? It's a term that gets thrown around a lot, both in TradFi sector. And I think when you dig into different providers and different clients, what they really think there can be different. The layer of services that we're building at Galaxy that are very important to our institutional costs are execution, liquidity, margin lending and netting and leveraging all of the additional service and products, it's ultimately going to be critical for us to be able to stake ETH when that comes online. We're going to have to rehire Bitcoin for customers that need that. So all of the things that we have become expert in for our own principal activity, we're going to roll out to our customers, and that will happen agnostic to the downstream custody provision. Galaxy, today, in our asset management business and in our balance sheet, leverages several different custodians to provide the back-end solutions that we need, depending on what the coin is that we need custody and the services attached to that. And so we can plug in the downstream custody services to our prime from a number of different providers if needed. And of course, we're hopeful that BitGo will be one of those. So really from a prime services product delivery perspective to our institutional clients, that front-end service solution is what we're good at and what we're continuing to build. And so that will not limit us in any way to providing services to our institutional clients.

So it doesn't sound like it's a competitive handcuff at the moment but is it delaying opportunities that you haven't been able to close the deal yet?

I would say no for the reasons I highlighted.

Yes. Listen, we are investing a lot in our technology to build out here. And so it's building product that will service those institutional clients. I mean, the interesting thing is, when you think of it something like Aladdin, it's an agnostic platform. They will have lots of people that plug in once there's product to plug in. So our race is to get that product built sooner rather than later.

And then my last question, just on the M&A front, again, related to competition. I think the prior question on M&A, I think a lot of the answer was related to your investment banking side of the business. How about Galaxy's M&A activities? You mentioned FTX buying other companies. What's your approach to the market, like you haven't seen enough lot on the street yet, Mike, to take anything?

No. I was really focused on cleaning our house, getting our understanding of how we spend money and where we spend money, getting our 8 operating businesses really mission-driven and steal the eye and focus. And so it's kind of Stage 1, clean our own house up and get set in Stage 2, look for the offense. We've been going through lots of opportunities during Stage 1 as well and haven't found the exact fit yet. It would have been a huge mistake to have gone through this full cycle and not done something offensively unless we have $1 billion in cash. And we think that we're on a cash flow positive operating run rate at this point. And so I want to be offensive and we're looking.

Okay. That makes a lot of sense. I mean, certainly tumultuous quarter. I mean you guys are on the right side of the regulations, when do you think you start getting credit for that?

Listen, I used to sit at conferences until the space, especially when it's much smaller that we need to self-regulate as a space or the regulators are going to regulate us. And when I look around at some of the behavior of our industry, there was not a whole lot of self-regulation going. There was asset liability mismatch, there was excessive leverage. There was all kinds of c*** behavior in our space. We are hoping to be a model of what regulation should look like and so that's been our play. I do think the regulatory landscape in D.C. is still at a bit of a standstill. There was some great legislation, bipartisan pushed to the AG committee recently to move Bitcoin, Ethereum to the CFTC. We'll see if that gets any traction, probably not until after the election. But my sense is, we're not going to see much movement until after the election and that is going to be one of the frustrations. So our plan is to stay in contact with everybody to try to be a role model. And hopefully, you will see, when markets crash and everyone gets scared, the first reaction is everyone kind of running for the hills. I think what you're going to see next is companies realizing, hey, I've got a sustainable business model or I don't and this is where we talked about the M&A activity picking up. I think you'll see some people go out of business, others grow. You're seeing TradFi guys deciding to get in at this opportunity. So I think the next 6 months will be pretty interesting for us. And hopefully, our framework on how we do business leaves us at a good position both with regulators and in helping set the new rules but also with customers.

We have next question from the line of Ken Worthington with JPMorgan.

Maybe first, higher level, is the contagion from Terra and Luna over? And if we're going to see more fall out, where does it come from and what drives it?

Yes. Listen, I think what you saw was a big deleveraging of a whole group of players that had, in many ways, borrowed customer deposits in these lending platforms. If it was Celsius or Voyager or BlockFi or many of these exchanges and then lent them out into less liquid and longer-duration assets. I think that deleveraging happened. That was the wash down to $850 in Ethereum and 1,800 in Bitcoin. We've seen a bounce from there as the fear went away. Those companies still are going to be absorbed or liquidated and so there'll be some pressure on asset sales that happen over time but it becomes a smaller and smaller portion of the market. I don't think there's another shoot to fall in terms of bad credit or someone who needs to be liquidated, I think now the industry needs new energy. So energy comes from narrative in our industry and so we're seeing it in Ethereum with the merge. And so Ethereum is outperforming because there's a story to tell and there's a really exciting shift in the supply-demand equation of the period. So you're going to have a less inflationary currency, you're going to have people who are incented and paid to HODL or to stake their Ethereum. And so prices are set on the margin, that's a story that Ethereum is shifting into a new chapter. The Bitcoin story continues to just slowly gain traction and adoption. We'll see what the macro environment is, if the FED flinches, if we have inflationary accelerate. But I think that story is less exciting than it was certainly when federal banks were pumping in tons of liquidity. And the third part of our business, which is really the long-lasting part of like building out Web 3, that just keeps grinding away and it takes time. So if that's the NFT space, if that's the DeFi space, that's not going away, there's a lot of venture money funding that. But again, I think for the industry to kind of take that next big leg up, we're going to need to see this institutional money come in, we're going to need to see that narrative. And again, is it going to happen in the next 2 months? I can cross my fingers and say a few Hail Mary's but we're taking a much more sanguine view that over the next 18 months, 24 months, all this stuff will happen.

And then following up on M&A, which seems like the topic de jour, so you talked about comp getting outsized in the bull market. And I guess my opinion is that bull market can also support maybe too many companies. So is the crypto ecosystem in need of some consolidation? And if so, what parts of the ecosystem seem to be more ripe? I think you mentioned the lenders might be right. And then you also mentioned that TradFi buying into crypto, what parts of the crypto ecosystem do you see TradFi firms most interested in?

So what's interesting is like what were the big winners in crypto, they were the exchanges. And exchanges really weren't even exchanges, they were broker-dealers in lots of ways. Like Voyager was a broker shop, others, blockchain.com or Coinbase, they collected customers who are playing in this new world. They were high-margin businesses. And the customers are really resilient and really sticky and so a pretty good business. I think you'll see some consolidation there and you've seen that with Sam and FTX already with both Voyager and BlockFi. And I think you're going to continue to see some consolidation there. When you think of things like custody, you're going to need a lot more custodians if you really believe that we're going to start having tokenization at one point in the future of other assets and that the crypto economy is going to continue to grow. We already have big traditional players investing lots in custody. They don't have the regulatory framework to do it yet but they're investing in advance. And so that will be an interesting space. What we do, there's not a ton of competition in. We have competition in each of our segments but in the derivative business, institutional lending business, Genesis is a big competitor. They've had their own issues recently. I think they'll continue, they're not going away. But we don't have a lot of kind of institutional level broker-dealer derivative businesses to compete against or even credit businesses. The big credit business that had suffered so much or places that we're taking in retail dollars and then lending them back out but I think that game is probably over for a while.

Can I just add a couple of things to help answer your question in addition to Mike's comments? I think every subsector of digital assets has a group of firms that are larger, and in many cases, they were able to raise capital in the 2021 and Q1 of '22 period. And a lot of these sub-scale smaller firms weren't as able or inclined to do so. And so I do think you're going to see a natural runway driven M&A cycle in almost every sub-sector. Mike mentioned a bunch of them. And that's going to be something that we're right in the middle of in our advisory business. We take a lot of cues from that through our venture investing business where Chris and the team really monitor very carefully all of our portfolio companies, which now total 100. And to give you a sense, I think an interesting stat for our portfolio, the average runway across the majority of those companies is just over 33 months. And that informs a lot, I think, when you look at the sector through that lens and where runway is, it really is more prevalent in some of the larger firms. And that's why you'll see a driver of roll-up in M&A.

And last thing I'd say, and flip my head for a second. But one area that I think needs capital and got off sides in this space was mining. I think the mining space, it just looked like it was such a good business that people were raising capital instantly, committing it to buy chips and shelf space in the future. And so that space, we find pretty interesting. We think we've got a role to play in both lending and potentially consolidation in that space. But if you think about kind of one sector that's probably got the weakest legs right now or the most challenges, it could be the mining space.

We have next question from the line of George Sutton with Craig-Hallum.