Cohen & Steers, Inc.
Q3 2008 Earnings Call Transcript

Published: 4 Nov 2008

[Operator:]

Welcome to the Cohen and Steer, Inc Third Quarter 2008 financial conference call. My name is Vanessa and I will be your conference operator today. At this time all of you will be placed on mute to prevent any background noise. After the speaker’s remarks there will be the question and answer period. (Operator’s Instructions) I would like to turn the call now to Mr. Salvatore Rafa, Senior Vice President and Associate General Counsel, please go ahead, Sir.

[Salvatore Rafa:]

Thank you and welcome to the Cohen and Steers’ third quarter 2008 earnings conference call. Joining me are Co-Chairman, Co-CEO, Martin Cohen; Robert D. Steers, our president Joseph Harvey, Chief Financial Officer, Matthew Stadler. Before I turn the call to Bob I am going to point out during the course of this conference call, we may make a number of forward-looking statements. These forward-looking statements are subject to various risks and uncertainties and there are important factors that could cause actual outcome to differ materially from those indicated in this statement. We believe that some of these factors are described in the Risk Factors section of our 2007 Form 10-K which is available on our website at www.cohenandsteers.com. It will be my guess that the Company assumes no duty to update any forward-looking statements. Also the presentation we make today will contain pro-forma or non-GAAP financial measures which we believe are meaningful in evaluating the Company’s performance. For detailed disclosures on this pro-forma metrics and their GAAP reconciliations, you should refer to the financial data contained within the press release we issued yesterday. Finally this presentation will contain information with respect to investment performance in certain of our funds. I want to remind you that test performance is not a guarantee of future performance. For more complete information about the funds we will discuss today including charges, expenses and risks, please call 1-800-330-3348 for a perspective, with that I will turn the call over to Bob.

[Robert D. Steers:]

Thank you, Salvatore. Good morning everyone. As usual I will start by highlighting the headline numbers, then move to a discussion of the current environment and then hand it over to Matthew to provide details underlining the headline numbers. As you know by now, last night we reported a loss of $1.6 million or $0.04 per share for the quarter. This included an after tax expense of $0.20 per share related to the sale of preferred securities namely of Freddy and Fannie. We also recorded a $0.04 per share adjustment to tax expense related to those sales. After adjusting for these items earnings per share would have been $0.20. During the quarter assets under management declined 8.7% to $24.6 billion from $27 billion in June. Although US REITs did generate positive returns of about 5% during the quarter, International REITs were off over 20% and value stocks declined by about 10%. As a result, the bulk of the sequential decline in asset was due to depreciation of $1.9 billion. In addition to that we experience net outflows of $465 million primarily from our open end funds. Investment banking activity remains depressed in the quarter with this group posting modest revenues and a pre-tax loss of $1.3 million. Before I get into the details regarding the fundamental developments in the quarter which were on balance very solid, I would like to first just recognize the elephant in the room which is, of course, the one critical variable we cannot control stock prices. As you know, thus far, October has been by any measure disastrous month for virtually all markets and we have certainly not been immune. As some have already commented on this week, this time the versification has not helped at all. The industries representing the 3 strategies that comprise the bulk of our assets under management which are US REIT, International REIT and large cap value, as you know, have declined substantially this month roughly in excess of 35%, 20%, and 20% respectively. It is our sense and certainly our hope that we are nearing a positive inflexion point with respect to the health of our global financial system as well as valuations for REIT and equities in general. It is clear that the next 12 months will continue to be challenging to navigate. With these facts up in mind, let me turn to a review of our progress in the 3 areas that we can exert control over which is investment performance, distribution, and our financial management. It has been our experience over numerous cycles that good execution in these 3 areas particularly during dire markets will position as well for the recovery when it does arrive. Turning to investment performance in the latest 12 months, virtually all of our 4 real estate values strategies have exceeded their benchmarks. In a recent UBS report on public asset managers, we were cited for having the highest percentage of assets in the top half of our relevant the [0

[Matthew Stadler:]

Thank you, Robert. Good morning everyone. Yesterday we reported a loss of $0.04 per share compared with the earnings of $0.37 per share in the prior year and earnings of $0.32 cents per share sequentially. The 2008 quarter includes a $0.20 per share after tax expense associated with losses recorded on available for sales securities primarily from investments Fannie Mae preferred and a $0.04 per share increase to tax expense associated primarily with these available for sale securities. After adjusting for these items earnings per share were $0.20 cents. The 2008 quarter also includes accumulative adjustments to employee compensation which will be discussed shortly. The 2007 quarter included a $0.09 per share after tax expense associated with the previously disclosed structuring fee with the offering of a closed end mutual funds. After adjusting for this item, earnings per share were $0.46 cents. We reported revenues for the quarter of $49.1 million compared with $69.5 million in the prior year and $55.3 million sequentially. The declines were primarily due to lower average assets under management and lower investment banking fees. Net loss for the quarter was $1.6 million, compared with net income of $15.9 million in the prior year and net income of $13.6 million sequentially. The third quarter of 2008 includes the losses reported on available for sale securities and the increase to tax expense and the 2007 quarter included the closed end fund structuring fee. Our assets under management decreased to $24.6 billion from $27 billion at June 30 with market depreciation accounting for the majority of the decline. United States REIT common stocks comprised 48% of the total assets we managed followed by international REIT common stocks at 23% preferred at 10%, utilities and listed infrastructure at 7%, and large cap value at 5%. Turning to our two business segments, in our asset management business we reported quarterly revenue of $48.9 million down 24% from the prior year and down 10% sequentially. The declines in revenue are primary attributable to lower average assets. Average assets for the quarter were $26.22 billion compared with $33.7 billion in the prior year and $29.2 billion sequentially. Our effective fee rate for the quarter was 66.5 basis points up from 65.5 basis points last quarter. The increased was primarily due to the higher fee rate in our closed end and open end mutual funds. Pre-tax income for the quarter was $4 million compared with $23.7 in the prior year and $22.7 million sequentially. The third quarter of 2008 includes $10.5 million of losses on available for sale investments and the third quarter of 2007 included the structuring fee of $5.8 million. After adjusting for these items, assets management pre-tax income was $14.5 million and $29.5 million for the third quarter of 2008 and 2007 respectively. Asset management’s pre-tax margin was 30% for the quarter and 38% on a year-to-date basis. In computing our pre-tax margin, we added back the available for sale loss. Now let us review the changes in assets under management. Assets under management in closed end mutual funds totaled $8.6 billion at September 30, a decrease of $961 million or 10% from the second quarter. A decrease in assets under management is the result of market depreciation. Our open end funds had assets under management of $6.9 billion at September 30, a decrease of $695 million or 9% from the second quarter. The decrease in assets under management was attributable for market depreciation of $374 million combined with net outflows of $321 million almost all of which in our international realty fund. Assets under management in our institutional separate accounts totaled $9.1 billion at September 30, a decrease of $680 million or 7% from the second quarter. The decrease was comprised of market appreciation of $536 million and net outflows of $144 million the majority of which sub devise accounts. We recorded net outflows of $163 million in global and international realty portfolios and modest net outflows from domestic realty portfolios. Our large cap value in preferred portfolios reported modest net inflows. In our investment banking segment, we reported quarterly revenue of $116,000 compared with $4.8 million in the prior year and $840,000 sequentially. Our investment banking revenue remains very unpredictable. The banking segment recorded a $1.3 million pre-tax loss for the quarter. Moving to expenses, on a sequential basis expenses were up about 5%. Higher employee compensation, G&A. and distribution in service fees were partially offset by lower amortization of deferred commission. Our compensation to revenue ratio estimate for the year increased to 34.5% from our previously disclosed estimate of 32.5%. The 0

[Robert D. Steers:]

Thank you, Matthew. Just looking ahead, obviously, while we are hoping for the best and certainly it is beginning to look to us like the current level of valuation is promising, we are planning if not the worst for a continuation of a difficult market environment. So as Matthew discussed, we do intend to maintain spending discipline but we are also going to look to be opportunistic in our asset gathering strategies as we look into 2009 and specifically we plan to focus our marketing efforts, as I mentioned earlier, on large cap value and when the markets allow we will be ready to begin offering our global short-long in our real estate multi manager strategies along with our other core products. With that operator why do not we open it up to questions?

[Operator:]

(Operator’s instruction) Your first question is from Mike Carrier of UBS. Go ahead sir you are in the line.

[Mike Carrier:]

First question is for Matthew on the expense side. You mentioned on the G&A, on the third to be variable or at least we can take a look at and figure out what can be reduced. And then on the compensation side, currently the 34.5% if we look even in the next year in markets don’t rebound but your relative performance is still good. What portion of that is variable versus fixed cost?

[Matthew Stadler:]

We are not really prepared to discuss 2009 just yet, I mean will say that even in 34.5% which is a very careful evaluation to adjust, basically what we felt we needed to keep total comp on same-store basis in line with our projected revenue decline for the year, even at 34.5% we are significantly below our peer group which is also from early indications trending upward. I think, as with most firms the variable component of comp is less than the fixed component, suffice to say that we do not know where assets are going to wind up. We will be assessing that and on the next quarter call we will give some kind of guidance on where we think that ratio will be.

[Mike Carrier:]

Okay just one other question more on strategy. It seems like the long term strategy just, in terms of your products, you could get a shift and granted wherever the crisis mode things kind of go, current swing, weighing on one side If some of the products, the focus gets away from equities, I mean more towards for yielding products and that would favor the product mix.. In long term it is a good trend and the relative performance continues to do well, but just given the pressures on the business, how do you balance the long term strategy and the short term and not necessarily on the cost side but even in the cash side. It seems that depending if you exclude what you have in investment you will have 20% to 25% of cash on balance sheet relative to your market cap, so if it gets pretty high granted good to have cash on the balance sheet in this environment, how do you look at when the stock is at a certain price where buy-back starts to make sense or you just want to wait for more stability of the market before you go down that path?

[Matthew Stadler:]

I will take a stab at that. Your observation that when capital comes back into the market it is likely to come in to income oriented investments that are highly secure income streams which showed that deal. I think to some extent, helping to fuel the strength in our institutional side and in this environment I cannot say we are really excited about anything but actually, longer term, we feel extremely well positioned both in our existing products and the products were poised and ready to launch. They are going to be low-risk, highly secure income-oriented strategies and that is, who we are, we feel more comfortable than ever having liquidity and financial strength. We want to bolster that. We are really not too anxious to commit capital to anything right now. We think it is entirely possible that over the next 6 to 12 months that there could be strategic opportunities that present themselves that could present an opportunity for us to use some of our financial strength, but I think in that regard we are going to be counter punchers. This is an environment where I think you want to let the opportunities come to you and that is the reason that we maintain the cash position, as I said, we are looking to grow it. Stock buy-backs have to compete against these other potential opportunities that come along. It is difficult to say that any particular price we buy-back stock. That is obviously a financial opportunity that is on the table along with other strategic opportunities and we are mindful of that and we are ready and looking to evaluate all of these options.

[Mike Carrier:]

Thank you, guys.

[Operator:]

Thank you. Your next question is from Mark Irizarry from Goldman Sachs. Please go ahead.

[Mark Irizarry:]

Can you just talk about the closed end fund performance which seems to be down a little bit more tale of digits versus some of the other products on the open end side and then maybe we could just elaborate also on the margin side, Matthew, what do you think sort of the target margin of the business should be overtime?

[Joseph Harvey:]

This is Joseph Harvey with respect to the closed end fund performance, the majority of our closed end funds are leveraged in the 40% to 45% range so obviously in down markets that leverage will make those funds performance worst than un-leveraged funds by comparison because of the uncertainties of the markets and the fact that many of these funds are held by individual investors, the discounts to NAV at which they trade have widened. So those 2 factors account for what is going on with the performance both at the NAV level and at this stock price level.

[Matthew Stadler:]

Mark just with respect to the margin question, we do not really target or run the business into the margin per se obviously with assets where they are and results of this quarter and looking at where our pre-tax and operating margins are versus where they historically been. They are a little bit lower but the businesses demonstrated in our part of the sector in particular the leveragability of the franchise so therefore the margin is leveragable as well and it does not take a lot to move it back up. I think probably since we don’t target to a margin and don’t budget for that, we will probably have some guidance not specifically margin related but on the next call that will give the sense of where we think certain numbers are going to go and including comp and taxes and things of that nature which might be able to help you model that.

[Mark Irizarry:]

Okay thank you.

[Operator:]

The next question is coming from Cynthia Mayer of Merrill Lynch. Go ahead.

[Cynthia Mayer:]

Hi good morning. Just a follow up on the closed end fund de-leveraging, can you tell us the total of the leverage now in the closed end and also have you applied for a waiver in terms of the coverage ratios because I know [Winfrom] got one and I do not know if you are going down that path.

[Matthew Stadler:]

Yes we have applied for that exemption in the event that we might need it, we do not need it now and when you said total leverage what do you mean?

[Cynthia Mayer:]

Well, if your funds are leveraged at the 40% to 45% range so will I just take that and apply it to you closed end fund asset basically and say that amount of it is leveraged.

[Matthew Stadler:]

That’s about right. Fifty percent is the limit that we could go to in these funds and after which we will be required to regain or reduce bank borrowings.

[Cynthia Mayer:]

Okay, is that tested everyday or is that you have to…

[Matthew Stadler:]

We test it every hour. The volatility of the market is something that we watch very closely and I would say that our portfolio managers are watching these funds very closely because our strategies in investing these are very much tied to the amount of leverage that we have and we try to manage these funds conservatively so that we would reduce some of that data that has been problematic in the underlying assets.

[Cynthia Mayer:]

Right. Are you a little worried that the discounts, I mean, generally in closed ends, remain this big that they’ll be arbitrations come along and just attempt to open end a lot of closed end funds.

[Matthew Stadler:]

You know we had some… two of our funds were subject to a proxy [balance] last year, earlier this year and we are satisfied with those events and we take all the steps that we feel are prudent to reduced discounts. This is a clearly an issue that is plaguing the entire industry. I think the last numbers I saw was the average discounts was in the order of 20%, so yes there might be pressure. I also think that we are in the midst of an unprecedented storm here and all of the metrics seemed not to work for most things today. We believe that is a temporary phenomenon and one by one a lot of these issues get sorted out, particularly the pricing of the underlying security as in the pricing in these funds so I do not think that we are concerned right now. We always wanted to improve shareholder returns and we would love to mitigate any discounts but at this snapshot we believe and it maybe wishful thinking but we do believe that this is a snapshot that is not going to persist for a long period of time.

[Cynthia Mayer:]

Okay, you mentioned strategic opportunities and looking at the some of the other asset managers and the headcount cuts. I am wondering if you think to sell-off in the market including the REIT market could maybe leave some other managers with smaller refunds to reconsider even being in that area. Is there any opportunity, any silver lining in this for you, maybe in terms of grabbing a bigger market share of the REIT market?

[Matthew Stadler:]

The opportunity said that include that and potentially more. Certainly smaller managers, there are managers embedded in companies which are larger but primarily direct property, in the direct property business. They are going to be under a significant pressure and so it is unclear whether the opportunities will come from, there maybe some opportunities and businesses that are related to what we do but we are not currently in. Unfortunately I think there is going to be a lot of opportunity that will come along, maybe none of them are satisfactory to us from the strategic standpoint but again for us being un-levered might be as important as having cash. There are money managers who are levered, there are people in other businesses who are levered who have measures to doing things because of that and that we do not have.

[Cynthia Mayer:]

Okay thank you

[Operator:]

Thank you. It appears to be no further questions at this time. I would like to turn the floor back to Robert Steers for any closing comments.

[Robert Steers:]

Thank you all for listening in this morning and hopefully when we speak again there will be a little more sunshine in our market. Thank you

[Operator:]

Thank you. This concludes today’s conference call. You may now disconnect and have a great day.