Cowen Inc.
Q2 2017 Earnings Call Transcript

Published: 7 Aug 2017

[Operator:]

Good afternoon, ladies and gentlemen and thank you for joining Cowen’s Conference Call to discuss the Financial Results for the 2017 Second Quarter. By now, you should have received a copy of the company’s earnings release, which can be accessed at Cowen Group, Inc.’s website at www.cowen.com. Before we begin, the company has asked me to remind you that some of the comments made on today’s call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties described in the company’s earnings release, and other filings with the SEC. Cowen Group, Inc. has no obligation to update the information presented on the call. A more complete description of these and other risks and uncertainties and assumptions is included in the company’s filings with the SEC, which are available on the company’s website and on the SEC website at www.sec.gov. Also, on today’s call, our speakers will reference certain non-GAAP financial measures, which the company believes will provide useful information for investors. Reconciliation of those measures to GAAP is consistent with the company’s reconciliation as presented in today’s earnings release. Now, I would like to turn the call over to Mr. Peter Cohen, Chairman and Chief Executive Officer.

[Peter Cohen:]

Thank you, operator. Good afternoon, everyone and welcome to Cowen’s second quarter 2017 earnings call. I appreciate you taking time on a Thursday afternoon to be on the call, and I hope you will think it will have been worthwhile. Today, with me as always is Jeff Solomon, President of the firm and Steve Lasota, our CFO. We are very pleased to announce positive results for the second quarter of 2017. Cowen’s economic income has been reported as $11.5 million or $0.39 per diluted share compared to an economic income loss last year of $22 million or $0.82 per diluted share. Economic income revenue, $172 million compared to $80 million in the second quarter of 2016. We saw solid operating performance in each of our businesses, which reflects both the current market environment as well as the investments we have made to expand the platform over the last few years. And of note, there were no unusual items contributing to revenue and profitability in the quarter. Our performance was particularly strong in equity capital markets and incentive fees as a benign investing environment continued to be a tailwind for capital raising and fund performance. We also continue to see strong conversion of our M&A backlog we highlighted on the first quarter call. The backlog continues, but remains strong with closed transactions being replaced with new mandate across multiple industries. Extremely low levels of equity and credit volatility have made for a more challenging top line performance in equity and credit trading, but we have meaningfully improved our market share and taken out costs through the improved efficiencies. And we will continue to do so through the acquisition of Convergex, which closed on June 1. Our goal remains clear, to deliver greater financial resilience and profitability by creating scale in our areas of expertise. We have done so by investing organically as well as through acquisitions over the past 6 years. In some areas, we have broadened our range of products and service offerings. And in others, we have refocused our efforts on doing fewer things, but doing them better. Our strategy remains constant. We only do things to help our clients to outperform their peers using the broader and deeper set of capabilities that the firm now has. Our ability to deliver solid operating results this quarter provides what we believe is a strong indication of the potential of our platform as our business continues – or business has continued to take market share. Now I will review the results of the investment management division. The hedge fund industry is back to inflows with $23 billion coming in through May and is delivering overall positive performance. The funds with more than $1 billion AUM and returns greater than 5% year-to-date have attracted the largest flows. In the second quarter of 2017, our investment management business grew total assets under management by $286 million to $11 billion as of July 1 with positive inflows in real estate, merger arb and long/short equity. AUM was also increased due to the change in how we report our AUM, which now includes the value of an acquired CDO portfolio and several long-standing managed accounts. We are working to enhance the investment management platform by focusing on the central strategies that have proven themselves in the marketplace already or have reasonable prospects for future success. If they don’t, we’re not going have them on our platform. Our long short equity strategy, which is just primarily in the communications, technology, media and consumer sectors, is steadily gaining traction with investors in an environment that is very challenging for long/short equity funds. As an example, both the Merrill Lynch and Morgan Stanley distribution partnerships that we have went live during the quarter. These two platforms have a combined capacity allotted to us right now of $300 million. In merger arbitrage, we delivered very strong performance, exceeding the HFRI index by more than 300 basis points in the quarter and more than 450 basis points for the first half of the year. Real estate had its second close on June 30 of its sixth debt fund offering. We expect to raise approximately $450 million in total, which is kind of the optimal size for us in terms of our ability to timely deploy the assets without fees chewing up performance. We could raise more, but we like that size and this is our sixth one. We are also about to embark on our third real estate equity vehicle, which takes the form of GP partnerships. We have done two already and what we do is we use these to basically secure properties and then we go and we raise the LP money from our consistent LP investors. So we’re about to do our third GP partnership fund. The healthcare royalty business has committed just over $300 million and returned approximately $350 million of capital year-to-date. With the commitments year-to-date, the healthcare royalty team has committed nearly 55% of fund 3. Early next year, we expect to raise fresh capital to fund the next round of healthcare royalty investments through our next vehicle. Over the last 5 years, we have been incubating a record and investing in late-stage, pre-IPO biotech companies. We’ve been doing this with our own capital and one private partner. For the first time, we will be raising external capital, and our goal is to raise $200 million through our first vehicle with the first closing targeted for the fourth quarter of this year. The development of our private healthcare investment strategy seeks to capitalize on Cowen’s long and successful cross-capability healthcare franchise. Moving to the investment performance of our balance sheet. For the quarter, we generated $14 million in investment income compared to a loss of $22 million in the year-ago period, which if you remember was the break in the Pfizer-Allergan deal, which cost us dearly. Contributions by strategy were generally positive across the board, led by the performance of our event-driven team. With Cowen’s broader and larger platform, we are focused as ever on driving profitability through scale and cost effectiveness, including more efficient use of the balance sheet. We have identified several areas of cost synergies with Convergex and are hard at work to extract these savings as quickly as possible. Of note, we now have self-clearing capability, which will be self-clearing certain of our own balance sheet activities as well as certain portions of our prime services business. Our balance sheet self-clearing will relieve us of external capital requirements as the prime broker is enabling us to generate and redeploy substantial amount of capital towards opportunities that have the potential to create recurring income such as margin financing and securities lending. Now that we are self-clearing and we have the prime services businesses, it all fits together. Creating a more efficient balance sheet has been a goal, and the acquisition of Convergex is now allowing us to accelerate using our balance sheet much more efficiently than in the past. You will also see a shift in our expense profile going forward as few of the acquired businesses from Convergex have higher EFU of the acquired businesses – have higher variable non-comp costs but lower compensation expense. Steve will discuss this later in the call. We will continue to look to these opportunities, which dovetail with our core businesses and infrastructure and serve to strengthen every aspect of Cowen. We are now an 1,100 person organization. Each of our colleagues does an amazing job for the firm every day, and I would like to acknowledge their efforts, especially over the last couple of months where we were more than normally busy, which is usually very busy, and in the months ahead as we work through the integration of Convergex. Now let me turn it over to Jeff.

[Jeff Solomon:]

Thanks Peter. Our investment banking division reported a strong quarter, resulting from both a more favorable capital raising environment as well as the diversification of revenues across the industry sector. The benign investing climate resulted in an industry-wide equity proceeds raised in the U.S. for IPOs and follow-ons in our core sectors of $27 billion, which was a 76% improvement from the year-ago period. There were 141 transactions completed across these sectors compared to 104 in the prior year period. The increased activity came from both IPOs and follow-ons with the window for IPOs open as major market indices move to new highs. Investor appetite for new issue was also favorable, building upon the improved sentiment for the first quarter of the year. At Cowen specifically, the breadth of our services and investments we made in banking last year are having an increasingly positive impact on our performance. We continue to be very strong in healthcare, where we were the most active equity underwriter in biotech in the quarter. We saw strong contributions from our consumer practice, marking its highest revenue contribution in years, and continued momentum in our technology practice, which also had one of its best quarters. Both of these areas are sectors where we have invested in recent years. We are book – we are a book runner on the stack as well as convertible senior notes offering, both earning multimillion-dollar fees. We sole managed a PIPE transaction, which also earned us a multimillion dollar fee. And we advised on a $700 million sale of a technology company, earning us a sizable advisory fee. Our ECM business benefited from an active new issue calendar. ECM revenue grew 119%, exceeding the market’s pace. This was our best revenue performance since the second quarter of 2015. We participated in 31 transactions in the quarter compared to 21 in the prior year period, and our average fee per transaction was up 49% year-over-year to $1.8 million, which is our highest average yet, reflecting our increased position on the coverage of many transactions. The M&A business continues to track well as we convert the strong backlog we had coming into the year. So far, we closed in July 2 M&A transactions, and there are 5 other announced transactions that we expect to close in the third and fourth quarters of this year. This will represent significant fees when they close in the second half of this year, and in addition, as Peter mentioned, a robust M&A backlog for the back half of the year. We expect to have M&A fees for 2017 that should exceed our prior year’s. Our backlog continues to remain strong as we replace closed transactions with new mandates across a number of industries. And as our product industry areas scale, we’ve been winning bigger mandates. So all in all, pretty good on the M&A front. Turning to our brokerage business, we reported record revenue and year-over-year growth of 37%. Quarter included 1 month of Convergex, which closed on June 1. Just so we are clear on terminology, institutional brokerage, which incorporates cash equities, special situations, electronic trading, options and convertibles and from Convergex, non-agency execution and additional electronic capabilities, was up 26% year-over-year. Brokerage revenue also includes credit trading and prime services, which includes a team from Convergex as well as new capabilities acquired from Convergex including global clearing and commission management services. On the institutional brokerage side, we made significant strides in recent years to align ourselves with those accounts who value our ability to deliver high-quality content, execution capabilities and new issuance. These efforts have yielded positive results, and we’ve found ourselves among the top 10 in some of the largest funds in the United States. With Convergex, we have extended our audience with very little client overlap, both here in the United States and internationally. Post-Convergex, our daily brokerage per day is tracking according to plan for 2017, and while it is still early days, the integration is proceeding according to plan. We expect the acquisition to be accretive to earnings in 2017. As Peter mentioned, we are very focused on extracting the previously identified cost synergies in technology operations and in the corporate overlap. We’re also working to free the excess capital, as he mentioned, following the combination of these businesses by better utilizing the capital we acquired in the transaction. It particularly helps scale the securities lending business with our new clearing capabilities. In fact, the securities lending business has been a strong contributor to revenue this quarter, and we expect that to grow as we begin to run our matchbook business, which will begin to show up in the third quarter. With the New York Stock Exchange and NASDAQ composite volumes for the second quarter down about 4% year-over-year, and the generally difficult environment for equity reinforces our rationale for the Convergex transaction and for the investments that we have made over the years. We have meaningful scale and a differentiated equity franchise based on high-quality research and sophisticated, non-research-based, non-conflicted agency execution. There are very few firms on The Street that can say that with as much confidence as we can. Initial feedback from clients has been quite positive, especially our decision to close down the Convergex dark pool in order to reduce market fragmentation. Importantly, as the buy side consolidates their broker commissions towards their most important providers, and with the implementation of MiFID II, which will rollout in January of 2018, we believe we will be a major beneficiary given our strong research capabilities and our position as an important liquidity provider in the equities market. I will now turn the call over to Steve Lasota, who will review the specifics of our financials. Steve?

[Steve Lasota:]

Thank you, Jeff. In the second quarter of 2017, we reported GAAP net income attributable to common shareholders of $5.7 million or $0.19 per diluted common share compared to a GAAP net loss attributable to common shareholders of $12.2 million or a loss of $0.45 per diluted common share in the prior year period. Second quarter 2017 GAAP revenue was $160.5 million. Compensation and benefit expense was $102.1 million. Non-comp expenses, excluding interest expense, depreciation and amortization and restructuring costs, were $61.3 million. Net gain on investments and net gain from consolidated funds was $57.3 million, which includes a bargain purchase gain of $13.3 million or $7.9 million net of tax from the acquisition of Convergex. The deferred tax liability of $5.4 million will reverse over the life of the intangibles as a tax benefit. Income tax benefit was booked at $785,000, and income attributable to non-controlling interest of $21.1 million. In addition to our GAAP results, management utilizes non-GAAP financial measures, which we refer to as economic income. Management uses economic income to measure our performance and to make certain operating decisions. In general, economic income is a pre-income tax measure that excludes the impact of accounting rules that require us to consolidate certain of our funds, certain other acquisition-related adjustments and reorganization expenses, excludes the bargain purchase gain, which resulted from the Convergex acquisition, goodwill and intangible impairment and preferred stock dividends. The remainder of my comments will be based on these non-GAAP financial measures. In the second quarter of 2017, the company reported economic income of $11.5 million or $0.39 per diluted share. This compares to an economic income loss of $22 million or $0.82 per diluted share in the prior year period. Second quarter 2017 economic income revenue was $171.9 million compared to $80.4 million in the prior year period. Investment banking revenue was $64.1 million compared to $35.3 million in the second quarter of ‘16. Quarterly brokerage revenue increased 37% year-over-year to $67 million. And as Jeff said, it includes 1 month of Convergex. Management fees were $14.4 million compared to $16.5 million from the prior year period, and a lot of that is due to some of the funds that we have exited. Incentive income was $11 million compared to $429,000 in the prior year period, and investment income was $14.2 million compared to a $22.2 million loss in the prior year period. Other revenue was $1.3 million and the same amount in the prior year period. Comp and benefit expense for the quarter was 58% of economic income revenue compared to 68% in the prior year period. We expect that our compensation to economic income revenue will be lower than historical levels as a result of the acquisition of Convergex. Variable non-compensation expenses in the second quarter of ‘17 were $21.9 million, which is 12% of revenue compared to $14.8 million or 18.4% of revenue in the prior year period. The increase is primarily related to higher floor brokerage and trade execution cost due to higher revenue generated as a result of the acquisition of Convergex. We expect our variable cost to increase as a percentage of revenues going forward due to certain acquired businesses from Convergex. Fixed non-comp expenses, excluding depreciation and amortization, totaled $29.8 million in the second quarter of ‘17, which is 17.3% of revenue compared to $24.5 million or 30.5% of revenue in the prior year period. This increase is primarily related to the acquisition of Convergex. However, there are some nonrecurring expenses that are due to the integration of the businesses that resulted in some onetime service contracts and technology expenses. Depreciation and amortization expenses were $2.7 million in the quarter. Our amortization costs are increasing due to recent acquisitions. Reimbursement from affiliates was $0.6 million in the quarter and is unchanged from the prior year. Reimbursement from affiliates is a fixed charge, and we expect it to remain at this quarterly level for the balance of the year. GAAP stockholders’ equity increased by $61 million to $834 million at June 30, 2017, from $773 million at December 31, ‘16. Common equity, which is stockholders’ equity less the preferred stock, was $733 million compared to $671 million at 12/31/16. Book value per share, which is common equity divided by shares outstanding, was $23.58 per share compared to $25.11 at 12/31/16. Tangible book value per share, which is common equity less goodwill and intangible assets, was $20.55 per share compared to $21.88 at December 31, ‘16. Invested capital was $652 million as of June 30, versus $657 million at December 31 of ‘16. I will now turn the call back over to Jeff for closing remarks.

[Jeff Solomon:]

Thanks, Steve. Cowen has undergone a significant transformation over the last few years, and for those of you that have been invested for a while, you can see it. We continue to be well prepared for future opportunities as they present themselves. That is part of the reason behind the strategic partnership that we formed with China Energy Limited or CEFC China. As a reminder, the consummation of this transaction contemplated by agreements entered into with CEFC China are subject to approval from the Committee on Foreign Investment in the United States and other customary regulatory approvals and closing conditions. We continue to expect the transactions contemplated by the stock purchase agreement to close by the end of the third quarter of 2017, but given the timing of the CFIUS review process and the other closing additions, we and CEFC determine to extend the date, after which the other party is entitled to terminate the stock purchase agreement from September 30 of 2017 to December 31 of 2017. We have been actively engaged in a dialogue with CFIUS and have received numerous communications back and forth with them. But we want to make it clear that we’re continuing to scale our businesses without the capital from CEFC, and the progress that we made is not at all dependent on the completion of this partnership. This quarter’s operating performance exemplifies the success of the efforts that we’ve made to date. Last year, which was a more difficult year in general for the market, we talked about making the decision to invest in people and teams and businesses, and we’re seeing the benefit to that of having done so are anything but flimsy. With approximately $1 billion in capital, we are fortunate to have the flexibility to make strategic investments when some of our smaller competitors cannot. Our belief was that these actions would play an important in diversifying our revenue while bringing greater stability and consistency to our platform in 2017 and beyond. Much of the momentum we’re experiencing today is the result of these investments as well as other steps we’ve taken to scale of the platform, and they include things such as acquiring Convergex. We are balancing the costs as we scale revenue in a more diverse way and drive margin expansion, and one of our near-term priorities is to execute on the integration of Convergex. And as we mentioned earlier on the call, we are already hard to work on that front. Going forward, we will continue to optimize future capital deployment in ways that will drive shareholder value and ROE. And before we open up the floor for questions, I just want to make sure I want to echo Peters’ sentiments and thank everyone at Cowen for the contributions that you’ve made to our organization every day, especially, over the last few months, which have been extremely busy. Without your efforts, none of our successes would be possible. And with that, operator, we will turn it back over to you.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from Devin Ryan from JMP Securities. Your line is open.

[Devin Ryan:]

Okay, great. Good afternoon, guys.

[Peter Cohen:]

Hi, Devin.

[Devin Ryan:]

Hi. Maybe first one here on expenses, you mentioned some of the one-time costs in the quarter. Can you just walk through I guess how much of those were? And then I am just trying to think about, because there is some noise here with the timing of the Convergex close. So, have those expectations from Convergex in terms of the savings changed at all? How much were in the 2Q results and then I guess how much is left and how do we think about timing as well there?

[Peter Cohen:]

Okay. So from an economic income perspective, our variable non-comps increased about $5.4 million and almost all of it was floor brokerage and trade execution just due to the higher revenues both not only from Convergex, but the majority is due to Convergex. So we had Convergex for 1 month. Part of the problem, Dev, is the operations of Convergex, some of them were integrated into Cowen and Company’s existing business. So we’re running two different BDs, but some people were moved into Cowen & Company. But from what we can tell, prior to what we were running at as to after, again, the floor brokerage and trade execution is the majority of those variable non-comps. On the fixed side, we had an increase of $5.9 million. About $3.8 million of that is due to Convergex. There is another piece of one-timers that is just shy of $1 million and then just a couple of other fixed expenses that were higher in the second quarter, doing more investment banking business, you have higher legal fees and things like that.

[Steve Lasota:]

Devin, let me – it’s Steve, let me just add. So we closed on June 1 and there was a riff on June 1 intended to be sort of the higher paid management people who weren’t going to come along. But there were a fair number of people who worked during the month of June, got paid during June and who were riffed at the end of June. So you are going to see the cost savings or synergies from Convergex roll through really over the back half of the year as we continue to buy that as expenses. Unfortunately, in the old days, you used to be able to figure out what the benefit was going to be. You take a reserve for it. Then you charged everything against that reserve and you would kind of clean on day 1. You can’t do that now. So, we have to incur expenses until we can get rid of them. So 6 months from now, the Convergex-related expenses incorporated into the combined company should be a lot less than they are today.

[Jeff Solomon:]

Also, we are going to be going through a consolidation, Dev, as we do the back end merger here. What we – we will be getting 1017 approval from FINRA that will enable us to consolidate the number of broker dealers we have. That will obviously add to increased savings. So, I think Steve gave you a pretty good snapshot as to what the increase is for the first month, but we do expect that we will be bringing down some of those variable cost numbers over time.

[Devin Ryan:]

Got it, okay. Okay, good. Yes, I can certainly hop offline. I just kind of think there’s some of the mechanics of just modeling that, but that’s helpful. And then also, on Convergex, just the securities lending piece and kind of incremental revenue that could come from that, any sense of kind of orders of magnitude, how big of a deal that can be because that would seem to be all incremental to the firm?

[Jeff Solomon:]

So, we had started to build out securities lending at Cowen ahead of time before we were doing the Convergex transaction. And our expectation is that we would be able to earn pretty decent spreads by focusing on the hard-to-borrow part of the market and this is really an augmentation to our prime services business. And even without the Convergex transaction, we had applied and actually had received in April the ability to do self-clearing ourselves. Now at the same time we actually did the Convergex transaction, Convergex is a self-clearing organization. So what we were able to is take the capital that we had basically in Convergex that we acquired that was in support of their clearing business globally and actually count it as regulatory capital and excess net capital and use that as a way to start scaling into our securities lending business. So what we decided to do post merger is scale the securities lending business in the same broker-dealer where we have most of the capital. So this is a much more specific example that Peter talked about earlier about more being more efficient with our capital utilization. Prior to Convergex, we were going to leave $100 million in excess net capital to drive the business. We think that would have been able to support in the first year, maybe up to $1 billion in the matchbook. But now we have the Convergex transaction, we should be able to use the Convergex capital or a large chunk of the Convergex capital to support that business. So, the matchbook will start – has already started in July. I would like to get that up to $0.75 billion or maybe $1 billion, but it’s really going to be dependent on where spreads are. We are much more interested in creating profitable trades and decent spreads rather than increasing the size of the balance sheet just for the sake of driving top line revenue.

[Devin Ryan:]

Got it. Okay, very helpful. Maybe just another one here just on the brokerage business with one quarter closer to the MiFID II implementation. Just any updated thoughts or – as you are having conversations with counterparties in terms of how you are positioned going in, and anything that has changed in terms of perspective as we learn more from asset managers and we get closer?

[Jeff Solomon:]

I mean, MiFIDs is something that we have all been talking about in the industry for a long time. And what I find really interesting is that sometimes we are still talking to clients and they look like a deer in the headlights because they are not exactly sure what do to or how to go about it. And honestly, in many instances, a lot of our clients in Europe don’t have any clarity from their regular – primary regulators of how the implementation is going to go. What I will say is there is a few things that are sure. One is that at least for our European clients, there’s clearly going to be a movement towards research payment accounts and segregating payments for research much more specifically. And as part of the Convergex transaction, we have acquired Westminster. And Westminster has some really great solutions with clients and has been working very carefully with clients in Europe to prepare for the eventuality of separate research payment accounts. And so I feel very confident that we have a market solution here that goes right at the heart of what our clients need from both a mechanical standpoint as well as a product need standpoint, a service standpoint. What I will say is I think what – the knock-on effect that people are concerned about and are harder to assess is whether or not the rules around research payments in MiFID II will extend beyond Europe and become market convention here in the United States and globally. And I would say on that front, it’s kind of mixed. Some of our clients in the U.S. are saying they’re going to adopt the MiFID standards, at least as it relates to payments for research. Some are saying they’re going to ring-fence the U.S. and don’t want to be doing that. They want to have a separate regulatory regime. What I will say is irregardless of how this goes, we are extremely well positioned for it. As you know firsthand, the drive towards unbundling and having commission payments be separated from execution payments and from trading is already pretty much the way the market has gone for a long time. And so our big goal has been to be positioned to take advantage of that. So if you’re not a top-tier research firm in a MiFID II world, you’re not going to be successful. And so our investment in our world-class research franchise, where we have come in terms of the number of votes, the top 10 votes, the places where we’re integral into the investment process, that puts us in a very, very, very good position. And the addition of Convergex and some of the things that we are doing in terms of servicing the client needs to pay for commissions, I think augments that significantly. So we are feeling pretty good about it.

[Devin Ryan:]

Okay, thanks for that color. Just one more here and I will hop back in the queue. Investment banking, I appreciate the granularity on the M&A advisory backlog and kind of what’s still to come here in the back half of the year. With respect to ECM, I know that can be somewhat market dependent. But we look at the strength in the second quarter, how do you feel like the momentum is there? Was there any kind of pent-up activity this quarter that maybe driven outside of the result or do you feel like you can build on that momentum into the back half of the year assuming market conditions remain healthy? Just curious, what things look like there?

[Jeff Solomon:]

Well, assuming market conditions stay as they are, I mean, we have hit the ground running here in the third quarter. We have done a number of deals. I would just say – again, I can’t speak to whether or not there will be market disruption, but barring a market disruption, there is certainly a significant amount of new issuers. And what I will say – new issue and what I will say, It’s not just follow-on. So we have gone through these periods of time in which it’s mostly been follow-on from existing clients. We are seeing a lot of repeat clients. I love to see that because it means that what we’re doing, the things that are in our control are really – we are executing extremely well. Where we are in covers, our positions in terms of our economics have improved significantly. It was a big driver in why our average transaction – revenue per transaction was higher even as we did more transactions. What’s happening now though is, I would say, a lot of the private companies that we have seen and that we’ve been working on are now beginning to contemplate IPO. And so I feel like the – now in addition to our existing clients who are doing follow-ons, there’s been a bunch of them over the past few weeks, which you can check on we are seeing new clients come to market with IPOs. As long as we continue to do well in that, not only will we see revenues in this quarter and the quarter after that, but those companies are going to be raising more money going forward as their clinical programs continue to evolve. We’ve been saying this for years. If you had to pick one area to focus on in equity capital markets, the area to focus on is healthcare. And within healthcare, the area to focus on is biopharma because of the repeat nature of capital raising. And when I look out over the next 5 years, with the number of new drug applications and the number of companies being formed and the high quality of researchers coming out of research institutions, I think we’re still at the front end of that curve, market conditions notwithstanding. And so as long as that continues to happen, we will continue to stay positioned to take advantage of that the way we have in the second quarter.

[Devin Ryan:]

Got it. Terrific. Okay, thank you very much. I will hop back.

[Jeff Solomon:]

Great. Thanks.

[Operator:]

Thank you. [Operator Instructions] And our next question comes from Steven Chubak from Nomura Instinet. Your line is open.

[Steven Chubak:]

Hi, good afternoon.

[Jeff Solomon:]

Hi, Steve.

[Steven Chubak:]

Steve, I wanted to maybe start off, it might be a question better suited for you. Just on some of the non-comp guidance that you guys have given, pro forma completion of the acquisition. And I appreciate the color that you had given at least talking about how the comps and non-comps should traject. But I am wondering given the – your non-comp ratio was already in the low 30s. It was a fairly healthy amount, above most of your broker peers, which are running somewhere closer to the mid 20s. What’s really driving that continued increase in the non-comps? And once the deal is fully integrated, where should we expect that to run rate going forward?

[Steve Lasota:]

Yes. Well, obviously, part of it is the acquisition. We picked up both fixed and variable non-comps. And as we have been saying before with Convergex as a couple of their businesses are, from a comp perspective, lower comp to rev, but higher non-comp to rev, just the way their business is run. And there is a few other anomalies compared to our peers. We look at this a lot. Couple of our equity investments, they come through as we have no control over the non-comps that we pickup from our equity investments. So, that’s a pretty healthy number that’s in our fixed non-comps every quarter.

[Jeff Solomon:]

From the affiliates.

[Steve Lasota:]

From the – we have equity investments in real estate and equity investment in a major fund. We pick up our share of the non-comps, which is in our fixed non-comps that affects – obviously, it drives it higher.

[Jeff Solomon:]

The other thing I would say, Steve, is that some of our competitors choose to exclude amortization from a customer list from their fixed non-comps as well as certain compensation that is attributed to their acquisitions, and we don’t. So if you look at our numbers, if you want to do apples-to-apples, I think at a minimum, you need to exclude the amortization that we’ve had from some of the acquisitions to try to get to a better number. I think those are things that we look at. Obviously, we’re working super hard to try and bring down our costs. What I will say is that the comp-to-revenue ratio that we will have as a result of the Convergex transaction will move our comp-to-revenue ratio lower because certain of the businesses, in particular the ADR business and the clearing business, have high variable costs because they’re expensive to clear and settle but lower compensation costs overall. And so as those businesses continue to scale, you’ll see that our comp-to-revenue ratio will come down. But the better those businesses do, the more we’ll spend in variable non-comps. I tend to focus – and we tend to focus a little bit more on fixed non-comps because those are really the ones where you can make good traction. We haven’t even begun to do things like eliminate duplicate vendors where we have multiple contracts with the same vendor. We are going to be consolidating those. I think over time, what you’re going to see is as some of our space rolls off we are going to be consolidating space. And Convergex allows us to move certain positions into less expensive locations like Atlanta and Orlando. And so when I take a longer term view of how we’re going to go at reducing our costs, it’s making us a little bit less Manhattan-centric, if we can and this certainly gives us an opportunity to do that in a normal ordinary course as certain of our leases roll off over time.

[Peter Cohen:]

Also too, Steve, as we start to get our balance sheet more efficiently deployed, that’s going to affect revenues. The variable cost associated with that would be immaterial relative to the sales and trading businesses. So, as revenues go up without commensurate variable costs or fixed costs, that will help bring the percentage down also. I mean, we have achieved a tremendous amount and we’re really at this very pivotal point now where we can start to substantially ramp a lot of activities that we just weren’t in a position to do before now.

[Steven Chubak:]

Got it. Thank you all for the helpful color. And actually, Peter, sticking to that last point that as it relates to your ability to maybe optimize the balance sheet. You have the China Energy partnership. We are awaiting the approvals for that. But it sounds as though the $100 million of show capital that was necessary to scale and really begin growing the sec lending operation, that’s already running full steam ahead. And so as you think about the capital and debt infusion, how does that inform your thinking around what you would potentially do with that additional equity, like where do your capital management priorities lie? And also, would you do anything to maybe address or refinance some of the preferreds and even the converts that are still outstanding?

[Peter Cohen:]

Good question. So, I think that if the CEFC transaction happens, clearly refinancing part of the debt is on the top of our minds. I think we think that the preferred, since it’s perpetual, there’s no reason to touch that. That should stay there forever. And if we get the – so let’s say we get our $275 odd million roughly from China. There is a certain amount of that that we are going to use to buyback, well, hopefully, to reduce the $65 million of the baby bonds. And so net proceeds now will be down to like $200 million. And that money is going to be earmarked for growing the asset management business, supporting what Jeff wants to do in the broker dealer. Probably there are some very niche things that we’ve picked up from the CRT where we can deploy capital at very high rates of return. And frankly, if we have the liquidity that we are comfortable with, buying back stock is very much sort of on the drawing board.

[Steven Chubak:]

And as it relates to some of the opportunities at the broker dealer side, Jeff, I didn’t know if you could speak to where you’re seeing compelling opportunities to invest. Recognizing you may not be inclined to show your entire hand, but I know there were some acknowledgment that while you believe you have a differentiated offering that should certainly be able to navigate some of the MiFID challenge as well, just given the expectations for declining commission pool, how that informs your thinking about investing within that business?

[Jeff Solomon:]

So I think we are at scale. I mean, I think that we have highlighted some of the other areas we’re going to be growing off the back of an equities business certainly, prime services and sec lending are two areas that are less MiFID-dependent and less research-dependent. I think these are opportunities for us that exist. Other people are in those businesses and they don’t have the research franchise we have. I think if you’re trying to start a research franchise today, I think it’s super hard to do that. And so our view is that we’ve actually invested in what we consider to be the hardest and lowest margin part of the business, which is secondary trading, and there’s going to be some real opportunities for us to now do some of the higher-margin business off of the back of our NRC expertise. The others that come to mind, we talked about leveraged finance and talked about our capability – our ability to do that, and I think that’s an area where we see untapped potential. Our clients in corporate finance clearly need solutions that are more than just ECM and being able to do financing for them and underwrite financing for them was an essential part of the reason why we did the CRT acquisition last year. We’ve been extremely patient in figuring out how to attack that marketplace. So that’s something that in the not too distant future you can see us doing. And then I think the logical place for us to go – and I think it’s just something we haven’t done because we haven’t found the right opportunity, would be to look at advisory businesses where you can really leg into an M&A practice in a particular sector and do a lot of corporate finance and capital market raising business for those clients. I want to be clear, I mean, a lot of people don’t understand what we’ve done with our investment bank. So in 2010, we had – when we first did the Cowen acquisition, we had like 150 people in banking and capital market. And that year, Cowen did $38 million worth of revenue, almost all of which was ECM. Today, with the numbers that you see, we have 150 people in banking and capital market. And we’ve chosen not to purchase or take big swings where we have a lot – a ton of goodwill with advisory businesses because we thought that growing organically is much more sustainable long term and you take less risks with the culture of the organizations. I think at this point, we can probably look at selected sectors where we can leg in. We did the Morgan Joseph transaction last year where we assumed the operations of Morgan Joseph, and those bankers were largely in technology and in consumer. And we can see that you bring on talented individuals, what they can do with the platform and the success we’ve had in consumer and some of the – frankly the success we’ve had in our tech practices has been a function of the fact that we were able to attract talented individuals. So that’s probably where if we are going to do anything where we’ll spend our time, it is because it’s obvious that we can convert an advisory – convert an acquisition in advisory spaces.

[Peter Cohen:]

I want to go back to my earlier comment about CEFC and the additional capital. For the last, I guess, few years on these calls, there has always been this need to draw more on private meetings about why don’t you buyback stock, buyback stock. And I have always taken a position that you can’t grow your business from treasury stock. And if you look at what we’ve done in the last 1.5 years or even less, capitalizing our broker-dealer so we could meet the $100 million threshold of excess net capital so we can get – we can clear counterparties and go self-clearing. There was a big chunk of cash that went into the broker-dealer for that. We bought Convergex, half stock, half cash. We wrote a check for, I don’t know, $45 million in cash. While Convergex had that much cash in it, it’s really tied up in deposits and clearing organizations. They do business in 106 countries. So it’s not like we swap cash for cash. We actually laid out $45 million, thereabouts, in cash. And we can’t access their cash yet. We merged the broker-dealers, and that probably freed up some capital. We spent some money buying CRT. And that’s not a terribly large amount of money, but nevertheless, money. We spent a fair amount of money getting into the prime services business. And that’s, what, 2 years ago that we bought Conifer and Concept, right? And we used a lot of cash there. So if you roll it altogether, it’s probably $145 million, $150 million of cash that went to work. If we didn’t have it, we couldn’t have done those things. The firm that you have today, Cowen, is a reflection of all of those investments, and its earning power going forward will be a reflection of the integration of all those. So CEFC, in a way, goes to replenish that liquidity. Now there’s substantially enough money coming in so that we might be in a position where we can do what we want to do and buy back stock at the same time. But you can’t grow a business if you keep buying back stock. You look at FBR and you see what happened to them. They basically sort of bought themselves into oblivion and they had to merge with whoever it was that they merged with because there’s no way to grow the business. So I just don’t – I don’t want that lost on people, we spend a lot of money positioning this company to grow.

[Jeff Solomon:]

And now it’s time to drive earnings. And that’s it.

[Steven Chubak:]

Buying oneself back into oblivion, I may have to borrow that, Peter, if that’s alright, but thank you for taking my questions. Appreciate the helpful color.

[Operator:]

Thank you. And I am showing no further questions from our phone lines. I would now like to turn the conference back over to management for any closing remarks.

[Jeff Solomon:]

Well, we hope you all enjoy what’s left of the summer and we look forward to spending more time with you at the end of the third quarter. Thanks, everybody.

[Peter Cohen:]

Thanks, everyone.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day.