Cowen Inc.
Q2 2018 Earnings Call Transcript

Published: 26 Jul 2018

[Operator:]

Good morning, ladies and gentlemen, and thank you for joining the Cowen’s conference call to discuss the financial results for 2018 second quarter. By now, you should have received a copy of the company’s earnings release, which can be accessed at Cowen’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 has no obligation to update the information presented on this 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. Jeffrey Solomon, Chief Executive Officer.

[Jeffrey Solomon:]

Thank you, operator. Good morning, everyone, and welcome to Cowen’s Second Quarter 2018 Earnings Call. This is Jeff Solomon, and joining me today on the call is our CFO, Steve Lasota. Building off of a record Q1, our second quarter results added to the strong momentum we’ve been experiencing recently in our businesses. We are benefiting from a continuation of some favorable trends including a robust capital raising environment and elevated equity trading volumes. In addition, a number of the strategic actions we have undertaken have helped to improve operating performance. More specifically, we’re gaining noticeable traction in scaling businesses, driving margin through cost cutting, diversifying our revenue streams and harmonizing our balance sheet activities with our operating businesses, all in order to generate more accretive returns for our shareholders. As I stated before though, we view our recent accomplishments as a work in progress. I’m proud and encouraged by the robust improvement in our results for the first half of 2018. But I also want to stress that we are in the early innings of Cowen’s transition into a simpler, more consistent, more transparent and more profitable company. That being said, Q2 represented another solid milestone for Cowen, compared to Q2 of last year. Economic income grew 88% to $21.7 million on a 36% increase in economic income revenue of $234.3 million. Economic operating income which represents economic income excluding depreciation and amortization was $24.7 million for the quarter versus $14.2 million for the second quarter of 2017. And was $51.7 million for the first six months of 2018 versus $22.3 million for the first half of 2017. Economic operating income is a metric we have begun to use, as we believe it enables us as managers to better measure how our businesses are performing across the platform, regardless of whether we scale and profit are coming from organic growth or through acquisition. It is also easier for us to establish targeted operating returns and margins for each of our businesses as we look to improve our return on capital. Finally, we’re trying to be more transparent with our shareholders and potential investors by making it easier to compare our operating results with other publicly traded financial services companies who exclude costs related to acquisitions from their equivalent of economic net income. Turning now to our results and progress in each of our specific businesses. In banking and capital markets, while we continue to take advantage of a robust capital raising environment particularly in our leading healthcare franchise, we also made inroads in some of our other areas of expertise, including technology, industrials and consumer. Investment banking revenue grew 25% from the second quarter of 2017 to $80 million on an economic income revenue basis as investors continue to show interest in IPOs and follow-ons during the period and companies chose to finance themselves. As our results for the past few years have shown, healthcare equity capital markets have been our biggest growth driver in this segment. We made strategic decision almost seven years ago to embrace and focus on equity capital markets and in healthcare in particular, as it is long been a core competency at Cowen. As a result today, we are one of the leading capital raising investment banks in this sector, which demonstrates the consistent need for equity capital raising. Thus it remains a solid foundation for our business even as we look to diversify. Following what was a record quarter first quarter of 2018, healthcare ECM had another strong quarter marking our strongest first half since the formation of Cowen Inc. While the first six months was conducive for the healthcare sector to do capital raises in general, it is worth pointing out that this period is actually second to the first six months of 2015, which was the last major period for healthcare new issuance. However, in the first six months of 2018 it is a record for us at Cowen, which points to how much share we have continued to gain from our competitors. Aside from the success we have been experiencing in healthcare, we are continuing to invest in our non-healthcare verticals and advisory activities to diversify our revenue mix, and we’re making good progress on this front. Non-healthcare revenue on an absolute dollar basis continues to grow. In the quarter, our non-healthcare revenue was $26 million, a 64% increase from the second quarter of 2017. As a percentage of revenue, it represented 32% of banking revenue compared to 25% in the second quarter of 2017. We are clearly making progress on our goal of diversifying banking revenue on a percentage basis, though at sometimes be hard to see that in periods where healthcare ECM is also experiencing strong growth. In the quarter, merger advisory revenue was up 81% from the prior year quarter to $14.5 million with transactions coming from healthcare, industrial, technology, information services and special situations. In fact, this was one of our most diversified quarters as it relates to industries underlying our M&A revenue. For the first half of the year M&A revenue was $28.9 million, which is a record for Cowen since its formation in 2009. It’s worth noting that the majority of the growth in M&A has come from organic hires over the past seven years as we set out to rebuild the franchise methodically. As we have said previously, diversifying our business towards higher margin activities, this is a multi-year process. We plan to continue investing in our advisory capabilities both organically and inorganically in order to drive long-term margin growth. In spite of the pace of investment banking, transactions in the quarter, in the first half of the year, our backlog has held steady throughout the period as we have been mandated on a number of transactions even as others have closed. Now turning to our markets businesses. Our brokerage revenue grew 69% on an economic income basis compared to the second quarter of 2017. As a reminder, the prior year quarter included one month of Convergex. Total brokerage revenue averaged $1.8 million per trading day compared to $878,000 per trading day in the year ago quarter. Over the years we have made significant long-term investments to elevate both our research and brokerage franchises. Our efforts are paining off, enabling us to gain market share especially in a post MiFID II environment. Clients value us because of our sophisticated and differentiated approach to research and our position as a key market liquidity provider on a non-conflicted basis. For purposes of this call, we will broadly describe the individual units within the markets business as institutional brokerage and institutional services. As a reminder, institutional brokerage includes cash equities, special situations, electronic trading, options, convertibles and credit. Institutional services includes prime services, global clearing, security finance and commission management services. Starting with the first component, institutional brokerage, we have doubled from the second quarter of last year. Much of this is due to the acquisition of Convergex which closed in June of 2017. With the addition of Convergex we were able to build on our competitive position by leveraging our larger platform to gain further market share with clients and begin to drive down costs due to our improved scale. Our institutional services business rose to 127% from the second quarter of 2017 with much of the growth once again reflecting the diversification in the business following the acquisition of Convergex. With respect to MiFID II, it is still early in its implementation and we continue to experience a muted impact, though we continue to see improved market share among our MiFID II specific clients. Moving to the investment management business. As of July 1, we had $10.9 billion in assets under management, which was a $40 million increase from April 1 of 2018. Our private healthcare strategy, which is our first Cowen DNA investment platform, we are exploring the potential launch of a complementary public market fund that will leverage our market position. Our healthcare royalty business is currently 75% committed to its third commingled fund. And the business had a strong first half of 2018 having deployed $315 million across all active vehicles. Merger arbitrage outperformed the HFRX merger arbitrage index as it successfully navigated an investment landscape made increasingly volatile by the geopolitical environment and decisions made by the Department of Justice in certain landmark cases. Real estate held its final close for its third equity vehicles. Our long/short equity strategy which invests primarily in the communications, technology, media and consumer sector produced positive results which compared favorably to the long-term S&P 500 Index and the HFRX Equity Hedge Index. But the investment management business is still a business in transition. Last year we eliminated products that did not show an ability to scale and brought the total number from 10 last year to 6 today. We are continuing to value each of the remaining businesses based on their ability to be accretive to our targeted ROE objective over the near term including their utilization of capital. We will continue to make decisions based on each strategy’s ability to scale with our client base thereby fostering improved margins and returns on equity. As we discussed on prior calls, going forward we’re focused on developing alternative investment products that leverage Cowen’s expertise in certain domains, such as our private healthcare strategy which we launched last fall. This is what we term Cowen DNA. We also made a shift in how we launch these strategies going forward, whereas traditionally we would incubate strategies internally first before raising outside capital. Today we’re focused on raising external capital first and putting our balance sheet to work simultaneously. And for new strategies, we are focusing our efforts more towards private equity style strategies versus traditional hedge fund strategies on which Cowen had been previously focused. Over time we expect a combination of these actions will result in a more focused and profitable platform, that is better aligned with the broader Cowen platform. We will continue make adjustments to this business to better leverage the broader franchise and in our deep domain expertise to drive high returns for our shareholders. Having gone over our individual businesses I will now spend a moment or two expanding on some of the strategic initiatives we’ve been talking about for the past few quarters. The first is simpler, fewer, deeper, which you’ve heard me address in portions of my prepared remarks today. simpler, fewer, deeper is not some sort of catch phrase we drove out there to be – describe what we’re doing, it is actually a roadmap for taking Cowen to the next phase of our evolution, which we call the value creation phase. Evolution started of course with the merger of Cowen and Ramius in 2009. And since that time we’ve undergone a rebuild and position phase to reposition the platform around our core competencies and position ourselves for increasing growth in economic income. Now the challenge and opportunity rests squarely on laying out the framework that will guide us to driving greater shareholder returns. Simpler, fewer, deeper is one of the core pieces of that framework and you’ll begin to hear us talk more about it as we share some of our progress in executing our initiatives. One of the initiatives we’ve been working on is improving our capital allocation process to drive higher returns on equity. Our view is that capital allocation should be balanced carefully to achieve the appropriate long-term objective which should drive stronger growth and returns to the business, while also returning capital to shareholders when the right opportunities present themselves. I think it’s evident that we would not experience this strong result in the first half of 2018 had we not judiciously allocated capital to the areas of our business but the greatest risk adjusted opportunities. But at the same time, we recognized our opportunity to reward our shareholders along the way with buybacks, which is why we repurchased $3.3 million of our common stock during the quarter leaving approximately $14.1 million available to repurchase under our current program. That is to say we plan to return capital in addition to growing the business, not the expense of growing the business. Of course, complementing this balance capital allocation view is an overall longer perspective of the business which comes from – which comes with the territory. We can’t deliver value creation and simultaneously return capital when taking a short-term view, which means that we’re comfortable of optimizing returns in the short-term sometimes by closing down some of our underperforming funds in order to scale returns over the long-term. In this fashion we believe we will be in a better position to drive more sustainable returns on equity. We’ll also be continuing to optimize our balance sheet activities to align them more closely with our operating businesses. As you’ve heard me say before, this plays into our philosophy that balance sheets are meant to be seen not heard. In addition to making further reductions in our quarterly investment volatility by de-risking the balance sheet and growing the contribution from spread businesses, we’re also working on a roadmap to monetize some of our private investments. And it’s clear to us that this is a legacy area of our business that has confused a lot of investors, so I’m going to take a few minutes to explain it in more detail. If you look at our investor presentation, we break down the components of invested capital. For the quarter ended June 30, 2018, invested capital totaled $716 million of which $119 million is tied to our private investments as well as a non-core real estate investment. During the first six months of the year, those investments did not contribute anything to investment income. That is to say, our economic operating income and economic net income was generated with very little coming from a large portion of our balance sheet. I will leave it to you to do the math on the true ROE of our operating businesses over the quarter. So with that said, I will turn the call over to Steve Lasota for a brief review of our financials and then we’ll close it up. Steve?

[Steve Lasota:]

Thanks Jeff. For the second quarter of 2018, we reported GAAP net income attributable to common shareholders of $3.7 million or $0.12 per diluted common share compared to $5.7 million or $0.19 per diluted common share in the prior year period. Note that our GAAP stockholders equity increased by $45 million to $793 million at June 30, 2018 from $748 million at December 31, 2017. I will discuss this further later on in my comments, our GAAP revenue was up 46% year-over-year to $234.6 million compared to $160.5 million in the prior year period. The increase as Jeff had touched upon earlier was due to the continued of our businesses especially banking and brokerage, which benefited from a healthy market demand for capital raising as well as higher trading volumes. Compensation and benefit expenses were $131.8 million, non-comp expenses were $88.4 million and D&A was $3.2 million. In addition, other income from gains on investments was $47.1 million, income tax expense was $4 million and non-controlling interest expense was $24.6 million for the quarter. We adopted new revenue recognition guidance as of January 1, 2018, which is impacted several components of our GAAP income statement. For one, revenue on our investment banking business segment is now recognized on a gross basis rather than net of any associated underwriting expenses as it had been presented before. This change however has no impact on our GAAP net income. Moving to the investment management business, the majority of fees from certain funds that we previously presented as incentive fees are still being recognized but are now being presented as equity investments in the funds with associated gains or losses in the income statement. Only a portion of our previously recognized incentive fees will be deferred for GAAP to a future period at the point that they are crystallized, we have to address any questions related to these changes later in today’s Q&A section. Now turning to our non-GAAP financial measures, which we refer to as economic income. As a reminder, we use economic income to measure our performance and to make certain operating decisions. In general, economic income is a pre-tax measure that eliminates the impact of our consolidation and consolidated funds and excludes goodwill and intangible impairment, certain other transaction related adjustments or reorganization expenses, certain costs associated with debt and preferred stock dividends. Economic income revenue also include incentive income during the periods when incentive fees are not yet crystallized with GAAP reporting. The remainder of my remarks will be based on these non-GAAP financial measures. But before I get into the actual economic income results for the quarter, I would like to take a step back and walk through our rationale for using this metric and why we think is important to focus on when valuing our true underlying performance. Economic income strips out one-time our economy related items that are not core to our business or our profitability in cash generation. We do make sure that adjustments are transparent as possible. So that investors can exercise their own judgment to arrive at an appropriate valuation our investment decision. With that being said, let’s take a look at our economic income results for the quarter. We reported economic income of $21.7 million or $0.71 per diluted share for the second quarter of 2018. This is nearly doubled the $11.5 million or $0.39 per diluted share of economic income we generated in the prior year quarter. $0.26 of the GAAP to economic income reconciliation is related to the loss from the embedded option feature associated with our convertible notes. Prior to our June 26, 2018 shareholder meeting, the embedded conversion option feature was recognized at fair value in accordance with GAAP as a derivative liability, subsequent to receiving shareholder approval for share settlement, the embedded conversion option was reclassified to equity and will no longer result in profit and loss movements. Economic income revenue increased 36% year-over-year to $234.3 million, compared to $171.9 million in the prior year quarter. Similar to the increasing GAAP revenue, the increase in economic income revenue was due to strong performance in equity financings, as well as growing contribution from the advisory and non-healthcare sectors. Investment banking revenue was up 25% to $80 million from $64.1 million in the second quarter of 2017. Quarterly brokerage was up 69% year-over-year to $113.2 million. Management fees were $12.5 million compared to $14.4 million from the prior year period. Incentive income was $9.4 million compared to $11 million. Investment income was $20 million compared to $14.2 million in the prior year. And finally our other revenue was a loss of $721,000 compared to revenue of $1.3 million in the prior year. Now turning to our expenses, due to our acquisition of Convergex, our comp to economic income revenue percentage was lower than prior year levels. Comp and benefit expense for the quarter was 56% of economic income revenue compared to 58% in the prior year period. Fixed non-comp expenses totaled $34.9 million in the second quarter compared to $29.8 million in the prior year period. We’re continuing to reduce non-compensation costs to drive margins and reach a more efficient cost structure. We’re also continuing to lead this synergistic benefit from the Convergex acquisition by working to integrate and streamline our collective technology operations and corporate practices. Variable non-comp expenses in the second quarter of 2018 were $37.2 million compared to $21.9 million in the prior year. The increase was primarily related to higher floor brokerage and trade execution costs related to the Convergex acquisition. Economic operating income which is economic income before depreciation and amortization was $24.7 million, compared to $14.2 million in the prior year quarter. As Jeff mentioned, economic operating income as a metric we have begun to use. Depreciation and amortization expenses were $3 million, compared to $2.7 million in the second quarter of 2017 and similar to the prior quarter, the increases due to an increase in amortization of intangible assets and depreciable fixed assets related to the acquisition of Convergex. GAAP stockholders equity increased by $45 million to $793 million at June 30, 2018 from $748 million at December 31, 2017. The increases related to our six month 2018 earnings and a reclassification to equity of the embedded conversion option associated with convertible debt which I previously spoke about. Common equity, which is stockholders equity less preferred equity was $692 million compared to $647 million at the end of 2017. Book value per share, which is common equity divided by total shares outstanding increased to $23.37 as of June 30, 2018 compared to $21.82 as of December 31, 2017. Tangible book value per share, which is common equity less goodwill and intangible assets grew to $20.40 as of June 30, 2018, compared to $18.77 as of December 31, 2017. And lastly, invested capital was $716.1 million as of June 30, compared to $695.3 million as of 12/31/2017. This completes my financial summary. I’ll now turn the call back over to Jeff for closing remarks.

[Jeffrey Solomon:]

Thanks Steve. So there’s a real momentum in our business and it’s not just captured by our strong financial results. It have to do with the collective entrepreneurial mindset here, Cowen to achieve great new things and outperform in every sense of the word. Our clients share this vision and mindset, which is why we believe they choose to partner with us. Our intent is to continue the string of successes we’ve been experiencing only in a much larger and more sustainable scale. One of which our clients, employees and shareholders can all be proud. So I’ll say again because it bears repeating, the first half of 2018 was the most successful start to year that we’ve had since we formed Cowen, nearly a decade ago. The results we accomplished so far will serve as a blueprint for evolving the company going forward. But we’re not extrapolating these results out into the rest of the year. That is to say we will remain judicious in how we continue to invest in our growth. While we’re seeing real progress towards our objective of a more transparent, predictable and sustainable results, we’re still not at the stage where you stand out Q1 and Q2 by default translates into an exceptional year. But everybody here is working super are to make sure that that happens. But I hope you gain from today’s call a sense of what our future can look like. If markets are okay and we execute on our plan. Objectively, we are making great strides towards achieving that plan. And I want to go through the objectives that we discussed here at Cowen, as we execute. One, we are looking to scale businesses that will drive margin. Two, we are focusing on opportunities where we have strong domain expertise and can leverage the Cowen D&A. Three, we are improving revenue diversification. Four, we are maintaining and growing contribution from recurring revenue businesses. Five, we are harmonizing balance sheet activities with our operating businesses. Six, we are implementing the philosophy that balance sheets are meant to be seen, not heard. Seven, simplifying our balance sheet by exiting non-core investments and non-core strategies. And eight, improving the capital allocation process. Over time, we believe the successful execution of these objectives will translate into increased earnings power, greater operating consistency, lower volatility and improve transparency results. The ultimate outcome of course is higher and more sustainable shareholder returns. I look forward to joining the talented partners and teammates we have here at Cowen and taking the next step towards making decision a reality. And I want to thank everybody here for all the efforts that we’ve made so far this year. And with that, we’ll open up the call for questions. Operator?

[Operator:]

Thank you. [Operator Instructions] And our first question comes from Sumeet Mody with Sandler O’Neill. Your line is open.

[Sumeet Mody:]

Thanks. Good morning, guys. Looking for a little color around the recruiting and - recruiting environment and investment banking and where you guys see the opportunities for continued diversification that you mentioned earlier on the call and kind of the more non-healthcare sectors. And what your appetite there before you kind of reconsider, any pace of change?

[Jeffrey Solomon:]

Hi, Sumeet, good to hear from you. A few things, we laid out the core strategies in the industries in which we’re looking at. I think obviously we recognize that building out merger advisory revenue is a much higher margin business. And as we’ve noticed that the equity capital markets outside of biopharma and healthcare are just they’re different and not as robust. And so as we continue to look for talented individuals, we certainly are looking for both who have the ability to not only win but execute on merger advisory business, debt capital markets and other things. The goal is to bring people who understand the value of the domain expertise that we have. And I think that’s a really critical differentiator as we have been out talking with a number of people, either teams or businesses that may be for sale that we may look to acquire. One of the things we talk about is the value of the content we have in the domain expertise that we have in the industries we cover research. And so we’re very much interested in bringing people on to platform who see the value and figure out how to monetize that value in investment banking, not just through finance but through advisory services as well. And so I mean, I think we’ve announced a few over individuals, over the past few months. And you can see these are really senior individuals who are choosing to come here from the places where they are because they see an opportunity to apply, what we do to their clients and bring their clients into an organization and really understands exactly how we can prosecute the business and effectively build a great long-term partnership. So maybe that’s a little too general but we’re being extremely selective in who we bring on because we want to make sure that as people come into the organization and hit the ground running.

[Sumeet Mody:]

Great, helpful. Thank you. And then secondly, what would you say are the most important metrics for people like us to track from the outside to get a good feel for Cowen to progress thing as you simplify the business?

[Jeffrey Solomon:]

Well, I think from an operating standpoint, certainly there’s enough out there in the public domain about how financings are going that’s still a primary revenue driver. I would certainly see on the markets business. You can take a look at volume and advertise volume. It should give you a pretty good idea of as a proxy for how well we’re doing relative to other non-conflicted trading shops or other independent shops. I would say as it relates to that, I would not compare our equities business at all to the Bulge or anybody who has a dark pool. That’s not an effective comparison mechanism, those are different businesses. I would also say that we recognize that the very large banks are using their balance sheet to trade and position that’s not what we’re doing. So I think we can help you offline to sort of think about who we compare ourselves to. But we look at those metrics all the time internally and that drive pretty good – a pretty good comparison. On the investment management side, I still think it’s helpful to look at hedge fund indices as a way to try to get a sense for how performance is going. We are increasingly less dependent on market directionality. We try to squeeze as much of that out of our organizations we can by running our bounty to be relatively, I would say, market neutral, but we’re not necessarily looking to beta ride on our investment. So that’s probably a pretty good way to access how well the health of the market is doing. Of course we put out I believe quarterly AUM numbers. And I think there’s probably any one of a number ways you could determine in how our funds are performing because I think we published those, so that would be a thing. And then lastly I would say is, increasingly we are really managing our business through economic operating income, and that’s one of the reasons why we are highlighting this metric today. Depreciation amortization rules are very convoluted and it can – you can make bad decisions if you’re looking at margins after those. We’ve made some acquisitions as you know and making sure that that we’re driving operating margins, and really putting the tools in the hands of frontline managers to drive their targeted margins. It’s a really important thing that and people own – our senior managers own the responsibility for driving margins in their individual businesses. And as we’ve said, certainly with the integration of Convergex and some of the things that we’re looking to do in the merger advisory business, our business managers understand exactly how to drive margin both in revenue and in cost, and we are rewarding them through a compensation mechanism for doing so. And so economic operating income is more what we’re using internally here. And so we’ve added that as a metric for you to look at because that’s what we’re looking at. And if we can drive economic operating income, overtime that will drive ROE, we know that to be the case. And so it’s working for us. And six months in that’s why we decided to share with you all so that you can begin to track that in a much more meaningful way because that’s what we’re doing. So I hope that answers your questions, Sumeet, but, you’ll – let me know.

[Sumeet Mody:]

Yes, that’s very helpful. Thank you. Just one real quick one last question from me. Regarding the roll-off of some of your non-core investments and invested capital. Just maybe on a high level, how are you guys thinking about using the capital from monetization especially from maybe the larger investment like Linkem?

[Jeffrey Solomon:]

So we haven’t said and the reason is because timing wise I would love to figure out how to monetize those. But we have partners in all of those investments and so we are just working to monetize it. We’ll access it at the time what we can do. With the capital there’s a way for us to deploy to grow the business. We will be looking to return some of that capital to shareholders. There’s a number of things we can be thinking about. But I think the point of our highlighting it as carefully as we have on call today and then in our subsequent meetings with shareholders is to say that we recognize that those investments are not driving our core operating business. And we can have discussions and debates about how to value them, and I’m happy to go into that with anybody want to spend time. People want to – we think they’re obviously mark-to-market, so they’re valued fairly by an independent third-party. But we debate whether or not there’s future growth or whether or not people have concerns about it. The bottom line is it’s not core to driving what we think is going to the ultimate value creation engineer and so we’ll be looking to figure out ways to monetize it as it is. We will take a look at the landscape when that happens and we’ll make some determinations as to how best to deploy that capital.

[Sumeet Mody:]

Okay, great. Thanks for taking the questions, Jeff.

[Jeffrey Solomon:]

All right. Thanks, Sumeet.

[Operator:]

Thank you. [Operator Instructions] We have a question from Devin Ryan with JMP Securities. Your line is open.

[Devin Ryan:]

Great. Good morning, Jeff. Good morning, Steve. How are you, guys?

[Steve Lasota:]

Good, Devin. How are you?

[Devin Ryan:]

Doing well. So I guess first question here, I heard the comments on increased market share in brokerage kind of early dates of MiFID II, but I think the results that you guys have been putting up speak for themselves. I guess the question here is what are you hearing from clients as to why they’re consolidating in their wallets? And why you’re winning at Cowen? And then kind of the second part of that is within Convergex your revenues have been coming in ahead of at least our model, it sounds like there’s still some expense synergy still to come there. So I’m just trying to think about kind of the margin outlook and then kind of operating leverage within the business, and I don’t specifically break it out to that granularity, but just to try to think about the potential margins moving forward if there is some more expense savings?

[Jeffrey Solomon:]

Okay. So first question, so let’s just break this into two components or pieces. There’s that MiFID II regulated accounts. I want to remind everybody that we don’t have a very large European equities business. We do have one, but it is relatively small percentage of our overall markets revenue. It’s less than 10% of our revenue. And there’s no question that MiFID II is impacting those folks. As it relates to our research payments, we’re up year-over-year with MiFID II accounts in part because I think they’re actually going through a consolidating their counterparties and we’re on the winning side of taking market share. I do think there are a number of firms who are not on the winning side of that and they’re being eliminated. And so we’ve talked about this for a long time. The market surveys that talk about the impact of MiFID II are broad market surveys that talk about what the likely impact is going to be on the aggregate commission dollars aid to the Street. But we’ve long held the view that most of those declines are going to come from people going to zero, and that the rest of us will end up actually gaining share, again, a bigger share of a smaller pie and that’s what’s happening to us with our MiFID II accounts. Now we saw some work there do. We were looking at becoming a systematic internalizer in London. It’s a small amount of capital that we got to put up to do that that will enable us to be able to provide more liquidity on an upstairs basis to European accounts, we’re doing that because our clients are asking us to do that so they can actually do more with us. And so we’ve been reacting to the feedback we’re getting from clients and knowing full well that when we engage there we actually have more flow we can take. The second part of MiFID II is really what I would call the global players are doing in response to MiFID II. So they may not be specific MiFID II compliant entities, but a lot of the global players either ring fencing their MiFID II or adopting what I call MiFID II Lite, which is to say unbundling. And we’ve been saying for a long time, there’s no news there. Everybody is unbundling. They want to know that for their commission dollars, what they’re paying for research, and what they’re paying for trading are clearly distinct. And that’s actually an advantage to a firm like Cowen who can really compete head-to-head with anybody either in research, contact and quality or in trade execution quality. And so the purpose of doing the Convergex acquisition was precisely to give us that market heft and scale to in order to – to be able to sit down with buy side training desk and offer them heads-up highly competitive liquidity options for them to do business with us. This enables us effectively to re-aggregate the wallet. So that if certain of our clients are facing pressures on commission dollars but have an opportunity to pay us with trading and they’re unbundled, we’ll re-aggregate and make sure that we’re pushing them adequately to look for – to enable them to continue get the best of what we do at Cowen. Now we have an internal optimizer around how we’re using our resources. And so it’s very clear that we have to be extremely judicious with how we’re spending our time and our energy both in research and trading for the clients that match-up best with us. And so we’re going through a process where we’re looking at how to do more with the clients we have. Certainly acquiring Convergex gives us more clients. The reason we’re experiencing I think a better than we anticipated top line revenue is because one plus one actually has equaled more than two for us. These are clients that were not doing business with Cowen ahead of time and the Cowen clients weren’t really doing business with Convergex. And so bringing the two together has enabled us to really scale our business in a much more meaningful way. And so that’s part of what we’re seeing there. As far as operating margins, we haven’t given specific operating margins for the markets business and we’re not going to start now. But I will say this, we look at it, we look at it hard. And when we look at our quarter-over-quarter numbers and our year-over-year numbers, the margin expansion has been better than we anticipated. We continue to find ways to wring out costs from our vendors because of the size and the half that we have now. Certainly there are more venues that are soliciting us to drive business to their particular venues. I love that because it means that we actually matter meaningfully to market liquidity and that’s a very powerful position for us to be in before our clients. It allows clients to know that they can come to Cowen and actually get outstanding execution because of the demand and attention that we’re getting from the people that ultimately end up executing trade. So that margin has been much more – much greater than it had been historically for us and is really – it’s been quite impressive for us. So I’m not going to give you specifics, Dev, it’s suffice to say it’s something that we’re very proud of.

[Devin Ryan:]

Yes. That’s great color, Jeff. I appreciate all of that detail. And I guess second question, I heard the comments live and clear, not the annualized going to be great first half for investment banking imperially because it can be lumpy. But if you look into the back half of the year, you just think about kind of the environment that we’re in right now, you should have some visibility I guess into the M&A pipeline, so it would be great to get some perspective there in terms of expectations. And then at maybe at a higher level in equity capital markets, where results have been great. There wasn’t anything unusual that you would point to in the first half in kind of the market tone or environment that that drove the outside results that has changed. So I’m just trying to get a sense of directionally if it still feels as good and that just it’s a lumpy business so it’s not a promise that we can repeat this every quarter.

[Steve Lasota:]

Yes, to caution of my voice always because I’d rather manage people’s expectation. It’s been a good environment. I don’t want to minimize it. But the underpinnings of that – those drivers of that market remain intact. So let’s talk about ECM first. It is a very good time for biotech companies to be raising money and new company formation has increased significantly. We’ve had – we’ve been staying for a long time. When these companies exit, when there’s M&A in the business two things happen; one, that capital gets returned to shareholders; and if as long as there’s not massive withdrawals from the healthcare funds, that capital needs to be redeployed and there are limited places to redeploy that capital. The second thing that happened – so they’re basically they’re looking for new investments. And that what opens up the opportunity to find the best investments and to create new companies. The second thing is those management teams often go on to start new companies. So they’ve had a success, they understand a therapeutic area really well and they’ve got the ear of a lot – the trust of a lot of investors in this space, so they go and they find really new exciting science that they can bring along. And so private company formation, off the back a really successful public company exit is absolutely happening. And so the dynamic is such that they sell the businesses for billions and billions of dollars, and then they come back to the market and they raise hundreds of millions of dollars. So you think about that dynamic. As long as we can have good science and they can do some FDA, there are teams who are being formed, really well healed teams are being formed with good track records and having successfully negotiated or navigated exits for their prior companies that are now looking to raise capital. So – and when you make a list of the banks that you want to spend time with who have the best connectivity and the best research and can really actually weave through what’s likely to be successful, it’s a short list and we are absolutely positively in that. If you’re bringing a company public in the biopharma space and you’re not talking to us, you’re doing yourself a disservice. And so we’re being selective with who we bring on and thought that dynamic continues into the back of the year. I just can’t tell you what’s going to happen with the overall geopolitical environment or markets in general. We do know that if markets get a little bit uneasy, people will pause and wait for a better time. But they’re definitely going to raise money eventually because that’s what they do. And the fundamental underpinnings of this market suggest that that could continue for a while. On M&A, our pipelines have been refilled. So one of the things we measure is I think if we – we just burning off pipeline or we replacing. And I think I said in the call that our pipelines continue to be at the same level that we saw them at the beginning of the year. Even though, we've closed down a little less than $30 million of revenues. We've already put up a couple of prints in the month of July, that would suggest that things are moving to pace. We have pivoted our business in M&A away from the big cross border, Asia based acquisitions where it seems to get hung up in [indiscernible]. And so that was something we recognized from our own experience last year with [indiscernible], which you'll remember. So in our calling efforts and our advice we’re giving to companies we've been able to find our clients, the right kind of investors that are likely to have successful exits. So it's not just announcing transactions as getting them close. And that's something our bankers are extremely tuned to doing because we've got to get stuff over the goal line. And so I would say all-in-all steady state. I'm not – we could certainly see a pick up as we add new people. And I don't expect that to happen but I don't see anything currently from a macroeconomic standpoint that would undermine the momentum that we've had.

[Devin Ryan:]

Okay, great. Thanks Jeff. One for Steve, just you had mentioned the accounting impact on incentive income and that accrual, can you just maybe give a little more detail on that. And I just want to make sure that that does not impact the carried interest accrual accounting for our healthcare royalty?

[Steve Lasota:]

It does not. It's just – as I said certain of our funds that the incentive fee has not crystallized. So in looking at our earnings Dev, its $0.05 this quarter that they uncrystallized what they should be crystallized by year-end. So for GAAP purposes you'll recognize them by year-end, for economic income purposes we recognize them currently. So it’s a small minority piece, right. The majority of them as I said moved out – just moved for GAAP purposes to equity investments whereas this piece is it has to be crystallized before a real incentive fee. In our view, it will be crystallized so we reflected in economic income.

[Devin Ryan:]

Got it, okay. Thanks. And then just last couple one kind of bigger picture. I know this is a little bit difficult to probably go through in a lot of detail. But if you take the first half earnings which clearly are strong in any ways that's about $3 a share of E&I. And if I look at the stock price at this morning nearly $15, you're still – it's less than five times kind of E&I of the annualized first half. And so at what point I know that you were kind of like setting the bar here and the success is kind of building upon itself. And so hopefully the market starts to appreciate that to the extent there is consistency in the results. But at what point, do you say kind of enough is enough. I mean, you can obviously buy back more stock and that's one kind of method to potentially try to take more control of that. Is there anything else do you guys thinking about doing or just kind of that you feel like it could be done to help the valuation because it does seem that for the success they've had over the first half, it's not being reflected in the share price at a sub-five times, four multiple for the mix of businesses that you have?

[Jeffrey Solomon:]

Mostly one thing we will definitely be doing is asking our research analyst to take us on the road, introduce us to investors who can appreciate the new story. So that’s one place where you could be helpful. And to me, 100% I think – I don't think you understand the story yet. And I think that we've been trying to take great pains over the past few calls to really lay out our objectives, repeat them, be more transparent, talk about the parts of our balance sheet that we're going to be migrating away from, and where we're going to be migrating to. We're just not going to financially engineer ourselves to book value at the expense of making sure that we have a business that’s sustainable. We understand that if we don't have places to put money to work to drive are mid-teens ROE objectives. And then we've said publicly that our goal is to be able to in any normal environment to be able to drive mid-teens ROE by the year 2020 in a more consistent basis. So we're clearly able to do that today. But sometimes it may mean that one particular sector outperforms and so everybody says what if that sector doesn't outperform. And our answer is well, this is why we're diversifying our revenue base because like we're not counting on the first six months in healthcare ECM to be the same all the time. But as you can see other businesses are beginning to pick up momentum that will fill the revenue bucket for us when there's a little bit of softness in that area. So again this is why we're taking this longer term view and we think that on an earnings basis alone, clearly the business is very inexpensive relative to what our peer group looks like. And so we understand the allure and the attractiveness of buying back stock. And we're continuing to do that. We certainly are but a lot of it is making sure that we're doing it in a way where we're not if we do have any sort of softness or we do have any sort of a downturn in the market that we're not going to be thinly capitalized in putting the franchise at risk. So we'll continue to do it over time. Certainly as we monetize some of these assets, we have a lot more financial flexibility to do things like that.

[Devin Ryan:]

That's great. Okay, appreciate all the color. And good response, thanks Jeff.

[Jeffrey Solomon:]

Okay.

[Operator:]

Thank you. And our next question comes from Justin Hughes with Philadelphia Financial. Your line is open.

[Justin Hughes:]

Hi, good morning, Jeff and Steve. Thanks for hosting the call in excellent quarter. My first question is just on the buyback obviously was down significantly from 1Q. And I know it could be a timing, I just want to – is that a timing issue, is that – where the stock prices at in the quarter, blackout periods et cetera what should we expect in the second half?

[Steve Lasota:]

We'll continue to do – we'll continue to buyback stock out of operating earnings. I think we certainly had a shortened quarter this quarter because we did the debt raised. So we knew we are going to do a debt raise so we lost a week and a half there. And I just feel like we've been taken away at the stock, pretty consistently. Certainly we also in the quarter we bought – we buyback stock from employees on a net settled basis, we are going to be cleaning up over the course of the next nine months, we’ll be cleaning up the remaining outstanding converts we had from the first deal. So we've got some things to consider there. But yes, we're going to continue to buyback stock at these prices, we see how the business is going and we have a lot of confidence in our ability to execute on it. So why wouldn't we. It's super cheap and relative to the earnings power of the organization, we’ll continue to do it. And are we going to chase it higher, I think everyone would love for us to do that. But we're going to be smart about it make sure that we're doing the right thing from a cash flow standpoint to ensure that we're not going to put ourselves in harm's way. We have the flexibility to do it, we have – we do have enough buying power here, remaining and when we burn through that we'll go back to the board and ask for more. We talk about it at the board level, the board is happy with the pace that we're going at and understands it that we have the flexibility to do what we want to do as we see opportunities to do it. So I hope that helps with the answer.

[Justin Hughes:]

And then you've identified about $120 million within a non-core assets if I look at the core facility of the business, its $50 million were monetizing the cash tomorrow, what would your top three priority be to use that $50 million of cash?

[Jeffrey Solomon:]

That's a good question. I would say so I'm not – if somebody else asked that question a little bit earlier and I punted on it. Because I think – we don't expect to have the monetization of those assets in the next six months. Like we're working on it but there's just some things that will – that need to happen that are not in our control before we can actually have the monetization events occur. So I'm not going to commit to doing it, to give you a top three list, I think we've laid out very specifically capital optimization. There are businesses that we're likely to buy. There's also opportunities to buyback stocks all of those are at play and when we monetize those position, we'll take a look at where we are and what we've already accomplished and make the decisions accordingly. I just I'm not – I don't want to commit to doing anything specific over the next six months I don't expect to be able to have meaningful monetization in those businesses for reasons that are outside of our control. I wouldn't say we're working super hard to make sure they happen but I don't expect it to happen between now and year-end. And next year was a different year and we'll take a look.

[Justin Hughes:]

Okay. And then one – a very strong quarter overall but one most encouraging is the pick up in M&A advisory. And you said, you have been adding headcount there. Can you give us a little more specific numbers on what your MD count within M&A versus a year ago or six months ago, so can you give a little bit of a sense of how much of this is organic growth versus just a strong market and kind of what your pipeline is for M&A, MD recruitment?

[Jeffrey Solomon:]

Great question, so I don't think that the success we are seeing now is the result of recent hires. So as we discussed – and we discussed this, it takes a while for people to put on the Cowen uniform, go out and executive business. So the success that we're seeing in our M&A franchise is a result of people that we've hired, in 2011, 2012, 2013, 2014. Certainly if you look at our 2016 results we made some significant hires in the back half of 2016 when there was a lot of softness. And those people have contributed mightily to our performance over the first half of this year, it does take a good 18, 24 months for people to start to print in a meaningful way though. I will say several years ago, it would take like three years. And so there is an element of momentum that when you're printing, the more qualifications you put up, the more brand you build the more likely it is that you find yourselves in final competitions and the more likely you are to win. So we do know that as we approach $100 million in annual M&A revenue, when that starts to happen, your brand just becomes pervasive in the industries and what you cover. And so we're going to continue to look to do, the environment is actually pretty robust for recruiting for us. And that's because there's just a lot of unhappy people in places that were honestly they come to work every day and not having fun. I don't want to make it seem like we're – it's a party over here every day but the reality is we try to create a culture where people come to work and do what they do best and enjoy it and enjoy being with everybody and making happy in an environment like that. There's just very few of those places where you can do that on Wall Street and not have a lot of political blowback. And so what we're seeing is people like I'm sick and tired of working here, I’m good at what I'm doing. And I want to go work at a place it has amazing content and a great culture where I can be, who I am and do better. I'll take it maybe a half a step back and this year’s – our next year's earnings because I think over the next five years, this is going to a place where I can really make a big difference. For us to decide it could be two or three or four critical hires in the years that could be enough to really make a meaningful difference, if they're successful in the following year. So we'll continue to do that, I think we can be careful to make sure that the people that are here and put up numbers that they get paid. That's obviously something we are super mindful of. And so as we look at funding new organic growth, we'll just make sure that we're doing it judiciously so that the people that are being successful on this platform are being well compensated and well taken care of for essentially putting up good numbers.

[Justin Hughes:]

Okay, anyone has been an investor at Cowen had shown that they have the virtue of patience. So if you have to hire people now and wait 18 months to see the results I think that’s most calm shareholders.

[Jeffrey Solomon:]

Well, I appreciate that. And I would say you and I, we talked about this. They're very few people like you understand how long it actually takes. And obviously that's something that we know firsthand and appreciate that and we'll continue to do that because we're getting good results.

[Justin Hughes:]

Thanks.

[Jeffrey Solomon:]

Great, thanks Justin.

[Justin Hughes:]

Yes.

[Operator:]

Thank you. And I'm showing no further questions at this time. I'd like to turn the call back to Mr. Jeffrey Solomon for closing remarks.

[Jeffrey Solomon:]

Well, thanks operator. And thanks everybody for dialing in this morning. I know it's lengthy but we wanted to take the time to really lay out our strategy a little bit more. So we appreciate everybody’s patience and attention and we look forward to coming back to you next quarter with our results. Have a good day.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today's program. You may all disconnect. Everyone have a great day.