Cowen Inc.
Q4 2016 Earnings Call Transcript

Published: 16 Feb 2017

[Operator:]

Good morning ladies and gentlemen and thank you for joining Cowen Group Incorporated’s conference call to discuss financial results for the 2016 fourth quarter. By now, you should have received a copy of the company’s earnings release, which can be accessed at Cowen Group Incorporated’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 risks and uncertainties described in the company’s earnings release and other filings with the SEC. Cowen Group Incorporated has no obligation to update this 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. A 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 morning everyone. Welcome to Cowen’s fourth quarter and full year 2016 earnings call. With me today, as has been for many, many years, is Jeff Solomon, President of the firm, and Stephen Lasota, our CFO. 2016 saw major equity categories post positive gains in the fourth quarter and full year. I think we’re all acutely aware of that. Unfortunately, these positive market moves were disconnected from generally weak market appetite for equity financing, which resulted in the IPO market experiencing its worst year since 2003, which is partially reflected in our results. Equity commissions remain under pressure as active managers, both long-only and alternative strategies experienced one of their worst, if not the worst year for redemptions, while passive managers had one of their best years ever for inflows. Notwithstanding however, in 2016 each of our businesses actually performed well in spite of these headwinds. The investment management business continues to attract interest in its differentiated alpha-generating capabilities, and we added to our platform a number of unique strategies. Our investment banking and brokerage businesses both gained market share during the period in their respective markets. We reached the broader audience with our research and macro commentary products while maintaining our focus on providing in-depth insights and analysis on the issues that clients care about. The investment management business continues to attract interest in its differentiated alpha-generating capabilities despite challenging investment performance, and we actually raised and grew money during the year. But to be blunt, we turn out to be disappointed by the bottom line results of Cowen, so I want to put the numbers into context a little bit. Since 2010, our strategy has been to build a very diversified organization that delivers alpha-generating capabilities to its clients in investment management, investment banking, research and brokerage. The businesses and people that we’ve added over the years have been at its core about adding capabilities that contribute to this ability and consistency of our platform. I’ll parenthetically add here that while Cowen itself as a company is going to be 100 years old next year, our view is the Cowen that we’re responsible for is about seven years old, going back to when we merged it into Ramius in 2010. It’s taken a lot of redecorating to get Cowen to the place where it is today. 2016 was little different in that regard; however, the top line performance in investment banking and investment income was significant lower than 2015 and did not cover the expenses we incurred in ’16 to further build out and diversify our businesses, on top of some other, I would say abnormal events. As we have consistently said in our 2016 earnings calls, we made a conscious effort to invest into the business during 2016 and growing our platform through the slowdown in our core markets. Cowen benefited from the ongoing consolidation with the financial services industry, which is something we have consistently said we wanted to be a participant in. In 2016, we completed the acquisition of the credit products, credit trading, special situations, and emerging markets business from CRT. A few months later, the policy team from the Washington research group joined our platform. It didn’t actually get up and running until August 1, and we’re first starting to see the results of their work now, as did the merchant banking and investment banking teams from both Morgan Joseph and TriArtisan Partners which joined us, and several other important recruits in industries such as consumer, industrials, and financial sponsors. We also recruited new talent into the investment management platform and launched new strategies. Further, we also instituted an equity finance business which is literally up and running as of the first of the year, but expenses were incurred last year to get the people in place, the systems in place which will allow us to finance our Cowen prime services clients, capture margin debt balances and stock loans. So we’ve manned all those up, those are fairly substantial investments, so all told we invested $24 million in people and businesses that did not contribute revenue in any meaningful way to 2016’s results, while at the same time we were paring cost to reduce headcount in other non-productive areas. We made a decision to invest in these businesses and people as we see them playing an important role in diversifying our revenue in the future while bringing greater stability and consistency to our platform in 2017 and beyond. We believe that additional opportunities will continue to come our way, and with $1 billion in total capital we are well positioned to benefit from that ongoing consolidation. Lastly, let me mention that our balance sheet has not performed up to its historical standards, if you will, of what we’re capable of doing. A significant contributor to that was the April surprise that we got out of Treasury in Pfizer-Allergan, which we’ve covered, you know about. We ended up making all that money back and we were actually up for the year on our balance sheet, but not enough to get us to where we usually are. Some of the new strategies in the investment management business also had some difficult periods during the year. We’ve taken steps to shrink some of those strategies and our capital exposure to them, and tighten up some of the risk metrics that were surrounding our event-driven activities so that we can have a Pfizer-Allergan event again. For the full year, we reported economic income loss of $28.7 million or $1.07 per diluted share compared to economic income of $34.5 million or $1.19 per share last year. Total revenue was $467.6 million, which is a 12% decline from the prior year. For the fourth quarter of 2016, economic loss was $12.9 million or $0.48 per diluted share compared to economic income of $15.2 million or $0.54 last year. Total revenue in the fourth quarter was $128 million compared with $160 million in the prior year. Before turning the call over to Jeff, I just want to say that notwithstanding our results for the year, we’re actually pretty excited about the position we’re in and feel like the firm is in a stronger position than it’s ever been in before. With that, I’m going to turn this over to Jeff and let him cover topics around investment banking, and he can talk a little bit about the investment management business too.

[Jeffrey Solomon:]

Thanks Peter. In 2016, the alternative investment space continued to mature. Several hedge funds closed during the year and the pace of AUM growth slowed to about a 5.9% compound annual growth rate between 2014 and 2016, compared to an 8.1% compound annual growth rate between 2008 and 2014. So there’s no question that the maturing of the industry is certainly something that overhangs just about every alternative investment manager. [Indiscernible] about $28 billion in outflows during the fourth quarter in 2016. In contrast, excluding the reduction of assets associated with the sale of the alternative solutions business, our investment management business actually grew its total AUM by $774 million to $10.5 billion as of January 1, 2017. In 2016, we raised about $600 million for emerging strategies, and those include events, equity long-short, global macro, and distressed credit. The management fees for the alternative investment management segment averaged $5.5 million per month in fourth quarter of 2016 compared to $5.2 million in the quarter of 2015. Most of the reduction there is the result of a sale of Ramius alternative solutions. The average management fee per quarter was 62 basis points compared to 53 basis points in the prior year period, and as we mentioned, we expected to see a bump in the AUM--in the average management fee calculation because the Ramius alternative solutions business was a low fee paying business. In mergers arbitrage, we ended the year with a positive return and raised new assets during the year, and we’re continuing to market the strategy in a usage format in partnership with Bank of America Merrill Lynch, which is enabling us to expand the strategy’s global footprint. The healthcare royalty business continues to attract investors and expects to raise new funds in 2018. In our global macro offering, it’s positioned as a risk-mitigation strategy, which seems to be of interest to large asset allocators. The consumer focused long-short strategy we launched in 2016 secured a mandate for a managed account with a multi-strategy firm, and our newest facility at a Longshore equity fund, focused initially on communications, technology, media, and consumer, launched in the fourth quarter of 2016 and is performing well. Its initial investors have increased their allocations so far in 2017, and the team has been approved by top consultants and hedge fund investors. We are really putting together selling agreements in place with a number of top wire houses and are at work on selling agreements with additional parties as we continue to grow and scale the business. Real estate successfully completed its raise for a multi-family equity fund and is currently raising capital for its newest debt offering. At the end of the year, the principal owners of Starboard exercised their right to acquire an additional portion of our ownership in that business. So overall, it was a pretty productive year at Ramius, and we plan in 2017 to continue looking and developing our emerging strategies as we reposition the business to take advantage of the opportunities where we see fund flows. I want to thank everybody in the active management division for all of the work and the efforts that they’ve made. Obviously with some of the performance during the course of the year, really everybody did an amazing job to get a lot of these funds launched and to raise money in a very difficult environment. After a record year in 2015 for investment banking, the market environment in 2016 was a little bit different. We’ve talked about this over the course of the year, that the industry experienced really a muted capital raising environment with lower investment banking fees across the board, particularly in our areas of focus, which are primarily on the equity capital markets. As we mentioned, we’ve used that downturn to expand the business and invest in key areas as talented individuals and teams and businesses have become available to us. In the broker dealer, we spent nearly $19 million in new business initiatives to scale and diversify. That 19 is separate and apart from the acquisitions we made and really didn’t have any appreciable revenue attached to it for the year. So in investment banking, we really had an opportunity to focus in areas such as tech, consumer, industrials and healthcare. We also focused on adding some new M&A capability and tech, so overall we recruited over eight managing directors, including a new head of debt capital markets, a new financial sponsors team, and a brand-new consumer investment banking capability. We acquired the credit products and credit research, as we mentioned, from CRT, brought on the Washington policy research--Washington research group to do policy research, which has really turned out to be quite timely, and added the merchant banking team from Morgan Joseph TriArtisan. We also invested a bit in our electronic trading business and staffed the new equity finance business, as well as international prime brokerage unit. So point being, I think if you look at our results, it’s really important to understand that a lot of the results we had and the losses we incurred at the broker dealer are really investing forward to broaden the platform and create a more meaningful market opportunity for us to take advantage of some of the things we’re seeing over the longer term. While we still need to close on our backlog, I would say to you that this year, especially in investment banking, our backlog is the largest its been since we’ve been doing this, and we’re seeing the diversification both by industry as well as product type, so it remains very encouraging to see that the investments we made and the teams that we made not only brought transactions with them, but were able to initiate new transactions on our platform that should tee us up to have hopefully a much different 2017. To review 2016 in particular, I think it’s worth noting that proceeds raised for IPOs in the U.S. and our sectors was about $129 billion, which is a 32% decline from 2015 levels, and the healthcare sector, which as you know has been the real driver of equity capital markets not just at Cowen but across the board declined 58% during the same period. But even with the decline in healthcare, it was one of the two sectors, the other being energy, that were the most active in the capital markets, and I think we did pretty well in focusing in what was a difficult environment. The ECM business actually posted its third best year since 2009, and in healthcare, despite the year-over-year decline, we actually gained market share. For the year, we closed 76 transactions compared to 129 in the prior year period. In 2016, we were a book runner on 55% of those transactions, which is similar to what we did the prior year. As expected, 2016’s revenue mix was weighted much more towards follow-ons and IPOs, and continuous shelf offerings also emerged as an important avenue for clients to opportunistically raise equity capital in an uncertain environment. This is a business that we started about four years ago, and it’s really shown tremendous traction. Our debt capital markets was essentially flat year-over-year, and we’re very confident that with the DCM leadership in place and new senior bankers, that we align quite well, as well as the fixed income distribution capability from CRT. We are very optimistic on the outlook for this business as we look to expand our capabilities there. We think in doing so over the course of 2017, which is one of our biggest strategic initiatives, it will also grow our M&A business meaningfully, and we’ve chosen to do that organically. So our M&A business actually did grow year-over-year by about 11%. We closed 15 transactions compared to 13 a year ago, and we’ve shown pretty good improvement in both fees and sector contribution but it’s still small, so we made several new additions to our team to significantly deepen our M&A efforts. As I said earlier, we’ve entered the year with our strongest M&A backlog yet since we’ve been doing this. Turning to our institutional equities business, which includes equities, prime brokerage, services, as well as credit, research and trading, which we acquired this year, our brokerage business experienced year-over-year growth as it benefited from the full-year contribution of prime services, formed in 2015, and the contributions from the businesses acquired from CRT in May of 2016. The equities revenue, which includes cash equities, electronic trading, special situations, options and convertible trading, increased 7% in both the fourth quarter as well as the full year. According to latest market research, we again grew our market share even as the wallet for U.S. commissions showed a sequential year-over-year decline. We were one of the very few firms that actually took market share in the year, so it’s very impressive to see us be able to do that in a tough environment and really reaffirms the belief that the investments that we’re making actually are extremely relevant to the clients we serve. We broadened our coverage to include credit for the acquisition of CRT and have added the macro commentary, as we mentioned earlier. So at the end of the year, we covered 745 stocks plus 150 in our current research team. The macro policy area really targets a very different wallet than the one that we historically have done at Cowen. We think this is a really tremendous opportunity for us to leverage our distribution network by attracting revenues from people at our existing clients that generally haven’t been paying us, and already the early results we’re seeing from [indiscernible] accounts are encouraging, so hopefully we can get those translated into revenues early in 2017. In electronic trading, we made two important hires, which include the new head of trading services and the head of market structure, which is a new position we created. Our view is that the product road map will really incorporate market structure with these product enhancements, as well as customized solutions. Increasingly, this is a very important part of being able to access the wallet at the buy side, and we’ve already had a number of significant client wins in 2017. The prime services business continues to develop nicely as the bulge prime brokers have cut back their support of smaller hedge funds. The fee compression in hedge funds means that managers are really seeking different solutions from their prime brokers, and we’ve actually found that we can be an ideal partner for these managers. Our institutional brand adds a lot of credibility with clients, and our client base as it matures has increased access to Cowen resources, such as research, corporate access, and things that become more important as these clients scale. The pace of new client wins picked up following a summer lull, and customer assets were $7.2 billion at the end of the year, which is up 7% year-over-year. Now, that does include the natural attrition of accounts that we’ve either removed or the ones that have closed, but we are excited about the fact that our clients seem to be performing reasonably well in this kind of an environment. We also began on-boarding our first international prime brokerage clients, and that’s going to be an area for us that we think could be significant growth. Our credit platform performed very much in line with our expectations. We acquired the platform, as you know, in May of 2016, and we focused on distressed trading and emerging markets, as well as special situations equities and trade claims. With the credit platform under Cowen’s umbrella for nearly eight months, we generated 19% of the revenue in that organization from the client network, so it shows that taking the cross-selling capabilities and the cross-pollination of efforts, the cross-asset research and the collaboration is beginning to pay dividends, so really excited about the possibilities as we head into 2017. As we plan to further integrate those credit products into our distribution network, I expect we’ll see some significant improvement there as well. So I know that’s a lot to digest, so I’m going to turn the call over to Steve, who will walk you through our financials more specifically, and then I’ll be back to close it out.

[Stephen Lasota:]

Thank you, Jeff. In the fourth quarter of 2016, we reported a GAAP net loss attributable to common shareholders of $3.6 million, or a loss of $0.13 per diluted common share, compared to GAAP net income attributable to common shareholders of $28.9 million or $1.03 per diluted common share in the prior year period. Fourth quarter 2016 GAAP revenue was $122.3 million, compensation and benefit expense was $92.7 million, G&A and other expenses were $52.4 million, net gain on investments was $14.3 million, income tax benefit was $12.5 million, and income attributable to non-controlling interests was $9.4 million. For the full year 2016, we reported a GAAP net loss attributable to common shareholders of $26.1 million or a loss of $0.97 per diluted common share compared to GAAP net income attributable to common shareholders of $39.7 million or $1.37 per diluted common share in the prior year. Full year 2016 GAAP revenue was $471.6 million, comp and benefits expense was $310 million, G&A and other expenses were $198.7 million, net gain on investments was $23.4 million, income tax benefit was $19.1 million, and income attributable to non-controlling interests was $6.9 million for the year. 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, goodwill and intangible impairment, and preferred stock dividends. The remainder of my comments will be based on these non-GAAP financial measures. In the fourth quarter of 2016, the company reported economic income loss of $12.9 million or $0.48 per diluted share. This compares to an economic income of $15.2 million or $0.54 per diluted share in the prior year period. Fourth quarter 2016 economic income revenue was $128.1 million compared to $160.7 million in the prior year period. Investment banking revenue was $35.1 million compared to $36 million in the fourth quarter of ’15. Quarterly brokerage revenue rose 11% year-over-year to $53.6 million. Management fees were $17.3 million compared to $18.8 million from the prior year period. Incentive income was $7.1 million compared to a give-back of $462,000 in the prior year period. Investment income was $4.6 million compared to $43.5 million in the prior year period. Other revenue was $10.3 million compared to $14.7 million in the prior year period. For full year results, the company reported economic income loss of $28.7 million or $1.07 per diluted share as compared to economic income of $34.5 million or $1.19 per diluted share in the prior year period. Full year 2016 economic income revenue was $467.6 million compared to $529.7 million in the prior year. Investment banking revenue was $133.3 million compared to $222.8 million in ’15. Brokerage revenue was 29% higher year-over-year at $207 million. Management fees were $67.2 million compared to $70 million in the prior year. Incentive income was $26.3 million compared to a give-back of $1.5 million in the prior year. Investment income was $4 million compared to $62.6 million in the prior year, and other revenue was $29.8 million compared to $15.4 million in the prior year. Comp and benefit expense for the year was 64% of economic income revenue compared to 60% in the prior year. Variable non-comp expenses in 2016 were $61.2 million compared to $56.2 million in the prior year. The increase was primarily related to higher floor brokerage and trade execution costs due to higher brokerage revenue and increased marketing and business development expenses, most of which is related to acquisitions during late ’15 and during 2016. Fixed non-comp expenses, excluding depreciation and amortization, totaled $101 million in ’16 compared to $94.2 million in ’15. This increase was due to higher communication and increased occupancy costs, both of which are primarily related to acquisitions during late ’15 and 2016. Depreciation and amortization expense increased $1.5 million in ’16 to $11 million, and this is related to the acquisitions that we made. GAAP stockholders equity decreased by $14.9 million to $773 million at 12/31/16 from 12/31/15. Common equity, which is stockholders equity less the preferred stock, was $671.3 million compared to $688.7 million at December 31, 2015. Book value per share, which is common equity divided by shares outstanding, was $25.11 per share compared to $26.09 at December 31, 2015. Tangible book value per share, which is common equity less goodwill and intangible assets, was $21.88 per share compared to $22.90 at 12/31/15. Invested capital was $657 million as of December 31, 2016 versus $731 million a year ago. I’ll now turn the call back over to Jeff for closing remarks.

[Jeffrey Solomon:]

Thanks Steve. If you look at our history, the way we’ve grown the organization has been really quite methodical, and we’re certainly in a better position today to perform over the market cycle. I think a challenge that we face is always, how do we manage for quarterly results versus doing what we think is the right thing to do to grow the business over the long term? Our view is that if we can invest in and retain and attract really talented individuals to deliver really unique ideas to the clients that matter, that’s a winning strategy, and there’s some times when you’ve got opportunities to invest in those folks at times when the revenues are a little bit delayed, and that’s really the story for us in 2016. As we said in our third quarter call, it really does take courage to invest in times of market turmoil. While others are eliminating businesses and shrinking themselves, we’ve had the opportunity to actually grow top line, or grow our investments to drive our top line revenues for longer term growth. The fact that the markets we serve are cyclical in nature has not really deterred us in trying to create long-term shareholder value. We’re not where we want to be just yet. We’ve made good progress despite the bottom line results, but we are more confident in our ability to scale today than we have been at any other time. I think I want to echo Peter’s comments earlier - the existing results for 2016, I think don’t exactly show you the enthusiasm we have as we come into 2017. We’re fortunate that our strong capital position provides us with the flexibility to invest for the long term as we look to advance each of our businesses, and we’re taking the opportunity to do that across the platform on a very targeted basis as we look at the opportunities in investment management banking and research, as well as equities. We’ll continue to look for businesses that we think can add margin and scale, our fixed cost structure, which is really critical for us. But at the end of the day, it starts with hiring and retaining the best talent and driving our core businesses, and making sure that when we do platform synergies like the acquisitions we’ve made over the last few years, that they are accretive out of the gate, which is what they’ve been. So in a sense, as Peter mentioned, we’re seven years into really creating the network effect that we think is going to be the firm of the future, and 2017 is all about nurturing the investments we’ve made and harnessing our energy towards the areas we believe we can have the greatest impact. I just want to close by saying to everyone at Cowen who works so hard to make this place the best place to be on Wall Street, we just want to say thank you. Really, without the efforts of you on a daily basis, none of the efforts that really we would do at all matter. We have so much really more to do, and frankly we’re just getting started. So with that, I will turn it back to the Operator and we’ll open it up for questions.

[Operator:]

[Operator instructions] Our first question is from the line of Devin Ryan of JMP Securities. Your line is open.

[Devin Ryan:]

Okay, great. Good morning everyone.

[Jeffrey Solomon:]

Hi, Dev.

[Devin Ryan:]

Hi. So maybe just starting here, bigger picture, clearly a lot of headwinds in the backdrop in 2016. You guys kind of went through a number of those. But if we’re looking into 2017 and you make the assumption that the base case is maybe a more functioning capital markets backdrop and 2016 was more of an aberration, and maybe you start to see some contribution from all the recent hires that were expensive in ’16 so they’re contributing in ’17, how are you guys thinking about where operating margins should be? What are the targets, and how would you like to see in the trajectory for the ROE as well?

[Jeffrey Solomon:]

So I’ll take a first stab at the operating stuff and then we can tell you what we’re thinking about. Just to start from your first part of the question, when we talk about the growth initiatives we’ve made, I think the goal for us is to have more diverse revenue and be a little bit less dependent on ECM and the challenges and cyclicality of that business. I think I’ve said it on numerous occasions, the fact that we’re focused on healthcare is a wonderful thing because those companies in particular that we bank have to raise money regardless of market cycle, so it really does underpin a lot of what we’re doing. The fact that the rest of the ECM market outside of healthcare was so dismal last year, the fact that we still had a reasonably good year suggests that we picked the right industry to focus on, and we’ll continue to do that. I think you’ll see M&A be more meaningful, you’ll certainly see our business diversity pick up across sectors, just based on the way that the backlog looks. I think a lot of our margin growth depends on how we ultimately end up doing through investment income and investments on the balance sheet, so hedge fund performance was very difficult last year, and I think our investment income really--you know, notwithstanding some of the challenges and specific things that happened to our balance sheet, investment income should be a more meaningful contributor this year in an environment where there’s a lot less volatility, frankly, in the markets, given the fact that we don’t have an election cycle to worry about. So when we look long term, the investments for us--you know, this is still very much a high single digit margin business at the end of the day, and I don’t know that that’s going to change much. This is why we think scale is so critical and so important to us, and that’s why we’ve made acquisitions in the area where we can take out significant costs and add synergies. So long term, I would say our goal is to be double digit ROE. I think a lot of that is still going to depend on how certain of the businesses perform, but if we end up in a situation where hedge fund performance, and in particular the performance of our funds does well so that our balance sheet does well and we have incentive income, you’ll see it at the higher end of the margin range, and on a much higher ROE. If it turns out that that is sort of fair to mid-laying and the rest of the businesses kick in and we drive M&A volume and investment banking in other areas, I think you’ll see some margin expansion. If it turns out that that remains muted, we’re still in a position where we’ll be able to make sort of mid-single digit margins and the ROE will be a little bit lower. But our goal over the long haul is really to drive double-digit ROE on a consistent basis, and as Peter mentioned, it’s really critical for us to be able to drive investment performance on the balance sheet as well as incentive income of the asset manager.

[Peter Cohen:]

Devin, let me add some things here that won’t be easily obvious looking at the numbers. You know, we suffered during the entire election cycle with this very populous notion, and I’m not picking on Trump here, I’m picking on both candidates, or all candidates. One of the great themes was drug pricing and they kept harping on that, and that put a pall over the whole industry, the whole drug industry, which made it difficult to bring new companies to market. It had an adverse effect for sure on our merchant banking activities where we have a portfolio that’s not insubstantial in pre-IPO and some public biotech companies that we had financed as pre-IPO. That cost us some real money on the balance sheet. So you know, I think that that’s behind us now, and if you look at grappling with getting control of healthcare costs, one of the things this administration talks about is expediting the whole FDA process, that has to happen. That’s good for us. Something you will not be able to pick off from the numbers is there are variable non-comp costs related to executing our equity transactions. It was the lowest this year, or in ’16 that it’s ever been as a percentage of revenue, so we’re getting the economies of scale out of that. Another thing you won’t see is that if you had backed out, could back out all the fixed investment we made in other areas, whether it was CRT or getting the equity finance business up and running or the full-year effect of the prime services business, if you backed out those fixed expenses, non-comp expenses related to those, our fixed expenses actually went down during the year, so we’re starting to get leverage out of our cost structure. There are things that whether or not we have a tax bill this year or next year, there will certainly be things in a tax bill that will be very good for the M&A world, for the financing world. If they’re talking about lowering corporate--and they will lower the corporate tax rate, there will be some kind of tax holiday for repatriation of overseas liquidity, and that liquidity is not likely to get passed out in dividends because that’s what managements don’t like to do. They like to buy things, so I think that we’re in a much better position to participate in the M&A side, and certainly from the merger arbitrage side. I don’t want to leave anyone with the impression that our balance sheet is swinging around, doing things that aren’t related to our business. Our balance sheet is dedicated to our business, so the money that we have aligned with our merger arbitrage activities, where we took the hit in Pfizer-Allergan, is there to seed and grow that business, and it has grown. In spite of April’s performance, we actually grew merger arbitrage over the course of the year. We on-boarded a very talented woman named Samantha Greenberg in a long-short TMP consumer-based business, I would say from my limited experience over 48 years, the best risk manager I’ve ever come across, and we’ve seeded her with a fair amount of capital and she’s doing really well. She didn’t go live until late in the year. Everything we do with our capital is to grow AUM, or grow our business somewhere, so we do have a fair amount of capital committed to the merchant banking activities of the firm. We have new investment themes that we think we can build fairly robust, I would say customer assets around. It’s going to take some seeding using the firm’s capital. Real estate is an example where we are now--we just had our first close on our sixth debt fund. We’ve lent $4 billion over the last 22 years in mezz lending. Our sixth fund is going to be about half a billion dollar fund. We’ve closed on the first, I think 245 or $250 million. One of the things people always want to see is that our money is in there. You know, finally because our record is so good, the amount of money that we have to put in is substantially less. We used to put $25 million into those funds. Now, this fund, we’re probably only going to put $5 million in. You know, I just--take this for what it’s worth, don’t misread last year’s results as being indicative of the strength and depth and breadth of what this firm is capable of. From my vantage point--and look, I’m not happy with last year’s results, but we’ve never been in a stronger position, and all the new businesses we’ve started are really--you know, they’re not growing sprouts, they’re growing tentacles now, whether it’s the prime services business which is really starting to take off, and suffered last year with declines in volume and the volatility in the markets, or in our reinsurance business that we have in Luxembourg, which is now a real business and is profitable and growing, or this little business we started in the bespoke aircraft finance leasing business, special mission aircraft has tremendous potential, was profitable for the full year and will grow, I think, substantially during the year. So a lot of the seeds we planted are up through the ground now, and I’m pretty charged up. I’m very charged up about it. So there is a lot you can’t say that’s happened, and all I can say is don’t over-read what did happen.

[Devin Ryan:]

Okay. I appreciate you guys walking through all of that. Clearly a lot of things in the backdrop that you can’t control, and you hit on the commentary around drug pricing and maybe we’re moving into a better backdrop from the comments late last year. But how should we think about the timing, or what are you guys looking for to maybe give the signal that the window is reopening, because that just is such a big driver of business as we look over the next year here. You kind of need to see the equity issuance window reopen, so I’m curious what you guys are looking for, and I know that your corporate clients have a timeline around they have to raise at some point, but just what are you thinking about a timeline of them actually getting back out and being in the market?

[Jeffrey Solomon:]

So I think there’s a bunch of them that are already doing it. I know what the queue looks like and I know that there’s a wave of companies that will need to go public this year through the IPO, so I think we’re already starting to see that. I think everyone expected--maybe people expected 2015 to be repeatable. I didn’t. If I look at the business from healthcare, I think it’s a pretty stable business and it has upside potential from it, so as far as I’m concerned, that window continues to be productive. The thing that I would say we’ll see is in technology and a few other areas, consumer and a bunch, there’s more companies and we’re doing more board meetings in other areas for ECM than we’ve done all year last year, so I think people are queuing up to take advantage of where the equity markets are, for sure, so we’re seeing a lot of activity there. I do think, though, that for us, this is a year in which our M&A business should be in a position where it’s meaningfully different, and we haven’t really put players on the field to grow an M&A franchise. I think we talked about this over the years, we’ve resisted the temptation to buy M&A advisory firms for a lot of cultural reasons, so rather we’ve been hiring people organically, which is a longer and a tougher row to hoe, but it really preserves your cultural integrity. The people that we put on the field last year and this money that we spent last year investing in these other sectors is really to drive M&A activity and financing activity to be less dependent on healthcare, so to me, if I look at the backlog and opportunity, I just think we’re less dependent this year on some window reopening in a meaningful way because the backlog is more diverse in the industry and more diverse from product, meaning I expect there to be more M&A capability given the people that we put on the platform in the last year.

[Peter Cohen:]

One last thought from me before the next question, two nights ago SoftBank made this announcement, they were acquiring Fortress, and you can read about it in the paper today. That’s a pretty significant transaction, not because it’s SoftBank and Fortress, but it’s indicative of an appetite or a desire on the part of very liquid foreign institutions wanting a bigger window on the United States and a way to deploy capital into the United States. I think--I don’t know whether it’s three months or a year from now, but you will see more transactions like that occur, in my opinion, as this build-up of liquidity in Asia wants to find a more efficient way to get into the U.S. in a more focused way. I can tell you just from the inbound inquiries we get that the area of greatest interest on the part of people we speak to is in pharma, and people keep coming to us, how can we engage with you in expanding our pharma business into the U.S., what can we acquire, what can we bring back to Asia. So I think there’s going to be some very interesting things that will happen around the industry, and there are only really a limited number of places it can happen. It’s not going to be the big banks because they’re too complicated and there’s no coordination, and they all have their own presence over in Asia. Among the smaller and midsized banks, there’s a limitation because of cultural differences that probably are pretty profound. But we have a history of working very well with foreigners, having basically grown Ramius substantially in Japan, having had a presence in China, and I expect some good things likely to happen to us over the course of the next year or two with respect to that.

[Jeffrey Solomon:]

To Peter’s point here, we made a very conscious choice last year to invest in comp and non-comp in areas we knew would not generate revenues. I think if you look at our fourth quarter numbers, I think as we’ve highlighted, the compensation number in the fourth quarter reflects the fact that we made a conscious choice to do that. Others have made decisions to acquire franchises as a way to gain talent on the platform. While we’ve done that in certain areas, as it relates to investment banking and research and some of the things we’ve done, we’ve made a different decision which we think is one that over the longer term is less disruptive to the culture potentially and more collaborative. So what Peter is saying--

[Peter Cohen:]

And protects our capital.

[Jeffrey Solomon:]

Yeah. What Peter is saying, the inbound inquiries that we’re hearing from Asian investors and from pockets of capital is coming to us in large part because there is a significant amount of content in this organization that knows where to go to find transactions. We have been angling that content to date largely at two markets

[Devin Ryan:]

Got it. That’s great color. I really appreciate it, guys. I’ll hop back in the queue here, thank you.

[Operator:]

Thank you. As a reminder, if you have a question, please press star, one now. Our next question comes from Steven Chubak of Nomura. Your line is open.

[Steven Chubak:]

Hi, good morning.

[Jeffrey Solomon:]

Hi Steve.

[Steven Chubak:]

Jeff, I was hoping to get a little bit more insight into what you’re seeing in terms of the backlog. You noted that for as long as you’ve been tracking it, it appears to be at a record. The messaging around M&A clearly sounds quite constructive, but as you noted in one of your earlier comments, ECM has really been driving the bus for a while. As I look at the revenue trajectory, you had an IB revenue number that was north of 200, just a few--I guess just last year, and I’m just trying to think about given the decline of 40% we saw this year, could we get back to that record level? Is that how you’re thinking about it, given all the new investments that you’ve made, or is it going to really be a function of the mix?

[Jeffrey Solomon:]

So I would say first of all, I’m not expecting to get back to the record level because that was largely driven off probably the best biotech market in the history, so we’re not building this firm with the expectation that that’s going to be the new normal. We’ve invested in other areas where we see opportunities in ECM, and I will say that we have--you know, we’ve got better ECM backlog outside of healthcare than we’ve had in a long time, and that’s just indicative of the fact that there’s a cycle coming where people want to raise equity outside of healthcare, and we’re in position with people to take advantage of that in spots like consumer and industrials and in technology in particular. I think for me as it relates specifically to the backlog comment, M&A is such a vital part of the universe in sectors both in healthcare and outside of healthcare, and we have to be in a position where we put people on the table who actually understand how to drive M&A processes. So when I look at the backlog, if I take a look at a snapshot of the beginning of the year, we really only rolled backlog six months forward, and we do it only where we have mandates. So when I talk about the backlog, I’m talking about mandate in backlog six months forward at the beginning of each year, for the last six years. This is backlog that looks the best it’s ever looked by a multiple, and we will definitely not close on it all. By definition, you never close on 100% of it, but even if we come anywhere close to closing at the percentages we’ve historically closed on, it’s a very meaningful different number in terms of M&A and in terms of some of the other financings that we would be doing. So my optimism is based on the fact that I can see a very different product mix based on the people that we’ve hired over the course of the past year, and we’re going to be less dependent on having ECM or healthcare ECM in particular having the kind of year that it had in 2015 in order to drive margins in the business. I will also say this - that option always exists, so the fact that we were able to produce that kind of revenue on this platform suggests that if the market is there for that, the fact that we have all these clients, we are certainly in a position to capture that. If you look at what we did in 2015, I don’t think there was a deal that we didn’t do that we wanted to do. So for us, this is about making sure that we’re capturing the right kind of market share, and I don’t think there was a bank that captured more market share in healthcare ECM in 2015 than--or 2016, than we did. So I’m always looking at--I can’t really control what the markets will do, but what I can control is how well we attack those markets and are we in position to ensure that we capture the most of what we want to do, and even in a year like 2016, we did, certainly in healthcare. So I would say if it turns out that drug pricing policy is finally put to bed and people stop talking about it, and capital flows back into that business, there will be no shortage of companies that we see want to access that market. The new drug applications coming over the next four years are going to be intense, and these companies really want more than ever to be able to be independent longer, to develop commercial strategies longer before they sell, and so I think there could be--there’s upside optionality to the number we did in 2015, just by virtue of the fact that we were able to do what we did in an environment that had a massive political overhang and a drug pricing debate policy, and one in which we took share. So I’m not counting on it, like in other words, it’s not going to be central to our strategy, but upside potential from what we did in 2015 is certainly there if the markets come around.

[Steven Chubak:]

Got it. Thinking about the capital management priorities, you guys noted a number of opportunities to invest and where you wanted to maybe enhance your capabilities. How are you trying to balance share repurchase and maybe even inorganic growth pursuits and other acquisitions? Just trying to get a sense as to how you guys are focused on looking to grow, where you’re deploying all of your additional capital going forward, or how it’s being allocated.

[Jeffrey Solomon:]

So let me start by saying I think we’ve slowed down the stock purchases, and part of that is because we’ve recognized we have more ways to put our capital to work in businesses that are more capital intensive. Our job is to be able to drive margins in the business, and the easiest way for us to drive margins in the business, frankly, in the short term is to put our capital to work, make money on that capital, because that’s the highest margin business. The compensation ratios on investment income are the lowest at the firm versus, let’s say, ECM and equity commissions are probably the highest at the firm. So when you’re--you know, if you could put money to work off the back of your distribution network and your origination network in a way that doesn’t risk the firm’s balance sheet meaningfully, that drives margins pretty significantly. We are only levered--if you take a look at our balance sheet and you strip out some of the fund consolidation that has to happen, we’re levered two to one, which is really low. We do that because we’re conservative and we want to make sure that we have a solid balance sheet so that we don’t ever get ourselves in a situation where people are concerned, or our employees are concerned. I think that’s been a huge benefit to us in terms of being able to attract and retain talent, is that we have a stable balance sheet and a stable platform. Growing into the equity finance business, it’s an area where we can continue to again leverage off our fixed cost structure and put capital to work, so we would defer--we are opting to do things like that and really drive the return on the balance sheet more so than stock buybacks. With stock buybacks, you get a short term bump in that, but you sacrifice your ability to effectively drive margin in the business with some of the more obvious spots. I would say we continue to look at leveraged finance as an area for us to expand, and certainly given our origination capabilities, it’s an untapped opportunity for us to put some capital to work in areas where we can really drive the debt capital markets business more meaningfully. Again, we’ll do that in a very conservative way and in a way that really leverages our capital base, but it requires us to have capital. Then finally, I would say as we have a new head of asset management and as we begin to look at the strategies that we’re deploying in asset management, there will be chances for us to either acquire or launch new products that will require us to essentially put capital to work in those businesses, so as we look to drive margin, I think capital utilization is really critical to that, and we are opting to do that more so than maybe buying back stock in an environment where we really feel like we need to drive margins through the use of capital.

[Steven Chubak:]

Thinking about that margin focus that you just outlined, Jeff, I know you made some earlier comments around the pre-tax margin trajectory. Just want to get a sense as to what comp target we should be thinking about in a better revenue backdrop where there’s still this need to continue to fund some new investments. I know you had talked about low 60s in the past. Is that a reasonable expectation for this coming year, or could we see even more comp leverage than that?

[Jeffrey Solomon:]

So you know, we got down to below 60s when we have strong balance sheet years. I think really the difference between low 60s and high 50s is largely how well we do on the balance sheet, again because you can see it really shows through in terms of the contribution margin of investment income. We’re still targeting that area. I think it’s really critical for us to make sure--and we communicate this internally, really critical for us to be able to be around that area long term. Obviously this year, the broker dealer segment was much more significant because we made these investments in individuals who didn’t drive any revenue. I feel like it’s very, again, a conscious decision, so I think we’re not looking at making organic investments the size and the scale of what we made in 2016 in 2017. Now, it’s not like we didn’t reposition and take costs out - we continue to do that, but I think as we look at our business, as an overall firm to be in the low 60s, if we do better on the balance sheet I would say probably decreasing into the high 50s, that’s kind of the range. If it lags a little bit, I could see it moving a little bit higher into maybe the mid 60s, but I don’t see it being much higher than that long term because that’s just not a place where we want to be.

[Steven Chubak:]

Got it. Just one question relating to your tax policy changes. Looking at the balance sheet, the DTA still comprises a pretty substantial portion of your overall book value - I think it’s around 20%. There’s been some discussion around possible write-downs in the event we do see a reduction in the U.S. rate. Don’t know if you guys could give us some numbers or put some numbers behind it in terms of what the potential write-down could be if we see maybe a 10% reduction in the U.S. corporate tax rate.

[Stephen Lasota:]

So if the rate goes down to 25%, it would be about a $35 million adjustment. If it goes down to 20%, it’s about a $50 million adjustment.

[Steven Chubak:]

Perfect. That’s it for me. Thanks for taking my questions.

[Jeffrey Solomon:]

Great, thanks Steve.

[Operator:]

Thank you, and that concludes our Q&A session for today. I’d like to turn the call back over to management for any further remarks.

[Peter Cohen:]

Well, I think we’ve said it all. Again, we’re disappointed, but at the same time we feel very good about where we are, so we look forward to speaking to you after the first quarter and hope we can demonstrate that a lot of the things we’ve talked about are starting to bear fruit.

[Jeffrey Solomon:]

Thank you, everybody.

[Operator:]

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