Cowen Inc.
Q1 2015 Earnings Call Transcript

Published: 3 May 2015

[Operator:]

Good morning, ladies and gentlemen, and thank you for joining Cowen Group, Incorporated's Conference Call to discuss the financial results for the 2015 First 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 the risks and uncertainties described in the company’s earnings release and other filings with the SEC. Cowen Group, Incorporated has no obligation to update the information presented on the call. A more complete description of these and other risks and uncertainties and assumptions is included in the company’s filings with the SEC, which are available on the company’s website and on the SEC website at www.sec.gov. Also, on today’s call, our speakers will reference certain non-GAAP financial measures, which the company believes will provide useful information for investors. Reconciliation of these measures to GAAP is consistent with the company’s reconciliation as presented in today’s earnings release. Now I’d like to turn the call over to Mr. Peter Cohen, Chairman and Chief Executive Officer.

[Peter Cohen:]

Thank you, operator. Good morning and welcome to Cowen's first quarter earnings call. With me are Jeff Solomon, President of Cowen Group; and Steve Lasota, CFO of Cowen Group. This morning, Cowen Group reported strongest first quarter since the Cowen/Ramius business combination in terms of revenue and economic income. Economic income revenue was $162 million, a 46% increase from the first quarter of 2014; economic income was $24 million or $0.20 per diluted share compared to $10 million or $0.08 per diluted share in the prior year period. The capital raising environment was favorable in the first quarter and the segments we bank, and it was especially robust in the areas such as healthcare. Conversely, the overall market volumes for equity trading remain challenging. Nevertheless, our equities business performed solidly and was up year-over-year. In our asset management business our funds generally perform well and we have continued to attract more assets under management. Even as our business delivered strong operating results, we continue investing and optimize our operating businesses and capital base to help ensure we are in the best possible position to generate attractive, long term returns for our shareholders. We believe our strong balance sheet and the solid capital position distinguishes us from our well-capitalized peers. With $902 million in total capitalization, we believe we have the ability to evolve in ways that are difficult to replicate while we insulate the organization against economic adversity. We have a very robust operating platform that can support both accretive acquisitions and organic growth opportunities to meet our primary mission of delivering consistent alpha capabilities for all our clients. Finally, as always, I want to thank all of our colleagues for making our first quarter 2015 as strong as it was; without their help, it would have never happened. And we love the culture of the firm and we’re proud of [ph] everybody in it. I will now turn the call over to Jeff, who will review our individual business units. Jeff?

[Jeff Solomon:]

Thanks, Peter. I’ll begin with a review of Ramius. In recent years, we’ve developed an institutional quality for our products and sophisticated distribution capabilities for our differentiated alpha generating strategies. As one of the key platforms operating those strategies across a number of products, we have experienced strong investor demand across the variety of distribution channels for the products we offer. This interest, again, was reflected in the first quarter of 2015 where assets under management increased by $362 million. We ended the quarter with $12.8 billion on assets under management. To give some additional color on our established investment strategies, our hedge fund strategies including activist strategy and the event-driven products, we see positive inflows from a combination of new and existing mandates. Real estate strategies also saw an increase in assets under management as we close on a new product. The Ramius Alternative Solutions business benefited from increased mandates by 50 clients and we’ve been working with our partners at State Street Global Advisors as they ramp-up their marketing efforts for the State Street Ramius managed future strategy where assets under management have grown significantly since we ended our partnership with them in 2014. Management fees grew 18% in the quarter primarily due to increases in AUM and activist and healthcare royalty business. The average management fee in the first quarter was -- of 2015 was 53 basis points compared to 55 basis points for the full year of 2015. Incentive fee saw a strong year-over-year growth due to performance in both the activist and Ramius Alternative Solutions businesses. And now for an update on our new investment strategy, we continue to focus on our fundamental global macro strategy that we announced last fall and currently expect to see close this quarter. During the quarter, a large public plan announced its intention to invest an initial amount of $50 million in new fundamental global macro strategy. This one is an important validation of our efforts to scale this new capability. During the remainder of 2015, we are planning new product launches from the established investment strategies on our platform as we look to scale our capabilities in the various fusion channels we have developed. We also planned to continue broadening our platform of capabilities by developing new partnerships in products with talented teams, both the merging and mature. To that end, we have signed a memorandum of understanding with another strategy team with respect to a product we expect both will stay in our platform significantly. We’ll also announce initial details of this in the coming months. As we’ve mentioned in the past, we meet with a large number of managers in order to find the right teams with the right strategies that we think can meaningfully scale in our platform. We continue to see an increasing amount of talented individuals and teams who are desirous of joining an institutional quality platform with a strong brand identity in the marketplace. We are quite excited by the potential and the teams that we have identified thus far. Their success over the long term will play an important role on our future growth, however, near term revenue contribution from these teams will be modest as their businesses scale. We remain confident that we can continue to invest, going forward, with emerging managers even as we grow our more mature strategies. Now turning to Cowen and Company. We had a solid operating performance in both investment banking and brokerage as we continue to provide alpha generating capabilities in research sales and trading, as well as in banking and capital markets. New issuance, during the first quarter of 2015, was as decidedly less skewed towards follow-on offerings rather than IPOs. For the industry as a whole, there were 38 IPOs in the United States raising $6.4 billion which is considerably less than the prior year period which was 73 IPOs and raising $12.7 billion. Conversely, there were 262 follow on offerings in the first quarter of 2015 representing total proceeds of $74.7 billion compared to 233 in the first quarter of 2014 for $43.7 billion. Mirroring the market trend healthcare experienced a significant pickup in follow-on activity. There were 107 healthcare follow-ons in the quarter which was up 49% over the prior year period. Proceeds raised were up over 160% year-over-year. As an active participant in the new issuance calendar our banking and capital markets business were quite robust in the first quarter. At Cowen, we participated in 47 equity transactions in the first quarter of 2015 compared to 41 in the prior year period. Similar to the market’s overall trend, the majority of the transaction we completed were follow-ons and healthcare related. Our average fee per transaction was up 16% year-over-year. In addition to serving the corporate banking ease of our clients were also generating positive alpha provides their clients through our capital markets activities and many of our capital markets activities have actually outperformed the market. In the DCM market, we closed on one transaction, and our strategic advisory business closed two transactions during the quarter. Our equities business performed well and will continue to be challenging volume environment overall. In the quarter, equity market volumes in the United States were down 3% year-over-year. However, our brokerage revenue was up 3% year-over-year underscoring our ability to improve our value with commission paying clients despite the decline in volumes. Contributing to the overall growth in our equities business with continued growth in our electronic revenue and improvements in our options business. We believe our [inaudible] as our focus on high quality of the generating equity research product and we have shown significant improvement in our ability to deliver that product which measurably helped clients make better investment decision. The latest market research shows that we gain market share with both hedge fund and long-only clients and our largest gains remain with the top commission paying clients where we have focused our energy and efforts over the past few years. We continue to look for ways to innovate our product and make it more relevant as we gear specifically to the needs of active managers. I will now turn the call over to Steve Lasota who will review our financials. Steve?

[Steve Lasota:]

Thank you, Jeff. In the first quarter of 2015, we reported GAAP net income of $16.7 million or $0.14 per diluted common share compared to GAAP net income of $9.8 million or $0.08 per diluted common share in the prior year period. In addition to our GAAP results, management utilizes non-GAAP financial measures, which we term as economic income to analyze our core operating segment’s performance. We believe economic income provides a more accurate view of the operating businesses by excluding the impact of accounting rules that require us to consolidate certain of our funds, certain other acquisition related expenses, reorganization expenses and taxes, and goodwill and intangible impairments. As a reminder, with the release of our deferred tax valuation allowance in the fourth quarter of 2014, our GAAP results going forward reflect an increase in income tax expense. However, given the size of our deferred tax asset, we do not expect to be a cash tax payer for several years. As we mentioned a moment ago, economic income excludes the impact of taxes. The remainder of my comments will be based on these non-GAAP financial measures. In the first quarter of 2015, the company reported economic income of $23.6 million or $0.20 per diluted share. This compares to economic income of $10 million or $0.08 per diluted share in the prior year period. First quarter of 2015 economic income revenues were $161.7 million compared to $110.6 million in the prior year period. Investment banking revenue was $65.2 million, up 32% year-over-year from $49.6 million. Brokerage revenue rose 3% year-over-year to $35.5 million. Management fees were $16.6 million versus $14.1 million in the prior year period; incentive income was $15.4 million compared to $4.6 million in the prior year period. We generated $28.9 million in investment income compared to $8.2 million in the prior year. Comp and benefits expense was 59% of economic income revenue compared to 61% in the prior year period. Variable non-comp expenses were up 38% year-over-year $15.2 million, this increase in variable non-comps is attributed to an increase in client services, business development and other expenses. Fixed non-comp expenses were up 11% year-over-year to $25 million. The increase was primarily due to higher legal and other professional fees and an increase in cost from equity method investments. Stockholders' equity increased by $158 million from March 31, 2014 to $690 million at March 31, 2015, which was primarily related to the release of the valuation allowance against deferred tax assets in the fourth quarter of 2014. As of March 31, book value per share was $6.21 per share; invested capital stood at $614 million as of March 31. Finally, moving to our share repurchase program. In the first quarter, we repurchased approximately 1.4 million shares in the open market and 530,000 shares as a result of net share settlement related to the vesting of equity awards at an average price of $5.28 per share and a total cost of roughly $10 million. As of March 31, $17.8 million remained available under our share repurchase program. Since we announced our original repurchase program in July of 2011 we have repurchased 19 million shares in the open market and additional 5.9 million shares as a result of net share settlement related for the vesting of equity awards. The total cost of all buybacks to the first quarter of 2015 was $87.9 million which represents an average price of $3.53 per share. I will now turn it over to Jeff for closing remarks.

[Jeff Solomon:]

Thank you, Steve. As Peter mentioned earlier, we’re in a strong capital position and well-equipped to adapt to the changes in market conditions. As we consider our outlook, we see the U.S. macroeconomic environment is uncertain. Interest rates in global currency political issues are among the things that we consider when we look at new businesses and they may inject period of volatility into the markets over the course of the remainder of the year. We have all seen what short term volatility can do to markets, but in the wake of such pull backs we believe there is great opportunity for organizations with staying power. Our goal has always been the one of those firms created -- has created a focused platform that will perform well over an extended cycle regardless of market condition. Our banking and capital markets businesses, which we know can be cyclical in nature, are focused on key sectors of the U.S. economy that we believe exhibit characteristics of sustainable growth over the next decade. And our asset management business offers a broad range of differentiated investment capabilities that we believe are highly relevant in the current environment and should prove helpful if current market conditions change. Before we take questions, I just want to echo what Peter said earlier. The efforts of our colleagues and our outstanding efforts in the past quarter cannot be overstated. They all did an amazing job of making a positive difference in the lives of our clients and in the lives of each other. I’d now like to open up the call to questions. Operator?

[Operator:]

[Operator Instructions]. Our first question comes from the line of Mike Adams from Sandler O'Neill. Your question please. Mike Adams, you might have your phone on mute.

[Mike Adams:]

Congratulations, guys, really a standout first quarter. So first, just in-light of the impressive investment banking results in the first quarter, I'm curious, were there any sectors that outperformed other than healthcare? I’m just trying to figure out if there are any other verticals that could maybe boo your performance if there is a slowdown in healthcare?

[Jeff Solomon:]

Well I think healthcare was a large part of the story for the first quarter as it was for almost -- well for the entire industry. I mean if you look at the number of equity offerings across the board in other sectors they were down pretty remarkably, across the board it’s about every sector other than healthcare. What I can tell you is that our backlog going forward for opportunities outside of healthcare is pretty strong and certainly in both equity capital markets transaction, debt capital market transaction, as well as M&A which we’re starting to get pick up in some of our businesses there, almost all of those are inclusive of our strong -- inclusive of healthcare. So, I think we continue to see the same kind of dynamics and we’re certainly seeing that the backlog is beyond just healthcare.

[Mike Adams:]

Got it. So I'm glad you touched on healthcare there at the end. So, just in light of the recent correction, you are saying that clients aren’t really getting more cautious with the pickup in market volatility so the pipeline remains in place for healthcare?

[Jeff Solomon:]

It remains strong; we've had a pretty strong April.

[Mike Adams:]

Okay.

[Jeff Solomon:]

The deals we -- that we’ve done are public record, so I think it’s pretty easy to check on that. I'm not saying that it will be the that the entire quarter will be the same as the first quarter but the demand that we’re seeing for the deals that we’re doing remains pretty strong. I think, again, as always, in type of the high quality companies and we’re being extremely selective with the kind of companies we bring so that we end up in a situation we are successful, complete the transactions which is actually all that matters.

[Mike Adams:]

Right, okay. And you’ve been very consistent for several quarters now, several years, that you’ll be buying back stock once below tangible book value. Now you’re finally in a position where the shares are trading right around tangible book. Could you update us on the capital return policy, should we expect you to continue to remain active with the buyback?

[Peter Cohen:]

This is Peter. I think it’s going to be a function of the stock price. In and around here based on how we see the future, we’re probably going to be selectively continuing the buyback. What we’re very, very careful and conscious of is not no spending cash over our real tangible book value and husbanding our capital resources. So, I mean if the stock performs we’ll probably be out of the market and if the stock is around here or low we’re going to probably continue to be in there.

[Mike Adams:]

Okay, understood. Thanks, Peter. And last one from me. In terms of the commission revenue in the quarter, Jeff, I think you mentioned that you continue to pick up market share with a number of top paying clients, but in some of the commentary the printed commentary you mentioned that I think there was compression on the average commission, just trying to better understand what's driving the average commission down?

[Jeff Solomon:]

I don’t think I mentioned that; I don’t think there is compression on average commission. I think it’s been pretty steady.

[Peter Cohen:]

I think its volume compressing.

[Jeff Solomon:]

I would say, what we’re I think -- we are seeing in our business mix more people choosing to do business in electronics. And so by definition when you’re growing your electronics business I think you can see that the average cost per share will come down simply because electronic commission is less expensive. So I would expect that trend to continue for us, but I mean we take a look at our clients in holistically and we have ideas of how much they should be paying us in aggregate dollars. We’re agnostic frankly in all the pass as long as they’re paying us commensurate with what the -- with the resources we’re commissioning or commissioning them for so. I don’t really look that execution cost per share as a metric that we manage to.

[Mike Adams:]

Okay, makes sense. Thank you. Congrats again.

[Operator:]

[Operator Instructions]. Our next question comes from the line of Doug Doucette from KBW. Your question please.

[Doug Doucette:]

So just noticed the little sequential dip on -- in the brokerage line despite the strong actively underwriting quarter, and I know those are links. So I was just wondering if there is something else driving that line or is it just sort of the decline in overall market volumes?

[Jeff Solomon:]

So we closed our securities lending business at the beginning of this year. So when you look at year-over-year comparables there is probably about I would say $6 million, $6.5 million of revenue that were -- that’s attached to that securities lending business that is no longer at -- in the brokerage line.

[Doug Doucette:]

Okay. And that makes sense. I think that’s it from me. Thanks, guys.

[Operator:]

Thank you. [Operator Instructions]. And our next question is a follow-up from the line of Mike Adams from Sandler O'Neill. Your question, please.

[Mike Adams:]

Hope you guys didn’t miss me. So, just following up on that, Jeff, what are the costs connected to that sec lending business? I'm assuming its maybe like a break even.

[Jeff Solomon:]

I think the issue for us is we’re starting to look a lot more carefully at return on equity, and that’s a business that requires a capital deployment in order to have counter parties. And when you just look at the return on equity in that business on a net basis relative to where we could deploy that capital elsewhere it less costs, it’s just take sense for us not to be in that business. I think these are the things that we think about now that the business is upscale. I think in years past, we were looking at ways to scale businesses and scale revenues to sort of cover our fixed cost. And listen, the securities lending business is not a bad business, it’s just we have other things to do with the capital that are more efficient, and we continue to look at ROE as a metric to drive shareholder value and that one just didn’t make the cut.

[Mike Adams:]

Got it. Okay. And then looking at Ramius solid asset growth, do you mind breaking that down between flows and performance that I didn’t catch it in the release?

[Jeff Solomon:]

Yes, let us get it for you -- wait just a minute.

[Mike Adams:]

And then while you guys are digging for that one, last one I promise, is on some of the non-comp lines here, fixed non-comps specifically, up a few million bucks year-over-year, I think you highlight something like legal and professional fees, where should we expect that over the balance of the year; what is the run rate?

[Peter Cohen:]

I think lower than the first quarter. The first quarter is -- tends to be loaded by -- we have a lot of comps in the first quarter for those expenses that are in there and, frankly, we spend a little bit more than we anticipated on the conferences. If we have this exit charge in the quarter related to litigation and I think I should -- you should not expect that kind of increase in the fixed non-comps on a go forward basis for the year.

[Mike Adams:]

Okay, great. So these are more in-line with the run rate we saw last year?

[Peter Cohen:]

Yes.

[Jeff Solomon:]

Yes, I mean, there were two other factors I would say are more than that. First of all, we had a couple of busted deals that where we wrote-off that expenses associated with those. Those are legal cost, I don’t think that that’s there -- I have nothing else that looks that way. And then that going forward -- and then certainly with the volume of deals that we did in the first quarter they are just expenses associated with managing those deals, some of the subscription that we have that are specifically tied to the use and utilization of software when you’re doing a number of deals you’re doing were higher. So, I view the increase in variable cost it's very much mentioned with the fact that we’re driving more revenues.

[Mike Adams:]

Without question, I don’t think anyone is complaining about a 46% increase in net revenue. And Steve, did you have any chance on those flow numbers?

[Steve Lasota:]

Yes, actually, so the flow was the $362 million were inflows. We had for positive performance, but we also had in FX loss that basically took away a lot of that performance. So the performance came in different funds but in one of our funds we did have an FX, an FX loss that took that performance away.

[Peter Cohen:]

So basically, it's all new money.

[Steve Lasota:]

Yes.

[Mike Adams:]

Just like an accounting translation loss as you bring back to dollar?

[Steve Lasota:]

Correct.

[Mike Adams:]

Okay. Great. Thank you, guys.

[Operator:]

[Operator Instructions]. And our next question comes from the line of Keith Rosenbloom from Cruiser Capital. Your question, please.

[Keith Rosenbloom:]

Hi guys, great progress, just really impressive to watch it. Quick question first a clarification, your book value of $6.21 that includes no value attributable to your star board interests, is that correct?

[Steve Lasota:]

We do not mark our management companies to market; we'll -- it just includes our investment in that, in those companies.

[Jeff Solomon:]

At cost.

[Steve Lasota:]

At cost, correct.

[Peter Cohen:]

Cost, yes.

[Keith Rosenbloom:]

So to value at cost.

[Steve Lasota:]

Correct.

[Peter Cohen:]

Yes.

[Keith Rosenbloom:]

Okay. And on the share repurchase, can you give us a flavor for the pace that which you see your repurchasing stock? You still have some opened some availability as you talked about in the press release on the share repurchase program.

[Peter Cohen:]

Well again, it’s going to be a function of the market, but let’s say putting that aside we certainly want to buy back as much stock as best for compensations during a quarter. In this quarter, we bought back about 300,000 shares in net settlement. We’re actually going to be buying back more 350,000. 1.4 million we bought in the open market; we’ll be buying back more in stock in the second quarter from vesting, net settling for pay the taxes for everybody. And again, it depends on what our view of kind of where book value is going, it’s going to guide just how aggressive we’ll be in buying back stock.

[Keith Rosenbloom:]

Okay. Thanks a lot guys. I appreciate it.

[Operator:]

Thank you. This does conclude the question and answer session of today’s program. I’d like to hand the program back to management for any further remarks.

[Peter Cohen:]

Well ladies and gentlemen, thank you very much for dialing in this morning. We’re quite pleased with the results of the quarter, but of course what we did is we just raised the bar for ourselves and I would say that the pace, the frenetic pace of this place has accelerated because everyone now see is what kind of leverage we have in the operating side of the Cowen Group pieces, and this is a very charged up place. If the environment cooperates we hope that this portends well for the future, one that I really can say.

[Jeff Solomon:]

Thanks everybody.

[Operator:]

Thank you, ladies and gentlemen, for you participation in today’s conference. This does conclude the program. You may now disconnect. Good day.