BGC Group, Inc. (BGC) Earnings Call Transcript
February 14, 2023
Earnings Call Speaker Segments
Good afternoon, everyone, and welcome to the 24th Annual Credit Suisse Financial Services Forum. This is Gautam Sawant, Credit Suisse's Equity Analyst covering the U.S. exchanges, and it is my pleasure to introduce Howard Lutnick, Chairman and CEO of BGC Partners. BGC facilitates trading in fixed income, derivatives, foreign exchange and equities through its electronic platforms and inter-dealer broker. Howard, thank you for joining us.
Thanks, Gautam.
First, can you begin by highlighting some of the macroeconomic factors that you're excited for in 2023?
Sure. So 0 interest rates were a very, very difficult raw material for us. I mean if you imagine we're in the volume business and interest rates went to 0 in 2008 and pretty much stayed in and around 0 for 14 years, I mean that is just a tough market environment. I'll give you some statistics. Issuance used to be very positively correlated to trading volume, right? So think about issuance and Credit was up 2.75x from 2008 to 2021 and volumes halved. Treasury volumes 5x the issuance, volume flat, whereas previously, if volumes doubled -- if issuance doubled, trading volumes grow 66%. So you had this weird world of compressed interest rates, which deeply constrained trading volume. Obviously, you have the Treasury and the Fed buying all the volume, obviously, they're not doing anything. So that period has ended. And so 2023 is the beginning of the next cycle of trading volume. So we are seeing fantastic underlying fundamentals to our business. And I think what's going to happen is the difference of BGC from 2008 to 2014 was in that weird 0 interest rate world, you're now back to the regular world. And you're going to see BGC become a beautiful growth company going forward. So we are really, really excited about 2023 and beyond. I think you're going to see volumes grow. I think you're going to see our revenues grow. You can see our profits grow. It's just going to be fun to be BGC for the first time more than a decade. So that's kind of tough. But at least we're in the good times now.
Yes. So as you think about the fundamentals of the core voice in Hybrid business, can you speak to tailwinds that could improve broker production in 2023?
Sure. So if you think about it, we had 0 interest rates for a long time. So you had short-term rates in the United States. What's that to trade, right? Now, you're going to see rates volumes dramatically grow and volatility doesn't really matter. Because what happens is the cycle will go like this, there will always be peaks and troughs. But the graph is just going to go higher and higher and higher and up we're going to go. So I think broker production is going to go steadily higher for the next decade. And I mean this is -- we had a long period behind us and now we have a long period in front of us. So broker production is going to be better. Volumes are going to be better. You're going to watch the banks. Their sales and trading businesses are going to do beautifully well because for the last 10 years, they've been trading making money. Now they're going to be selling and making money, right? So now they can sell and trade to make money. And when your clients do well, it's much better for us. So we're going to do better. Brokerage is going to do better. Our broker production is going to do better. The whole thing is going to become a growth company going forward. And this is the beginning of that period right now. So we're really excited about that. Past is the past. And now we're going to the future.
So maybe expanding on why interest rates are important for BGC. What's the revenue contribution from this business? And what is your perspective on inflation and where that could settle or maybe where it could drive Rates to settle over the next 12 months?
All right. So on rates, this -- my opinion is that -- I'm 61. So I remember rates. You're a young gentleman. So you don't remember rates, but Rates stuck with us for a long time. So my view is the Fed gets to 5%, holds at 5%, and holds at 5%, unless the concept of a month ago, they were thinking rates get cut twice this year. I don't buy it. Rates get cut once this year; I don't buy it. Rates get cut next year, I don't buy it. I think the Fed just holds steady, and we get to 5% rates. We see the 10-year continue to drift higher, right, as it's been drifting now and drift higher and higher. And I think again crossed us 4% into the low 4s. That's my perspective. And then interest rates for us is the raw material in which we play, right? As we discussed just before, the ratio and the correlation between issuance and trading loan, it's got to be there. How could it not be there? How could -- if I issue 5x more Treasuries, how could we not trade more? And the answer we both knew was, well, the Fed buys them all, where's the fun in that? There is little trading in it. So as the Fed issues, just regular Treasury Notes. And the Federal Reserve -- the U.S. Treasury issues Treasury Notes and the Federal Reserve doesn't buy them. All of a sudden, you have volume growing. You have mortgages being issued, where the buyers hedge them like normal, sell Treasuries, buy mortgages and then that becomes the velocity of money and that trading happens. So you're going to see the beautiful return of the positive correlation between issuance and volume. And as I talked about in Credit, if issuance was up 2.75x and volumes were 0.5, volumes go to 0.6, still terrible statistic. That's a 20% growth in overall Credit trading volumes, and BGC has the largest Credit platform in the wholesale markets. So I think you will see natural growth. And then our margins when we produce $1 more of revenue in our Voice brokerage business, we generate at least 30% to the bottom line. So you have margins of north of 30% in our Voice business when it grows. In our Fully Electronic business and our Fenics business, you have margins north of 50%. So growth business, north of 30%, growth business north of 50%, you're going to see really beautiful statistics. And I think you're going to see a re-rating of this company as people realize the past was not about the company. It was about the market the company was in, and that market has violently and fundamentally changed and not a secret -- it's not a secret, everybody knows we have rates now and everybody should start to remember that with rates comes trading volume.
That's a good segue into FMX. Can you walk us through the Futures Exchange and Fenics U.S. Treasury opportunity?
Sure. So the history was we built the best electronic trading market in U.S. Treasuries. We sold it to NASDAQ in 2013 when I thought rates were going to be 0 for a decade, which they were, and volumes would not grow, which they did. So we sold it to NASDAQ. And then we went back in the business in 2018, started building the U.S. Treasury platform. That Treasury platform is up to 20% market share, and it's taken that 20% off a broker tech, which is owned by the big giant gorilla, Chicago Mercantile Exchange. So we took 20% market share off of them. Now what we're doing is we're taking that Treasury platform and we're going to do U.S. Rates futures as well on that same platform. That's Treasury futures and so far futures, which is short-term Rate Futures. And we're going to put both of those on one platform with the same system that's got 20% market share in U.S. Treasuries. On that same system, next, we go and bring in the banks and the big trading firms to be partners in that business. We do Futures on that same platform. We signed the LCH owned by the LSE, which is the largest holder of collateral in the world. So remember, to be successful in Futures, in FMX, you need 2 things. You need a rocking front-end trading system that's already installed everywhere because you can't just call JPMorgan and say, "I'd like to install a system." By the time you get installed to everybody who trades Diebold age. So a, it's already installed; b, it's already got 20% market share on it. So it already works beautifully. It's already the fastest system in the world. It's already working great, add Futures on top of that, bring in partners to do it together. And you've got a beautiful combination with LCH doing cross margining, which they've agreed to be our clearer and they will provide cross-margining. And that coupled together is what we call FMX, the Fenics Markets Exchange. Banks being partners, high-frequency trading firms being partners, BGC is the majority holder and that launches in the middle of this year, and we are really, really excited about it. We think it is a massive opportunity because of the Chicago Mercantile Exchange, which you know quite well, it's worth over $60 billion, great monopoly, little competition, pretty fun for us, and we think the opportunity is really outstanding.
And the potential partners that you're going to bring on, why are these firms interested in the opportunity? And how are they incentivized to help build the success or the volumes across the platform?
So the Futures business has gone back to unit economics, right, meaning they charge per contract. And these banks don't earn money per contract. They're hedging themselves, they're transacting business, and you've got this huge issuance that's just happened. And you know volumes are going to explode in the rates because we just discussed that. So huge volume coming. They're getting charged by the great monopoly, the Chicago Mercantile Exchange, an ever-increasing amount every year. The CME is great at putting up the price every year so they can raise their price every year. So the banks want competition. They want competition. And once they know they're going to support that competition, they want to own a piece of it because they say, "Look, we're going to help -- we want this to be successful. We're going to help make this successful. So we want to be owners of it as well." So we expect all the banks that matter to buy in, high-frequency firms will also buy in, and that will be the shareholder base that begins. But we expect to basically have a real competition, which is fast system, tight spreads, cross-margining, much cheaper than the Chicago Mercantile Exchange and build market share. I think we've been successful in U.S. Treasuries. I think we're going to be successful in the Futures. And I think it's going to produce tremendous value for BGC shareholders and for the shareholders of the banks, so they are partners in it because they're going to make it great, use it so they should own it with us.
And looking ahead, as you think about historical value creation from building technology platforms, what are the potential ways you can monetize the FMX platform in the future?
Well, the deal I have with the banks is going to be that -- it's a separate company, right? It's going to be managed separately. It's going to be on our platform, right? So our network, our platform. We're, of course, the majority holder. So we'll install the CEO. And eventually, I think the group may decide to take it public. We have to agree together with the banks. But if BGC, together with the banks decide it's time to take it public, it's okay. So that's the platform, but we have high hopes for it. Meaning the numbers we discuss between BGC and the banks, the numbers we discuss are well north of $10 billion in terms of value. We expect this to become an extraordinarily valuable asset because the CME is a spectacular organization, but it's alone, it can have a competitor, and they'll both be worth a fortune. But FMX is the competitor because it's got the system. It's got the clearing, connected to the banks. It's got all the ingredients necessary to win. And really, it's so exciting. I just so look forward to it, and that's 2023.
And given the positive outlook for the Voice and Hybrid business, potential for margin expansion and cash flow accretion from FMX operating independently, can you share your perspective on capital deployment?
Sure. So because interest rates were so low -- I'll just give some examples for you. So because interest rates were low, we became a catalyst company. When you first met us, you'd say, "Look, tell us what's happening?" And the answer was, well, we built this insurance business, we're going to sell the insurance business." And So we sold the insurance business for over $500 million, which we have built. And what did we do? We bought back 12% of the stock in the company, right? So we went right out and bought huge amounts of the stock of the company back. So we think the company is incredibly undervalued because of, a, the core business is now a growth business, whereas before, there's nothing you can do with 0 interest rates. But now that it's a growth business, I think the world is going to understand it's important to re-rate BGC. It's a growth company. People used to -- when I would come to a conference, some would say, "Oh, you're a melting ice cube because every year, the business will be a little smaller." And then they would say things like the Electronic guys like MarketAxess and Tradeweb, they're eating your lunch and they didn't realize that MarketAxess and Tradeweb are primarily B2C companies, right? They're buy side to sell side companies. They're an adjacent space. They're a little overlap with us. We probably have a 10% overlap both ways, us doing them and them doing us but they're really adjacent. And what you're going to see is they are going to grow nicely in this interest rate environment. And we are going to grow nicely. And we are going to -- they are going to outgrow us some quarters, and we are going to outgrow them in some quarters. And when we outgrow them some quarters, people said, "Well, I don't understand. I thought they were eating". No, they were never eating our lunch. They were just an adjacent business. So the opportunity for us to re-rate our business and grow is so exciting for us going forward.
So switching to some of the corporate decision-making. The firm recently announced the intent to pursue a corporate conversion and change the company name to BGC Group. Can you remind us where you are in that process and what the potential inflations are for the company's tax rate.
So we have completed all the internal documentation necessary. Meaning the Board has approved it, all the documents are signed. So it is really just process to completion. We got regulators who need to sign off on it in all the different markets we operate in just. Because you're changing your corporate structure, you have to apply and tell them. So it's process, really only just a process, process, documentation and process, but there is nothing standing in the way other than documentation and process, approvals and otherwise. So I would expect it in the middle of the year. And the idea for us is that if you've seen, we were in Up-C and now we're converting to a corporation. If you look at the other Up-Cs who've converted to corporations, their stock has traded brilliantly, for simplicity purposes, that the institutional holding of those companies has demonstrably increased, sometimes over 100% increase in institutional holding. So what I used to go see big buy-side firms, I'd have to spend after they spend time deciding do I like the company, I would have to spend 2 meetings discussing our structure, which was very tax efficient, but complex guaranteed. Now that will be over. It will be simple with a lot a simple explanation of the company, and we're a growth company. And I think the combination of the new growth because of the new market and interest rates coupled with the structure, I think we'll demonstrably improve the shareholding of the company, the breadth of people who buy the company, and of course, I think the stock price will naturally fall.
As we think about BGC's combination of data from the inter-dealer broker and technology platforms, what are the incremental opportunities from building new data products and new capabilities?
So I've been focused on making sure we capture all of the data that we have available to us. I mean we are -- we have a huge breadth of data. People underestimate the scale and scope of the breadth of our data. We are one of the 2 largest wholesalers in the world, and we capture all that data. So the capturing of that data, augmenting that data with AI to make sure we solve for all the questions that buyers of information would want. That will make a fundamental difference. So we're excited about the scale by which we can grow our data business. I think it's been growing between 15% and 20% a year. So it's got really nice growth, really great margins, that's sort of a 40-plus percent margin business. So I think the data business is a great place for us to grow, as I said, strong double-digit growth and great margins and great data capture, great data breadth. It's -- I don't think we've touched it. I think we have multiples to do. We can double that business and double it again. And I think we've got a long, long runway ahead of us in the market data business.
So BGC currently has about $100 million of data and technology revenues. As you look at the competitors down in the marketplace, what do you see them doing well that you can kind of emulate to grow the business? And maybe just touch upon the rate again of how much growth do you see in that business over the next 3 years and maybe longer term?
So we primarily focused our data sales on markets. Really, the literal -- you need to know where the thing is trading, right? And that was sort of our core. And what our peers have done is they've sold lots to pricing engines, people pricing their portfolios, end-of-day pricing, regulatory pricing, the whole back-office sales. And that's why they are now double our size. Now we had -- we were out of this world for a while because of 9/11. So we sort of are relatively newer in the space because of the events of 9/11. But we have grown ourselves to now be as big as anyone in the world. So I think that's the place where you should expect us to grow. We started signing some big contracts lately on the regulatory front, right, being end of day reporting, regulatory reporting. These are additional usage. And so I think we've got at least a double of the business over the next -- I would hope we will double the business over the next 3, 4 years. So that's -- just near term, I would expect 20% growth rates. We've been running between 15% and 20%, but I'd like to see us step that up to the 20% growth rate. And that 20% growth rate with the same plus 40% margins is my expectation over the next 3, 4 years.
And maybe just walk through Fenics markets versus the Fenics growth platforms. How do you see these 2 businesses or business -- or divisions kind of diverging going forward? And what is the objective of Fenics markets as you compared to Fenics growth platforms?
Okay. So Fenics growth are native Fully Electronic businesses, okay? And the easiest way to think about something that in Fenics growth is that it's just a beautiful technology that can be easily sold to an exchange, okay? And the history of BGC is we have sold a variety of businesses to exchanges, right? We sold Trayport to the New York Stock Exchange. We sold eSpeed to NASDAQ. So the exchanges like to buy sort of pretty electronic, Fully Electronic marketplace. And Fenics growth are those ones that we're building. Fenics markets are the mature businesses on which we have electronics. And those are businesses that, while some are integrated into our Voice business and some are not, they're just more mature businesses. The growth are new like U.S. Treasuries was new, Spot foreign exchange is new. Those businesses are relatively newer, but they are the kind of businesses that are easily saleable. And the history of the company is we have sold our Fully Electronic businesses in the 11 and 12x revenue category, right? And since BGC currently trades just over 1x revenue, when you can sell assets for 11 or 12x revenue more along the lines of MarketAxess, Tradeweb. So I'm not just pointing to them. We've produced, created marketplaces and sold them to exchanges. And I think that is in our future. So we will continue to create markets and then transact with exchanges. And then we'll just have tremendous capital which to deploy in -- obviously, we like buying back our shares, as you've seen when we sold our insurance business, we bought back a ton of shares.
Can you speak to the evolving dynamics in credit markets? There's a lot of enthusiasm for growth in credit trading in 2023. Can you speak to some of these changing market dynamics and how BGC is expected to benefit?
Sure. So there -- there's the traditional credit trading and BGC has the largest in the wholesale space, the largest platform for credit trading globally. So that's one of our best businesses. And we expect those volumes because of interest rates and because of issuances to continue to grow, and therefore, we expect our revenues and credit to dramatically improve as compared to where they've been. So we're going to have a nice growth rate, and that growth rate will continue for the foreseeable future. So we have a very positive look on it. Then you have the business of the growth of these passive ETF. And people think when it's a passive ETF, that's going to somehow reduce trading volume. You realize every time a dollar goes into a passive ETF, what do they have to do? They have to buy credit, right? Every time dollar goes out, they have to sell credit. And every time there's a maturity, right, or any corporate action, there's going to be buying and selling of credit. So it's just another type of fund buying and selling credit. And we have that, it's called portfolio match. And that's a business that is growing at leaps and bounds within the company, and that would be a growth platform, right? That's a new Electronic market. It competes with Tradeweb and MarketAxess but it's in the same model. So Credit is both a regular credit trading, and this portfolio -- what we call portfolio, but it's really passive ETF Electronic portfolio where they buy lots of names in small size. The regular credit market, people buy $5 million or $10 million of our particular name. And so we are really bullish on the volumes of that. And we went over before just I can't -- it makes me so happy when I go to sleep at night to think 2.75x the issuance produced 0.5 volumes since '08. That ratio is going to go back positive. It's going to go to 0.6, 0.7, 0.8, 0.9, 1.0, 1.1, 1.2. And you're going to see volumes in credit double over the coming years, and that's just great for our business. It's just wonderful for our business.
And maybe thinking about the other assets trader across the interdealer business like energy and commodities. How do you think about the negative volatility had that impacted markets in 2022, the outlook for 2023? And maybe also touch upon the ESG initiatives that you have and how you can benefit from ESG?
So the commodity markets, we have a nice business in commodities, but we are undersized. So you should see us, we're going to hire and acquire in that space and grow our market position in commodities, right? We hired a new leader for our Houston business. We're very focused on growing and building our business. We just did an acquisition in the energy space, relatively small, but still it's an example of how we're just going to continue to plug and play in the energy space. And so we're excited about that. I can tell you the name is Trident. And that's a business we just bought. And we're excited about how that's going to add and grow to our commodity space. So you're going to see us invest in and grow in the commodity space. Again, we think volumes will work well for us, and that's a great business for us. So we're not really -- remember, we make money on volume, not if it goes up or it goes down. We just want volume, volume, volume. And I think the bigger we are in that space, the better we will be. So we are -- I think we are a little undersized in commodities as compared to our peers, and you're going to see us march up that and that will be bigger.
And I think we can pause here for investor questions. If you have a question, please raise your hand, and they'll bring a microphone. And while we get that situated...
Can you hear me?
Sure.
Thanks for going into Fenics, but I've followed your company but I've always tried to figure out Fenics. So if I understand it correctly, as more volume goes into that platform, your margins should get better and better and better over time, right? So can you tell me how that transformation is going as far as taking volume from Voice and I forgot the other process to go into Fenics?
Sure. So when we have a Voice business, we generally pay our brokers on average between 55% and 60% pay out on average. All in, the full cost of having them the -- that counts the people and their assistant and all of the work, the compensations tends to be between 55% and 60%. And so our margin on that business would be in the neighborhood of about 15% with scale, right, which makes sense. When I convert the business to Electronic, those same salespeople -- I don't just do a simple example of how you convert it. Those same salespeople become Electronic salespeople because they don't need as many assistance. They don't need people with them. They can go help the client. And let's say the desk had 10 people on it. We can have an Electronic business with just 3 people, the 3 rainmakers. The 3 rainmakers can make 50% more money, right? And our comp ratio will drop from 55% to 35%. And our payout right -- and therefore, our profits go to 35%. And then over time, it drops to 30%, right? And all of a sudden, our profits are 40%. So that's the model, which is converting an Electronic, and that's Fenics market, right? So the idea is what's Electronic and where are we in that process, right? So if a trade is Fully Electronic, right, and our margins -- so the way we describe with Fenics markets is, we have to have at least a 25% margin in the business. And the only way you can really get a 25% margin on the business, the most practical way to get 25% margin on the business is to move things Electronic, right? Because the margins get higher and higher and higher. So that's the model. So where we are now is we have fully electronic products, and we have these integrated products where electronics are in it. And Fenics did $442 million in revenues trailing 12 months. So it's an excellent business, the margins -- I said the minimum margin to be in Fenics must be 25%. And the highest, of course, will be in the fully Electronic businesses, which are north of 50%. So the average -- if you look at where Fenics is, it's in the low 30s now, right? But it's going to continue to march higher and higher. As more and more goes Electronic, you're going to see as our margins grow higher and higher, we're going to get into the mid-40s.
The Treasury volume will increase just because you're saying the Fed won't be there to take away the volume that would go to traditionally the brokers or the banks? Is that the way to think about what's going to happen with your value increasing?
Right. Because so people say, look, Treasury issuance was up 5x. 5x, why is there not more trading volume? I mean, how is it -- well, a, if the 2-year note is 0 and Treasury Bills are 0 and the 5-year note is 0, we're going to trade. There's not a lot of fun to trade. Plus normally, you would have mortgages being hedged with treasuries, but the Fed's buying all the mortgages too. So there really wasn't a lot to trade. So volumes were suppressed. Now you have quantitative easing done, right, whether it's quantitative tightening, but they're basically just letting everything run off. Now you're going to have 10-year note issuance with no Fed buying. So everyone is going to trade, there's going to be huge volume as compared to what the old ones were, right? The old auction, they would issue $40 billion, but the Fed would buy. So there's no trading and no hedging, no nothing. Now that volume will be traded at $30 billion, $40 billion issuance will be traded. And so the volumes, you're going to watch volume and treasuries just grow, relentlessly grow. As the pleasure of trading comes back into the market, the need to hedge comes back in the market, the value of transacting comes back in the market. And you're going to just watch that creep up and that ratio between 5x issuance. And the same volume that we traded in 2008 with 5x more issuance, you just watch that grow. And as that grows, you're going to watch our Treasury business do better. You're going to watch our Rates business do better. You're going to watch our Credit business do better. And basically, you've had the most interesting concept for 14 years, 14 years, I've been in a bad raw material market, where the market declined, like we said, Credit went from 1 to 0.5, half of 2008 volume when that ends, which it has ended now in 2023. Right now, all of a sudden you've have a growth company. So the reason our stock is still where it is, why would people have figured that out yesterday. That's why you have me here to talk about it. That's why you understand the business because you're talking about that the world has changed for BGC. You picked up coverage on the company as the world changed because you understood that the world was changing. This was an inflection point, and you need to find -- you've got all these mortgage companies who have stress, right, with rates going up. Who's winning when rates are going up? Let's go find the companies that are going to win when rates go up. And this is it. It was just we're back to the company that we were. We were a great growth profit-making company before interest rate went to 0 and now you're going to see something really exciting. And the company is really -- we're just in a new place and that begins in 2023. So it's brand new. So you haven't missed anything the stock. No one's really paid attention yet and the stock is going. But as my expectation is you're going to see growth quarter after quarter after quarter going forward for such a long period of time. We're just a good company with just a growth company, having changed from 0 interest rates, which was weird. Do we all agree that that's weird to have 0 interest rates for you? I mean -- the U.S. Treasury has a $31 trillion deficit that gives to Finance for 0, not anymore. Now we're rich.
Okay. My last one. When you convert to a, I guess, a C-corp, right, Will the canter, I guess, percentage ownership be the same? Or how will that get sorted out?
So right now, the really directly or indirectly, I own about 20% of the stock, right? So I'm the biggest shareholder of BGC. So Cantor owns about 21% and we'll still own 21%, and this is done. The employees own just under 20%, and the public owns just over 60%. And I think that will stay the same. I don't think that will change. And I wouldn't expect Cantor not sold any and doesn't tend to sell any. And you wouldn't expect me to sell any. Having listened to the talk today, the only time I ever part with BGC shares is every once a while and give some to charity. But other than that, I'm keeping these. This is so much fun finally, finally.
And with that, I think this is a good place to pause. Howard, thanks for joining us today.
Thanks so much. There was a lot of fun.
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