Note: before diving into BGC, we wanted to touch on the prior VIC writeup (4/25/23 under “BGCP” – the ticker was subsequently changed to BGC). That author got a lot right. To wit:
Performance: published at $4.40, +50% since
Context: astutely flagged three historical developments (sale of insurance business, sharecount reduction via buybacks, and a mix shift from hybrid-voice to higher-margin electronic)
Valuation: 4-5x adj PE is cheap (now 6x, omg)
Secular Inflection: non-0 interest rates and volatility across the curve is a core revenue driver and has been dead for 14 years
Potential Catalysts: highlighted C Corp conversion (occurred earlier this year) and FMX launch (should be announced imminently).
The write-up garnered zero comments, a quality rating of 3.8, and insufficient votes for a performance rating. (Getting a tough reception sucks, but hopefully the author can dry tears with profits). The culprit seemed to be that folks like more meat on the bone (it was 1100 words with no charts or tables). Our aim is to circle back, add detail, provide updates, and set the stage for what we think could be another leg higher. BGC is currently our largest position.
Legal Disclaimer: we have legal language at the end, but the gist is, we do our best but can make mistakes. Therefore, do your own work and do not rely on this write-up. We have a long position and will benefit if the stock goes up. Looking ahead, we might sell for any reason and don’t really plan to announce that. This is not advice; it is just us flagging an interesting idea. Etc. etc.
Boil Down: BGC is an institutional trading business that benefits from non-zero interest rates, increased volatility, and elevated treasuries issuance. The macro backdrop has been a headwind for more than a decade, but recently flipped. Yes, the stock is off its lows, but if this inflection has legs, this remains in the first inning. BGC is cheap, has a healthy balance sheet, and can double on earnings growth and a modest re-rating. In addition to this core thesis, you get the upside from accretive monetizations on the electronic side (proceeds enabling buybacks). Finally, the Russell is estimated to be a buyer of BGC in the December rebalance and BGC should be added to the S&P 600 SmallCap Index in the relatively near future.
Business: The Traditional segment (74% total revenues) is voice/hybrid global brokerage specializing in fixed income, interest rate and credit derivatives, FX, equities, futures, and options. The Fenics segment (26%) comprises higher margin, technology-enabled execution, data, software, and post-trade offerings.
BGC has 490mm shares outstanding trading at $6.50/share for a $3.2 Bn market capitalization. Total cash is $621mm, debt is $1.18 Bn, yielding a TEV of $3.75 Bn. With forward EBITDA in the $600mm+ ballpark, net leverage is less than 1x. Valuation is 6.1x EBITDA and 6.5x PE.
Our math suggests $10-16 per share, or ~50-150% upside. That return potential doesn’t grow on trees, so we have been preoccupied with identifying the reasons for the opportunity. We have four explanations:
Why The Opportunity Exists:
Inflection is Early: the business suffered through an eternal period of depressed activity levels. This history has two effects. First, investors question the fundamental value proposition of the business. Second, to the degree evidence of a “new normal” is emerging, it is not yet definitive. The more the story ticks the “show me” box, the higher the stock goes.
Rebuttal: We see sufficient data to draw a line and make an investment. Investors are paid to see where the puck is going. What’s more, the outlook is in our favor (wait until you see the data on impending treasuries issuance!).
Perception of Voice Trading: a portion of BGC is tied to old-school voice trading. This segment seems ripe for disruption and, as such, BGC does not benefit from the high multiples of pure electronic players (e.g., TW, MKTX). Fenics and related electronic initiatives are in ramp mode and not big enough to fully drive the financials.
Rebuttal: If you put a low “stable FCF” multiple on voice and give a smidge of credit to electronic, the math works. This is likely too punitive, given the core business is growing. What’s more, even if the market never ascribes a fair blended multiple, BGC will force the issue with electronic monetizations, with cash used for buybacks. Selling at revenue multiples to buy back at low PE multiples is a recipe for appreciation.
Complexity: the org chart makes things hard to follow, which hurts multiples. Moreover, historically the Up-C structure limited BGC’s eligibility for major indices (already fixed).
Rebuttal: Already converted to C Corp. Changed ticker. FMX coming. Can hive off other small assets in coming 12-24 months. In short, working on simplification now.
Howard Lutnick: the CEO and largest shareholder (> 25% of the company) cuts a controversial figure. He is loud, outspoken, and not for everybody.
Rebuttal: He is 100% motivated and aligned. If you study the history of BGC and related entities, he has delivered on promises. We speculate that optimizing the value of electronic initiatives presents Howard with an opportunity for a lucrative and poetic career capstone. Though still high-energy, he had a recent (and public) health situation, is 62 years old, and has been with the Cantor/BGC complex since 1983. It all adds up.
Core Earnings Story: historically, issuance levels had a tight relationship with average trading volume. This made intuitive sense; the more sh*t out there, the more trading there was to do. However, post-GFC, this broke down. More and more paper was issued, but with rates 1-sided and near zero, trading did not budge. However, recently this relationship has begun to tighten. In addition, we see issuance ballooning in 2024.
BGC revenues track trading volumes, period. The relationship is crystal clear in the data and it makes perfect sense because trading is what BGC does. Not complicated. Adding this up, we have some basic logic/arithmetic:
Trading volume catching up to issuance +
Issuance levels high and the outlook strong for continued strength +
BGC revenues mirroring broader volume =
BGC revenues heading higher
The forward UST issuance outlook appears to be headed dramatically higher. In late October, the GS rates desk flagged potential net issuance +60% y/y in 2024:
And Twitter user @TaviCosta flagged an “unprecedented $8.2T of US government debt” maturing in the NTM. He also calls out that a projected fiscal deficit could drive this higher.