Description

Is BGCP getting credit for its commercial real estate brokerage or its electronic trading business? I believe the answer is “no” and moreover there are several catalysts which will collapse this value discrepancy leading to the potential for a 44% gain in the stock in the near term, with more upside longer term.  The stock is so dramatically cheap that excluding a couple of off balance sheet assets and the company’s real estate brokerage business, an investor is paying a de minimis or negative value for the company’s high growth electronic trading business, a business that would likely command 15x EBITDA.  Management is also a significant owner and seems motivated to unlock the value here, and the stock pays a healthy ~6% dividend while you wait.  In 2013, BGCP monetized some electronic trading assets which sent the stock up 60% in a day; today BGCP electronic assets generate 2x the pretax income as they did at that time.  

BGC Partners (BGCP: $8.79) is a combination of an interdealer brokerage and a commercial real estate brokerage business.  The EBITDA mix is roughly 36% CRE brokerage, 40% voice/hybrid brokerage, and 24% fully electronic trading.    The interdealer broker transacts on a non principal basis, acting as an agent between counterparties trading less liquid derivative products in the OTC market, typically interest rate swaps, credit and FX.  The commercial real estate brokerage provides leasing, sales and property management services for large corporate clients.  The real estate brokerage business is very similar to publicly traded companies such as JLL and CBG.

BGCP is currently getting little or no credit for its Real estate brokerage or electronic trading assets (the electronic assets are housed within its traditional “voice” brokerage business).

To summarize –

·         The company has net cash/saleable assets of ~$790m (22% of mkt cap) or $1.98/share.

·         The Commercial RE business is likely worth $4.50 based on peer multiples.

·         In 2013, BGCP sold its eSpeed business (electronic trading of US treasuries) for $1.2b on $58m of pretax, for a multiple of 12x sales and 22x pre-tax income.  Today, BGCP’s electronic assets generate 2x the pretax income of eSpeed.

·         Both near term and intermediate term liquidity events will unlock value –

o   BGCP just sold its Trayport trading platform acquired from GFIG for $650m or ~$570m net of tax

o   BGCP receives NDAQ shares annually (from its 2013 sale of eSpeed) which in aggregate are worth $710m, but the company may forward sale these proceeds

o   The Commercial real estate business is likely to be spun off or sold within 6-12 months

o   BGCP will utilize its liquidity to repurchase stock (recently upped the authorization to $300m) and accretively acquire sub scale CRE brokerage firms at only ~6-7x EBITDA

o   Longer term, more electronic trading assets will be monetized, which at precedent/trading multiples could almost equal the value of the entire company

Pro forma for the recent Trayport sale and value of its NDAQ shares (neither of which appear on BGCP’s balance sheet)  BGCP is trading at only 5.2x EBITDA, while 35% of EBITDA is likely worth 9-10x and another 25% of EBITDA is worth 10-15x and COULD be worth 15-20x.  A Conservative SOTP (shown in the “Valuation” section below) suggests 44% upside, with limited downside.

What is BGCP today and how did we get here?

Summary cap table:

In terms of the background, I think it’s worth pointing out that BGCP management has a history of smart value creating transactions in BOTH segments:

On the commercial real estate brokerage side, BGCP entered this business with the acquisition of Newmark Knight Frank in 2011.  In 2012, BGCP made an opportune purchase of another CRE brokerage “Grubb and Ellis” out of bankruptcy for a de minimis price.  Since that time, the company has made numerous other acquisitions at private market multiples (~6x).  Management has essentially taken this segment from zero to a $1b revenue company in only 4 years.

In the financial services business, in early 2013 BGCP sold its eSpeed business to Nasdaq for 22x pre tax income, which drove the stock up nearly 60% in a day.  Remarkably, the business was not generating outsized growth at the time (yet still garnered a huge multiple).  More recently, in 2015 BGCP acquired an interdealer brokerage competitor GFI Group (“GFIG”) for $750m.  The transaction is expected to generate $90m of annual cost synergies, most of which will be realized in 2016.  BGCP’s $750m purchase of GFIG included Trayport (an electronic information services and energy trading platform based in the UK), which BGCP just sold for $650m.  This implies BGCP acquired GFIG for an extremely attractive price (i.e. 1x synergies + core business for free).

Financial services segment

This segment generates 56% of total company revenue and 65% of total company EBITDA.  Within the segment are two separate but related businesses, the voice/hybrid business and the fully electronic trading business (called “Fenics”).  Voice/hybrid has higher revenue but lower margin and lower growth then electronic revenue.  Voice/hybrid represents 65% of financial services EBITDA and operates at high teens pretax margin, while fully electronic generates 35% of financial services EBITDA and operates at near 50% pre-tax margins.  Fenics trades similar products to the voice/hybrid business and also provides market data and software solutions.  Fenics is somewhat of a “crown jewel” within BGCP.

At its core, the financial services segment is a relatively simple commission based agency trading model.  The company acts as an agent/intermediary between other banks, focusing on esoteric credit products that are traded OTC.  Its primary products traded include rates, credit, FX, equities, energy and commodities.  BGCP’s role is to provide anonymity, liquidity and price discovery to its trading partners.  BGCP does not take principal risk on its balance sheet.

Today, BGCP has roughly 27% market share of the $10b interdealer broker market, which is a small piece of the overall bank FICC market of $165b and exchange/execution/data market of $47b.  BGCP has ~2,500 brokers and salespeople and more than 200 financial desks in 30 cities.

This is really a tale of two separate but related businesses, the voice/hybrid business and the fully electronic business.  Secularly, more products have moved over time from traditional voice/hybrid broking to fully electronic trading.  Management’s strategy has been to embrace this change and invest in technology to be able to capture this mix shift.  As a result, for the more liquid/exchange like products that are able to migrate electronically, BGCP is able to capture this order flow and migrate these trades electronically through its own venues.  In that respect, BGCP benefits from the move to electronic as margins in electronic are 3x higher then voice/hybrid.  Moreover, the fact is that due to the non-standardized and illiquid nature of products traded, a large proportion of BGCP’s volumes are unlikely to ever be traded on exchange or fully electronically.  As such, the Company should continue to “hold its own” in voice/hybrid trading (generating flat to lsd% organic growth), while migrating available traditional voice/hybrid revenue over to its higher margin and higher value fully electronic trading assets (which can demonstrate double digit organic growth rates).  Expectations are very low for the voice only segment, continuing to “hold its own” in this case I think will be good enough.

By way of example, let’s look at a simple sketch of an extreme mix shift in BGCP’s financial services segment over time.  This is really a hypothetical, but management has suggested they think the move from voice/hybrid to fully electronic is ultimately revenue neutral in aggregate.  Let’s assume 30% of the existing voice/hybrid business is able to be converted to electronic and that this occurs at a pace of 20% per year (this results in 6% of voice revenue being converted to electronic each year).  Starting electronic margins are ~50% versus voice at only 17% (post GFIG synergies).  By year 5, electronic as a % of total pretax income would more than double and aggregate margins would be expand by greater than 700 bps.  Assuming voice is worth 6x and electronic is worth 12.5x, the multiple would expand by nearly 2.5x.  So the future business would be much higher margin, higher growth and higher multiple, all of which would generate a lot of incremental value to BGCP shareholders. 

Note this is really illustrative only, as they will likely sell a lot of electronic assets over time and I can’t predict how this would all truly shake out.  My point here is more to suggest that secular headwinds here are actually as much of an opportunity as anything else.           

In addition to secular changes, BGCP has felt cyclical headwinds in its financial services segment over the past several years.  FICC trading volumes at global investment banks have been weak as banks have deleveraged in response to Basel III and Dodd Frank regulations.  Large bank RWAs have been cut by as much as 40% since 2010.  Enhancing these negative cyclical effects, the FED’s QE policy has acted as an anchor on volatility and volumes. 

I think there is reason for optimism as we are now more likely closer to the end of the RWA deleveraging (i.e. unlikely to see another leg down), and with the FED poised to raise rates in the relatively near future, it’s likely there will be some uplift in volatility/trading as market participants more actively hedge/bet on the shape of the curve, credit and fx going forward. 

Also, while capital has left the traditional investment banks, buyside AUM has continued to grow meaningfully creating a mismatch and a reduction in market liquidity.  There are many examples of this, for example in the high yield market where bid/offers are several points wider than a few years ago and it is more difficult to trade without moving the price of the bond.  Management believes that capital which has left the traditional investment banks will migrate towards hedge funds and other intermediaries that will seek to fill this liquidity void.  As such this business may not be permanently “lost”.  Citadel, as an example, has recently enhanced its market making presence.  As BGCP has existing relationships with many of these former sell side traders, the Company can participate in this market evolution.  Similarly, although historically BGCP has mostly traded in between investment banks, firms like Blackrock have recently suggested they will trade directly w IBDs like BGCP going forward.  With the total IBD market at only $10b vs the total FICC market of $165b, any small market share capture via movement of market making capital outside of traditional investment banks and expansion of buyside direct participation w IBDs, could be nicely additive to the IBDs (so a 1% market share gain from IBs would be a 16% gain to IBDs). 

All in, It seems reasonable that with the unwind of the FED balance sheet, renewed volatility from a rise in rates, bank deleveraging nearer to the end, and the potential for more direct buyside participation, BGCP could have some cyclical headwinds turn into tailwinds over the next few years and be able to generate some modest flat to organic growth its voice/hybrid business.  Again expectations here are very low, and I think any level of organic growth will be well received.  The business is largely variable cost (62% broker comp ratio) and hence doesn’t scale up or down meaningfully, so in a more bearish scenario with negative organic growth, the company’s opex will scale down in tandem mitigating significant profitability declines.   

Another positive is the recent combination of BGCP’s two largest competitors in voice/hybrid brokerage.  On November 11, TLPR acquired ICAP’s voice brokerage business for 10x pretax.  As a result of revenue dis-synergies in the deal (where customers do not want to concentrate all prior trading revenue in the Newco), BGCP may be able to pick up market share.  The two companies’ voice/hybrid businesses are now similarly sized and I’ve seen some estimates that revenue attrition could be as high as 10-20%.  Any pick up BGCP could get here would be a real boon to its voice/hybrid business.  TLPR LN is now a pure play voice/hybrid broker and trades at 5.5x EBITDA while IAP LN is now almost all electronic trading and information services and trades at 12.5x EBITDA.

Commercial real estate brokerage

On the commercial real estate side, BGCP’s real estate services division is one of the largest full service real estate brokerages in the US.  The Company operates in a highly fragmented market where the top 5 servicers have only 17% market share, and BGCP has 1% market share.  BGCP’s business (today) is 100% domestic.  The industry is benefiting from a large cyclical rebound but also a trend towards outsourcing and institutional ownership of real estate assets (which requires more professional CRE brokerage services).  The services offered include traditional brokerage services such as investment sales, leasing and capital raising, as well as other services such as consulting, valuation and property and facilities management.  Recurring revenues (largely property and facilities management) are roughly 40%.  Leasing services are less contractual, but have limited risk of repricing or occupancy declines absent another recession.  Organic revenue growth for this segment is currently running in the low double digits. 

The two primary publicly traded competitors for this segment are CBRE Group (CBG) and Jones Lang Lasalle (JLL).  The group trades at ~ 10x EBITDA currently.  I believe BGCP’s real estate segment valuation should map closely map to these peers. 

The real estate segment has limited synergies with the financial services segment, and is currently at scale.  On the most recent conference call, the CEO was more emphatic then I have heard him before that the time is now to realize the value here.  He specifically said it’s a “matter of when not if” and I have heard him before say that at $1b of revenue (which will be achieved this year), the business can stand on its own.  I believe it is likely the Company announces a spin off or sale of this asset during 1H 2016.  A $4.50/share valuation seems reasonable here.

Catalysts/timing from here:

Short/intermediate term (3-12 months) –

• ·         A week ago the Company again delivered, by fulfilling its promise to monetize its Trayport business.  It achieved a sale price of $650m, netting its purchase price of GFIG down to only $100m (0.15x sales versus 1.5x just paid by TLPR for ICAP voice/hybrid).

• ·         Forward sale the NDAQ proceeds.  BGCP receives $65m/year (at current prices) of NDAQ stock annually for the next 11 years as latent consideration from the sale of eSpeed to NDAQ in 2013.  It would make sense to monetize these proceeds immediately (and should be easy to do) via a swap with an investment bank. 

• ·         I would expect management to utilize virtually all of these proceeds from Trayport and Nasdaq to buy back stock and buy commercial real estate assets.  Post Trayport sale, BGCP will lose about $35m of pretax or 8c of EPS.  By buying RE assets at 7x pretax, they could deploy $570m of net proceeds from Trayport and acquire $81m of CRE pretax or add 17c in EPS, which is 10% accretive (net) to EPS.  Similar there would be more accretion from buying stock with the rest of their liquidity at these levels ($300m buyback currently in place).  I have suggested and the Company understands the value of buying stock now versus later while the stock is still cheap.

•       Spin/Sell the commercial real estate business.   This will surely be a big event for the stock.  As I said, management is becoming more definitive about a transaction here (per comments above).

Longer term (1+ years) –

• ·         Spin/sale of BGCP’s electronic assets

o   Each business/desk/product needs to achieve scale, (defined as > 50-70% fully electronic trading vs voice/hybrid)

o   Some are at scale currently, others will be over next several years.  I frankly need to better understand where they lie on the spectrum as far as level and timing here, to understand how immediate or not this could be.

o   There is the potential for a “home run” scenario in the stock when they monetize these assets over time.  Remember - In 2013, BGCP sold its eSpeed business (electronic trading of US treasuries) for 12x sales and 22x pre tax income.  Today, BGCP’s electronic assets generate 2x the pretax income of eSpeed.

Valuation -

Using a reasonable valuation range based on 9.5x for CRE, 6x for voice/hybrid, 10x for electronic drives $12.64 in value or 44% upside.  Ex CRE, cash and other assets, you are creating the entire Financial services business at only 2.7x EBITDA.  You are also creating the electronic business “for free”.  BGCP’s financial service business is 35% electronic and is being valued at 2.7x; a 7.4x multiple (10x electronic and 6x voice) drives a $12.64 stock price.  None of this assumes a) deployment of cash into more CRE deals, b) buyback.  If they are able to deploy the Trayport proceeds at 7x into CRE assets, that would add another 50c to the valuation.  Using $700m of Nasdaq proceeds to buy stock would retire 20% of the float and add $1 to the valuation all else equal.        

I would also argue 10x for electronic is too conservative.  For one, ICAP trades at 12.5x and the exchange group trades at 13.6x EBITDA.  Moreover, a sale of these assets is the more likely outcome.  Over the past several years, assets in the space have been bought for 11x sales and an average of 19x ebitda/pretax (range of 15-22x).  These include KCG hotspot, FXAll, 360T, and eSpeed.  Selling BGCP’s electronic assets at 15x EBITDA in the base case would imply a ~$14 stock or 60% upside, selling them for 20x EBITDA would imply $15.50 or 76% upside.  While such a transaction is likely more than a year away and the entire business is unlikely to be sold at one point in time or as a whole, I believe BGCP is sitting on a powder keg of value that will be unleashed and drive a similar result as the eSpeed transaction in early 2013.

In addition, I view the upside/downside here as particularly favorable.  See below.

As you can see, In order to get downside from the current stock price, I’d have to haircut the real estate segment’s ebitda by nearly 10% and value that segment at 6.5x or a 40% discount to CBG and JLL.  Then I’d haircut financial services EBITDA by 5%, and value it at 5x or a 35% discount to the comp set based on its electronic mix.  Valuing those at massive discounts gets me 2% downside in the stock from here, a scenario I just don’t find reasonable given the upcoming catalysts. 

Catalyst

deploy Trayport proceeds, monetize nasdaq stake, spin/sell real estate brokerage business, stock buyback, monetize electronic assets