Description

Company: BGC Partners, Inc. (“BGCP” or “the Company”)
Recommendation: Buy hedged BGCP
Trade: Buy BGCP (pre-spin)
Short 0.47851 shares (the spin ratio) of NMRK per BGCP (to create BGCP standalone)
Short BGCP’s standalone value (BGCP less NMRK distribution value) via XLF as a hedge                   
Upside: 39.9%
Downside: -15.1%
Upside/Downside: 2.64:1
Timeline: Q4’2018 / Q1’2019

BGCP has been written up three times before on VIC, by danconia17 on 11/17/2009, rii136 on 02/04/2013 and compass868 on 11/23/2015. The current trade recommendation will focus on the upcoming spinoff. Please refer to the three other excellent VIC write-ups for historical context.

Trade Recommendation

BGCP is spinning out its residual shares in Newmark and de-consolidating it from its balance sheet. The resulting corporate event will materialize in a new BGCP. The new BGCP has:

• 15% revenue in electronic brokerage referred to as Fenics, a high margin (~40% pre-tax adj. earnings margin) that has grown revenue at a 24% CAGR from 2010-Q1’18 LTM.

• A remaining business in traditional hybrid/voice brokerage, which recently grew by acquisition to have 35-38% of overall market share. The hybrid/voice brokerage has a focus in esoteric products that are less impacted by growth in electronic trading. While this sub-segment is partly impacted by the movement to electronic, any flow from hybrid/voice to Fenics is highly margin accretive.  

• An under-levered balance sheet with a net cash position and a proven management team with a history of value creation.

• Currently trading at 7.57x management’s $398MM Q1’18 LTM EBITDA, pro-forma for the new balance sheet and NMRK shares to be received upon spin. Adjusting management’s Q1’18 LTM EBITDA headline number to $359MM for onetime items results in slightly lower valuation, though still attractive at 8.38x.

Trade:

• Buy BGCP equity.

• Short 0.47851 shares (current spin ratio) of Newmark per share of BGCP to hedge the incoming spinoff distribution and create BGCP standalone/RemainCo.

• Short equal amounts of the Financial Select Sector SPDR Fund (XLF) shares per BGCP standalone value (i.e. BGCP pres-spin value less expected NMRK distribution value), as a sector hedge.

Once BGCP spins out Newmark, valuation will re-rate. BGCP’s SOTP value gives a current target price of $15.71, a 39.9% upside from the current stock price and a downside of 15.1% for a 2.64:1 upside/downside ratio. Upside and downside are outlined in the SOTP and differs on multiples used and spin conversion ratio.

Situation

On December 13, 2017 BGCP conducted a partial IPO of Newmark Group, Inc. (NMRK) by offering 20MM shares at $14/share and 3MM via greenshoe. The original expectations were for a 30MM share issuance at $19-$22/share and 4.5MM of greenshoe. Proceeds of $298.3MM, net, were used to pay debt.

Currently BGCP owns 59% of Newmark common stock, with over 90% total voting power and fully consolidates NMRK’s operations. By year end, BGCP intends to spin the remaining shares in NMRK and separate the two companies’ balance sheets, repaying debt Newmark owes to BGCP but is consolidated on BGCP’s balance sheet as a liability, leaving BGCP unlevered post transaction.

Company Overview

BGCP today is a combination of an interdealer broker and a commercial real estate (CRE) brokerage. The company's mix is currently 45% real estate services (CRE, the SpinCo) and 54% financial services (the RemainCo) as shown below.


Source: BGCP Q1’18 Investor Presentation

The interdealer broker (BGCP’s business post-NMRK spin), or financial services, operates as an agent between various counterparties trading illiquid derivative products in the OTC market (interest rate swaps, credit, FX). Within this segment BGCP’s crown jewel is its electronic trading Fenics business. This business consists of ~15% of the segment’s revenue and has ~40% pre-tax adj earnings margins. Products traded include interest rate derivatives, credit, FX, bonds; the segment also includes software, market data and post-trade services. Comparable companies are the NEX Group.  The other part of the business is the traditional voice/hybrid business at mid-to-high-teen earnings pre-tax earnings margin with 2,468 brokers and salespeople. Comparable companies include TP ICAP PLC and CFT SW.

The CRE segment (Newmark), or real estate services, provides leasing and sales and property management services for large corporate customers, similar to a Jones Lang Lasalle (JLL) and a CBRE Group (CBG).

Corporate Transaction

Spin Shares (Table to Follow)

• BGCP currently owns 150.3MM shares in Newmark to be spun to BGCP holders at the event, comprising 59% of all Newmark shares. Post distribution, the float in Newmark will increase from 9.1% to 68.2%. The spin ratio is 0.47851 Newmark shares per BGCP participant.

• While management is targeting a 0.47851 spin ratio, there is risk this number declines to a 0.31183 spin ratio if all of BGCP’s units convert to class A and B shares, thus accruing less value to current BGCP class A and B holders.

• The distribution and spin ratio are all calculated and shown below:



Balance Sheet (Table to Follow)

Importantly, both companies share a balance sheet and post spin this will end, as well as the intercompany loans in-between them with Newmark paying debt owed to BGCP and refinancing shared debt where Newmark is the obligor.

Key balance sheet points of the transaction:

• Newmark – At 3/31/18, NMRK had long term debt of $813MM and short term debt of $202MM for a total of $1,015MM in debt.

o Newmark debt is broken down as follows:
$202MM in short term intercompany borrowings – borrowed from BGCP and payable to BGCP.
$400MM converted term loan; NMRK is the obligator and plans to refinance this loan.
$300MM 2019 promissory notes payable to BGCP.
$113MM 2042 promissory notes payable to BGCP.

o In addition, assets include:
Cash of $48MM.
The company also has restricted cash of $243.9M; however the bulk of this is required for their credit profile and regulatory reasons.

• BGCP – At 3/31/18, BGCP had total debt of $1,382MM, this included:

o Newmark consolidated debt:
$398MM of unsecured term loan (the converted $400MM term loan, an obligation of NMRK).
$298MM 5.375% senior note ($300MM 2019 promissory notes payable to BGCP).
$109MM 8.125% senior note ($113MM 2042 promissory notes payable to BGCP).

o BGCP standalone debt:
$6MM in short-term borrowings (Itau Unibanco S.A.).
$241MM in 8.375% Senior Notes ("GFI" Notes).
$297MM in 5.125% Senior Notes (Make-Whole, CoC at 101).
$32MM in collateralized borrowings.

o Intercompany receivables:
A total of $430MM of intercompany obligations. This includes:
• $298MM 2019 Promissory Notes - Payable to BGCP.
• $109MM 2042 Promissory Notes - Payable to BGCP.
• Two short term intercompany loans netted are $22MM, consisting of:
o $202MM Short-term borrowings to NMRK from BGCP.
o $180MM Short-term borrowings to Cantor from BGCP.

o In addition, assets include:
Cash of $363MM (this includes $48MM of consolidated Newmark cash).
Other liquid assets of $92MM:
• ($89MM in securities owned plus $3MM in marketable securities ($96MM marketable securities less $93MM securities loaned) less $1M in repurchase agreements.

Separate capital structures are given in the pro-forma capital structure section.

The below worksheet summaries this section:


Nasdaq shares (“NDAQ”)

On June 28, 2013, BGC sold eSpeed to Nasdaq, Inc. for $750MM in cash plus an expected payment of up to 14.9MM shares of Nasdaq common stock paid ratably over 15 years beginning in 2013, assuming Nasdaq generates at least $25MM in gross revenues each of these years (vastly below the current level).

In connection with Newmark’s IPO in December 2017, BGC transferred to Newmark the right to receive the remainder of the Nasdaq payments. Newmark recognized the first of payment in Q3’17, and planned to receive shares ratably in Q3 of each of the next ten fiscal years (0.992MM shares a year).

On June 18, 2018 Newmark entered into a transaction that essentially saw NMRK:

• Receive net proceeds of $153MM, with proceeds being used to pay down the converted term loan.

• Monetize 2019/2020 Nasdaq shares and issue $175MM of exchange preferred limited partnership units.

Newmark, post the recent sale, retains several years of NDAQ share distribution. The below calculates the total value to Newmark based on the recent NDAQ stock price. The total undiscounted and untaxed value is $747.8MM, or $654.4MM not including the upcoming Q3’18 payment. This corresponds to the 6/20/18 BGCP annual shareholders meeting conference call, which stated this value to be approximately $650MM.

Using NDAQ’s WACC as the discount rate and Newmark’s tax rate, results in a post-tax NPV value of $431MM, as highlighted below.

Pro-Forma Capital Structures

The below summarizes the new capital structure of Newmark and BGCP with summary financials.

Newmark new capital structure and summary

As Newmark will be hedged out via a short of Newmark’s current stock in the same ratio as the spin-off ratio, a simple projection model based on consensus expectations was used.
 
BGCP new capital structure and summary



Key financial notes:

• Until Q3’17, BGCP accounted for the NDAQ impact within their financial services section, the SpinCo. The above numbers have been adjusted to remove this impact.  For example, BGCP’s headline management EBITDA number of $398MM Q1’18 LTM EBITDA includes the NDAQ impact; removing this results in a value of $359MM.

• Key financial drivers were in line with recent results:
Electronic Brokerage:  10% revenue growth.
Data, software and post-trade:  3% revenue growth.
Data, software and post-trade (inter-company): 5% revenue growth.

o Fenics (Fully Electronic) Revenues (SpinCo): a total of 6% revenue growth.

o Voice/Hybrid Other  (SpinCo): a total of 2% revenue growth.

o Pre-tax adjusted earnings
Fenics: flat margins assumed, as with 2017/2016.
Voice/Hybrid: 2% improvement in margins.

Company Review

Consolidated Segments

The consolidated company gave results by Financial Services (the RemainCo) and Real Estate. Distributions from Nasdaq holdings until Q3’17 were included in financial services, removing them from pre-tax adjusted earnings lower but also smoothes margins as shown above.   

BGCP Stand Alone

BGCP post spin will be a simple commission based agency trading model. The segment acts as an agent/intermediary between other banks and focuses on esoteric credit based products traded via the OTC. The company’s primary products are credit, rates, FX, equities, energy and commodities. BGCP provides anonymity, price discovery and liquidity to trading partners and takes no principal balance sheet risk.

Today, BGCP has 35-38% market share of brokering only revenue, which is a subset of the $10bn+ interdealer broker market, which itself is a small piece of the larger bank FICC market of $165bn and exchange/execution/data market of $47bn. BGCP has over 2,500 brokers and salespeople and over 200 financial desks in 30 cities.

• Fenics - electronic trading side of BGCP partners
o There is a secular shift from a traditional voice/hybrid business to a fully electronic trading platform, such as FENICS. BGCP has wisely invested in this shift and benefits from the flow from its voice/hybrid model to its FENICS product at 3x higher margins.
o Examples of BGCP investing in this sub-segment include the GFI acquisition in 2015 for $750MM with $90MM in cost synergies, which included Trayport (an electronic information services and energy trading platform in the UK) that was sold in 2015 for $650MM, creating the core business for 1x synergies.

• Voice/hybrid trading
o Voice/hybrid trading has a higher share of revenue but lower margin and growth than FENICS.
o The company’s illiquid and esoteric nature of products traded suggests a large proportion of BGCP’s volumes are not likely to be traded on an exchange or completely electronically.
o Industry consolidation has occurred in this space with two of BGCP’s largest competitors engaging in a transaction.

o On 11/11/2015, TLFP acquired ICAP’s voice brokerage business for 10x pre-tax earnings, leaving TLPR LN a pure play voice/hybrid competitor and ICAP an electronic and information services provider.

Newmark Standalone

On the commercial real estate brokerage side, BGCP entered this business with the acquisition of Newmark Knight Frank in 2011. Since 2011, Newmark has purchased over 35 companies, including its 2012 purchase of CRE brokerage “Grubb and Ellis” out of bankruptcy for a token price, as well as Silicon Valley based Cornish & Carey in CRE services, Apartment Realty Advisors or (ARA) in multifamily investment sales, and Berkeley Point in GSE lending and servicing. Over the past 6 years, BGCP took Newmark from zero to over $1bn in revenue. Newmark is headquartered in New York City with over 120 offices in 90 cities, 4,600 employees, and over 1,500 revenue-generating producers.

Main segments:
• Leasing (39% of revenue)
o Key drivers: volume of leases signed and market rental rates
o Revenues are split with the leasing agent, with the leasing agent receiving 50-60% of the total revenue in commission.

• Sales / capital markets (25% of revenue)
o Investment sales, equity financing, loan sale advisory
o Key drivers: CRE transaction volume and pricing, impacted by financing availability.
o This sub-segment has been pressured lately by the reduction in office transactions.

• Management Services (24% of revenue)
o Commercial services for tenants and landlords. Services include property and facilities management, servicing of loans originated by NRMK and third parties.

• Mortgage Banking (13% of revenue)
o This is entirely driven by the Berkeley Point transaction that Newmark bought in September 2017.
o Consists of origination of loans with borrowers and sales of loans to investors.

Within the CRE industry, Newmark has a vastly higher degree of stock compensation compared to peers, a large segment of the company’s adjusted EBITDA. This is due to the company’s structure as a partnership model, where producers sign multiyear employee agreements and accept equity as a large portion of their compensation. The valuation impact is notable and quantified below. CRE brokers are a historic high beta sector as shown below:

Source: 1/8/18 Goldman Sachs on Newmark
 
Valuation

Newmark

Newmark trades in-line with peers, including all management add-backs and excluding NDAQ value. Newmark is cheaper than peers when NDAQ value is included, and management add-backs are included.

For Newmark, stock comp (and other adjustments) makes up a large portion of adjusted EBITDA and has a large valuation impact as shown below.There is great sensitivity with stock comp as a higher stock price results in less shares issued and therefore a lower the dilution / higher EPS impact. Of course this works in the opposite direction as well.

Newmark is being removed from the BGCP trade via a short of the SpinCo distribution shares.



Newmark 2019E EV/EBITDA with management adjustments

Newmark 2019E EV/EBITDA without management adjustments



 

BGCP

The below shows the EV/EBITDA of BGCP standalone, with the full value of the spin shares at current market price. Adding the full value to BGCP’s standalone EV however understates their impact as its spread out among BGCP’s entire market cap (i.e. this NMRK spin valued is added to BGCP’s standalone EV, which includes 482MM shares), however only 314.1MM of BGCP’s shares (Class A and B) are due to receive the NMRK shares.

Upside 1 – Management’s Expected Spin Ratio of 0.47851

A sum of the parts on BGCP results in a 39.9% upside as shown below. This includes the NMRK value that class A and B shareholders are due to receive based on the current spin ratio and multiples below peers/precedent transactions.



 
Upside 2– Full Conversion of Units - Expected Spin Ratio of 0.31183

However, if all of BGCP’s 482MM diluted shares and units decide to receive NMRK’s stock, the difference would be approximately a $2.38/sh impact and thus a lower spin ratio.  The new spin ratio would be 0.31183, or 482MM / 150.3MM = 0.31183



Downside

Downside 1– Management’s Expected Spin Ratio of 0.47851

A downside package target for BGCP with reduced multiples: 7.5x multiple for Fenics and a 4.0x multiple for voice/hybrid. The Fenics multiple is half of Nex Group’s multiple and the voice/hybrid is below the valuation for TP ICAP, even with TP ICAP’s recent 35% downward move.


 
Downside 2– Full Conversion of Units - Expected Spin Ratio of 0.31183

Using the same multiples as the downside case 1, with the lower spin ratio results in the following:

Peer Review

Source: Compagnie Financière Tradition Q4’17 Investor Presentation

TP ICAP PLC

TP ICAP was the combination of Tullet Prebon and ICAP’s hybrid/voice brokerage (12/30/2016), with ICAP’s electronic brokerage becoming Nex Group. TP ICAP is a near pure play hybrid/voice brokerage broker. On July 10, 2018, TP ICAP PLC issued a profit warning and their CEO resigned, causing the stock to sell off by 35%.Weakness was due to higher costs from Brexit and MiFID II, IT costs (the company is moving to a large IT platform) and higher broker compensation (at least 51% of revenue up from 50.5% in 2017, despite expectations for a level in the high 40s).

Compagnie Financière Tradition

CFT SW is a low to no-growth traditional Swiss brokerage hybrid/voice brokerage trading above BGCP stand-alone despite lower margins and a lower quality mix. While CFT SW may have been an interesting hedge to explore, the stock has a low market cap and very low trading volume.

Nex Group

Nex Group post their asset sale to TP ICAP is a near pure play electronic brokerage.
Appendix

STRUCTURE OF BGC PARTNERS, INC. FOLLOWING NEWMARK IPO

Source: Q1’18 10Q

 
Sources:
BGCP

6/28/18 Form 11
BGC Partners, Inc. Deferral Plan for Employees of BGC Partners, Inc., Cantor - Statements of Net Assets Available for Benefits
https://www.sec.gov/Archives/edgar/data/1094831/000119312518207716/0001193125-18-207716-index.htm

6/22/18 Form 8K
Annual meeting votes
https://www.sec.gov/Archives/edgar/data/1094831/000156459018016025/0001564590-18-016025-index.htm

6/20/18 Annual BGCP Stockholders Meeting Deck
http://s1.q4cdn.com/101769452/files/doc_presentations/2018/06/BGCP-Investor-PPT-June-2018-Annual-Meeting-vFINAL.pdf

6/20/18 Form 8K
https://www.sec.gov/Archives/edgar/data/1094831/000119312518197451/0001193125-18-197451-index.htm

RBC Transaction. Newmark reaffirmed outlook for the full year 2018. BGC updated its consolidated outlook for the second quarter of 2018.

5/25/18 13D Cantor
https://www.sec.gov/Archives/edgar/data/1094831/000156459018014428/0001564590-18-014428-index.htm

5/10/18 10Q Q1’18
https://www.sec.gov/Archives/edgar/data/1094831/000156459018013040/0001564590-18-013040-index.htm

NMRK

May 2018 Analyst Day Presentation
http://s22.q4cdn.com/537561515/files/doc_presentations/2018/05/NMRK-Analyst-Day-2018-Presentation.pdf

IPO Prospectus
https://www.sec.gov/Archives/edgar/data/1690680/000119312517368896/d298983ds1a.htm

Catalyst

Spinoff of residual Newmark by Q4'18 / Q1'19