Description

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:

1. 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.
   1. 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!).
2. 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.
   1. 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.
3. 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).
   1. 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.
4. Howard Lutnick: the CEO and largest shareholder (> 25% of the company) cuts a controversial figure. He is loud, outspoken, and not for everybody.  
   1. 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:

1. Trading volume catching up to issuance +
2. Issuance levels high and the outlook strong for continued strength +
3. BGC revenues mirroring broader volume =
4. 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.

THE POINT: before you get tripped up on the catalyst path, BGC’s electronic efforts, buyback math, incentives, or index inclusions, it’s key to understand the tailwinds underpinning BGC’s business. To us, this de-risks our downside. We can track this as we go – we will be able to see, in real time, if rates plummet, volatility dries up, and we return to how things were from 2009-2022.

Simplification

Our general SOTP experience suggests that complexity is an obstacle to value discovery. With that in mind, the current layout needs to be reduced to something more digestible.

SOTP: big upside if BGC can garner comparable peer multiples for electronic efforts

Without question, underwriting sales multiples makes us uneasy. But in this case, we have fledgling, growth-mode assets with nothing more than longer-term target margins, so a sales multiple is the best we can get. We can sanity check the likelihood of the target margin with the levels of similar at-scale businesses and see the corresponding implied EBITDA multiples. Bottom line, it all foots, but it is not what a value investor normally underwrites, so it requires a copious degree of validation.

We think the comps show us what this could be worth if things break right. Moreover, we think the imminent FMX transaction will be vital in showing that legitimate, respected market participants will put up real dollars (read: more than $100MM) at these prices. Finally, the beauty of the exercise is that the stock is still trading at a $6- handle. If you think this math is crazy, it’s a free country! Slash away. But we believe there is exceptional value on this side of the business and the company wants to find a way to get full credit. If they succeed, this takes the stock to $16 on our math.

What to Monitor

              To see if we are tracking, we are watching for the following four things:

Index Inclusion

One final consideration is how the C Corp conversion has aided the causes with respect to attracting passive, index money. Improved liquidity and a large market cap will already necessitate a sizable Russell 2000 re-balance buy in December. From the Jefferies desk:

              For the S&P 600, eligibility requires a company to be US domiciled (NY - check), listed on a primary exchange (Nasdaq – check), with a Corporation structure and common stock (check), and with a market capitalization between $850mm-$5.2 Bn ($3.2 Bn - check). There is also a liquidity threshold (check) and a financial test requiring GAAP continuing EPS positive for the sum of the preceding four quarters (check). The final hurdle is simply industry composition. This is discretionary on the part of the committee and involves considering a desired mix as well as what kind of companies are being replaced. Of note, Financials is the largest sector (17.9%), which is good insofar as the index likes fins, but it also means BGC likely needs a financial to go out for it to come in. Deletions occur all the time, be it mergers, take-privates, moving up to the MidCap 400, or having problems and falling out of compliance.

              We read a KBW note that required buying could be 40mm shares (approaching 10% of outstanding shares and 20 days of volume). We have not checked that math and heard others speculate 50-55mm shares. Who knows. Bottom line, it is a “nice to have” and appears to be “when not if.”

Other Issue: SBC

              We often hear pushback about BGC's excessive stock-based compensation. We don’t disagree: it is high and we have argued as much to management. A couple of points in the company’s defense. First, some of the SBC ends up in grants with periodic vesting. When employees leave, as they often do, shares are forfeited so the dilutive impact ends up being less. Second, BGC has dropped its sharecount by 10% in recent periods (paid by insurance proceeds and FCF). Ultimately, the sharecount will be the arbiter and we expect it to fall. That said, we continue to push management to control this cost and thereby improve earnings quality.

Conclusion

              We think BGC has a secular tailwind that can take the stock to $10. The core business is a thematic winner in elevated issuance levels and a return of volatility and related trading activity. Juicing the bet is the potential for accretive electronic asset sales. Index inclusion will help technically and we see a motivated team fighting for every last dollar.

Current Investment. We have a significant long position in the securities mentioned in this presentation. Therefore, we will benefit if the stock price increases.  We may buy, sell or sell short the securities at any time without notice to anyone.

Statements of Opinion; No Duty to Update.  The statements in this presentation regarding the outlook for the business, future prospects, potential growth opportunities, financial projections, potential restructuring opportunities and similar matters are based on our opinions and beliefs as of the date of this presentation, may not be correct, and are subject to change without notice.   We have no duty to correct or update any information contained herein. 

Preparation of Report. We prepared this presentation. It was not compiled, reviewed or audited by any independent party. The presentation contains and is based in information (including information from third party sources) that we believe to be correct, but it has not verified that information and does not represent that such information is accurate or complete.

Forward-Looking Statements. There is no guarantee that the views and opinions expressed in this presentation will prove to be accurate. Such statements are not guaranties of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual returns could differ materially and adversely from those expressed or implied in any forward-looking statements as a result of various factors.

No Offer or Solicitation; Not Investment Advice. The information in this presentation is not an offer to sell or the solicitation of any offer to buy any securities, or an offer to provide investment advice or a solicitation of such an offer. This information is not investment advice, and no one should rely on the information contained in this presentation to make any investment decision. 

Catalyst

- FMX announcement (at least the names of partners, but eventually the terms of the minority sale, including cash contribution and pre- and post-money valuation)
- R2K index buying (December 2023)
- S&P 600 inclusion (TBD on timing, but eligible now, so could be next 12 months)
- Additional electronic trading assets monetized, proceeds to buybacks