The Toronto-Dominion Bank (TD) Q2 2015 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen and thank you for joining Cowen Group Incorporated Conference Call to discuss the financial results for the 2015 second quarter. By now, you should have received a copy of the company’s earnings release, which can be accessed at Cowen Group Incorporated’s website at www.cowen.com. Before we begin, the company has asked me to remind you that some of the comments made on today’s call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties described in the company’s earnings release and other filings with the SEC. Cowen Group, Incorporated has no obligation to update the information presented on the call. A more complete description of these and other risks and uncertainties and assumptions is included in the company’s filings with the SEC, which are available on the company’s website and on the SEC’s website at www.sec.gov. Also, on today’s call, our speakers will reference certain non-GAAP financial measures, which the company believes will provide useful information for the investors. Reconciliation of these measures to GAAP is consistent with the company’s reconciliation as presented in today’s earnings release. Now, I would like to turn the call over to Peter Cohen, Chairman and Chief Executive Officer.

Thanks, operator. Good morning, everyone. Lot of people called in, very happy to see that. Welcome to our second quarter earnings call. With me are Jeff Solomon, President of Cowen Group, Steve Lasota, our CFO, and a few other people from senior management. The second quarter was a mixed quarter. The conversation over interest rate hikes and the Greek potential default and the whole euro fallout from that kind of dominated the conversation, which led to mixed equity markets with the blue-chip benchmarks largely flat while the smaller cap indices outperformed and the mid caps pulled back. Healthcare was the best performing sector and the S&P and capital market financing activity was actually very robust despite of the market’s sort of confusion over the aforementioned issues. The amount of global M&A activity also continues to be quite meaningful reflecting the lack of growth in a number of economies and industries around the world. Outgrowth of that activity has been an increase in merger arbitrage spreads as there remains and has been consistently a relatively small amount of capital chasing too many transactions now that a lot of the larger big banks are basically precluded from participating in that. And even multi-strategy shops have just allocated a portion of their assets to merger arb, which is a good news story for us long-term, but has volatility in the short-term. Against this backdrop, Cowen reported solid results. Economic income revenue grew 12% year-over-year to $124 million. Second quarter economic income $10.2 million, a 19% increase over the prior year on a per share basis. Economic income was $0.09 per diluted share compared to $0.07 a year ago. Investor demand in the new issue market remained positive and the level of activity within our focus sectors, particularly healthcare, was very high and continues to be high. Our equities business continued to improve its market share despite a wallet that has been in decline in recent years. And at Ramius, our alpha-generating investment capabilities are resonating with clients. As a result, we continue to track new assets with AUM exceeding $13 billion at the end of the quarter. We are very encouraged by the potential of the new products we have in the pipeline and development. Over the last several years, we have built a business that has grown significantly both organically and through acquisitions. Increasingly, we think we will be consistent despite mixed market environments and I think that really attests to the stability that’s been built into the platform. As we have stated many times in the past, our goal is to evolve our organization to one that is successful over multiple market cycles and we think we are well along to accomplishing that. With $1 billion in total capitalizations, we are on our strongest capital position since the formation of Cowen Group in 2009, I would probably say the strongest position Cowen has ever been in its 97-year history. This position has enabled us to focus our organization around businesses that help our clients outperform, provides us with the flexibility to pursue opportunities, to penetrate new markets that can fuel our growth – all of the announcement we already made this morning and the one we made a few weeks ago, which we will cover in a few minutes, as Jeff provides additional color around the opportunities we see with respect to our recently announced agreements to acquire Concept Capital and Conifer Securities and our decisions to enter the prime brokerage space. Before I turn the call over to Jeff, as always none of this would happen without the tremendous effort of all of our colleagues in the firm. I and we want to thank them again for their commitment to turning this organization into something really special and I want to thank everybody for that. With that, let me hand this mic over to Jeff.

Thanks Peter. I will begin with a review of Ramius. As we discussed previously, one of our core competencies at Ramius has been the identification of differentiated alpha generating strategies that are highly relevant in today’s investment climate and have an addressable market for distribution. Our seven investment capabilities led by in-house and affiliated teams continue to see strong asset inflows. In the second quarter, AUM grew by $381 million ending the quarter with $13.2 billion in assets under management. Although the average management fee is not a metric we manage to, in the second quarter of 2015 it was 51 basis points compared to 55 basis points for 2015. Our strongest growth in AUM this quarter came from our activist strategy and our new global macro strategy, which had a successful fund launch during the second quarter and also won a sizable separate account mandate. Interest in the global macro strategy came from a variety of sources, including pension funds, endowments, high net worth individuals, family offices and fund of funds. In all we raised more than $280 million in this strategy for the quarter. In addition, Ramius Alternative Solutions secured a significant mandate that is expected to be funded during the third quarter and we also had positive inflows into our real estate and event-driven capabilities. As Peter mentioned, market volatility in June had a negative impact on performance fees in the activist strategy and was the primary reason for this quarter’s decline in incentive fees. At Ramius, we have the ability to position our strategies into various products to meet specific needs of various channels into which we sell. Those products include alternative mutual funds, traditional private funds and managed accounts. We are also exploring other formats such as RICs, BDCs and UCITs that we believe can meaningfully add to our asset-raising capabilities over time. As such, we continue to optimize our sales and distribution capabilities to make sure we direct our resources into the appropriate channels as we look to grow the business. This quarter we added an additional senior marketer to focus on single and multifamily offices for our innovative investment capabilities often find warm receptions and another to work primarily with the alternative solutions business. Finally, we continue to actively diligence several potential new investment strategies that we think outlines our performance solid alpha-generating potential. We hope to have these strategies on the platform later this year. Now, turning to Cowen & Company, our investment banking division reported another strong quarter. We again benefited from an active new issuance calendar and favorable dynamics in healthcare. We saw improved contribution also from M&A fees. In equity capital markets, we participated in 39 equity transactions in the quarter compared to 32 in the prior year period and our average fee per transaction was up 65% year-over-year primarily due to the number of book-run transactions we completed. Healthcare continues to be one of the most active sectors for IPOs and follow-ons. In the first half of 2015, total proceeds raised by sub $1 billion market cap healthcare companies were $33 billion, a 94% increase over the prior year period. Similarly, Cowen’s healthcare ATM revenue was up over 90% for the same period. We are impressed with the rate of innovation taking place in healthcare to the ongoing financial requirements fueled these companies development plans. And we believe these long-term trends will continue for the foreseeable future. To illustrate the consistent capital needs within the life sciences sectors, since 2011, Cowen has banked 256 transactions for 90 life sciences clients. 68 of them have been repeat clients representing 202 transactions or three transactions per repeat client. We believe that repeat clients, is one of the best metrics for judging the sustainability of the franchise over time and we are pleased that we are doing so well in that area. It’s also worth mentioning that we did not experience a slowdown in banking and capital markets despite the market volatility experienced in June. In debt capital markets, we closed three transactions this quarter. And in our strategic advisory business, we also had a healthy second quarter. Of note, revenue in the quarter included a sizable fee for the long-time equity and debt capital markets client. Winning M&A mandates from clients like this has proved the organization can scale over a longer time into more meaningful trusted advisor relationships as we further develop. In our equities business after adjusting for revenue associated with the stock loan business, which we wound down in the fourth quarter of 2014, brokerage revenue was up 4% year over year, a solid result in a difficult declining volume environment. Growth in the electronics business as well as the options businesses were the primary contributors to performance in the quarter. During the quarter we formed a new POD in sales and trading that will systematically address the emerging managers and family office accounts. This group is led by two individuals who have substantial experience in addressing these clients at their previous firms and their knowledge and relationship base is expected to be accretive to equities as we look to make further market share gains beyond the top 200 clients. This dovetails with our recently announced agreements to acquire Concept Capital and Conifer Securities. The acquisitions mark our entry into the prime brokerage business and provide us with an opportunity to deliver our premier institutional products and services to emerging managers. The emerging manager and prime broker opportunities are logical growth opportunities for our research inequities franchises as well as our capital markets franchise. According to market research the commission pie from our non-focus accounts exceeds that of our core focus accounts and if we are able to penetrate these accounts like we think we can, we estimate a meaningfully addressable increase in revenues and equities. Our push into this area not only reflects our belief that we can take market share from competitors, but it is very much in keeping with our strategy to add accretive revenues that help reduce the fixed cost nature of our business. I will now turn the call over to Steve Lasota who will review our financials. Steve?

Thank you, Jeff. In the second quarter of 2015 we reported GAAP net income attributable to common shareholders of 6 million or $0.05 per diluted common share compared to GAAP net income attributable to common shareholders of $8.4 million or $0.07 per diluted common share in the prior year period. The second quarter GAAP net income attributable to common shareholders includes a $3.3 million income tax expense whereas the comparable quarter did not. As a reminder, with the release of our deferred tax valuation allowance in the fourth quarter of 2014 our GAAP results reflect an increase in income tax expense. However, given the size of our deferred tax asset, we do not expect to be a cash tax payer for several years. Second quarter GAAP net income attributable to common shareholders also includes preferred stock dividend of $755,000 which is associated with the preferred stock issued in May. In addition to our GAAP results management utilizes non-GAAP financial measures, what we term as economic income to analyze our core operating segment performance. We believe economic income provides a more accurate view of the operating businesses. In general, economic income is a pretax measure that excludes the impact of accounting rules that require us to consolidate certain of our funds, certain other acquisition related expenses, re-org expenses and taxes, goodwill and intangible impairments and preferred stock dividends. The remainder of my comments will be based on these non-GAAP financial measures. In the second quarter of 2015 the company reported economic income of $10.2 million or $0.09 per diluted share. This compares to economic income of $8.5 million, or $0.07 per diluted share in the prior year period. Second quarter 2015 economic income revenues were $124.4 million compared to $111.2 million in the prior year period. Investment banking revenue was $68.5 million, up 126% year-over-year from $30.3 million. Brokerage revenue rose 4% year-over-year to $34.9 million after excluding revenue from the stock loan business which was wound down in the fourth quarter of 2014. Management fees were $16.5 million, a 2% increase over the prior year period. Investment – incentive income was a giveback of $7.8 million compared to income of $7.8 million in the prior year period. We generated $12.2 million in investment income compared to $21.6 million in the prior year period. Compensation and benefits expense was 60% of economic income revenue compared to 57% in the prior year period. The variable non-compensation expenses were up 4% compared to the prior year period to $12 million. This increase in variable non-comps is attributable to an increase in client services and business development. Fixed non-comp expenses totaled $24.8 million in the quarter compared to $22.8 billion in the second quarter of 2014. This increase was primarily due to higher legal and other professional fees and an increase in costs from equity method investments. Stockholders’ equity increased by $251 million from June 30, 2014 to $786 million at June 30, 2015, which is primarily related to the release of the valuation allowance against deferred tax assets in the fourth quarter of 2014 and the issuance of preferred stock in May of 2015. Common equity, which is stockholders’ equity less the preferred stock was $684 million. Book value per share, which is common equity divided by shares outstanding, is $6.22 per share. Invested capital grew to $736 million as of June 30, 2015 versus $579 million a year ago. Finally, moving to our share repurchase program, in the second quarter we repurchased approximately 2.8 million shares in the open market and 1 million shares as a result of net share settlement related to the vesting of equity awards at an average price of $5.53 per share and the total cost of $21.1 million. Since we announced our original repurchase program in July 2011, we have repurchased 21.8 million shares in the open market and an additional 7 million shares as a result of net share settlement related to the vesting of equity awards. The total cost of all buybacks for the second quarter 2015 was $109 million which represents an average price of $3.79 per share. As of June 30, 2.4 million remained available under our share repurchase program. On July 30, 2015 Cowen announced that its Board of Directors have approved an increase to the company’s share repurchase program that authorizes Cowen to purchase up to an additional 22.6 million of Cowen’s Class A common shares from time to time bringing the total available for purchase to 25 million. I will now turn it over to Jeff for closing remarks.

Thanks Steve. As you all know there are five ways we generate revenue; investment banking, brokerage, management fees, performance fees and investment income. Each of these revenue lines has experienced significant growth in recent periods even as we have streamlined the business and created opportunities to penetrate markets. It is becoming more evident with our quarterly results that our businesses have scale and operating leverage. Whereas in the past it was more about getting our fixed cost structure in line with the revenue opportunity, as we look to the future we are talking about driving revenue and adding margin to the bottom line through organic growth and acquisitions. We are always strategically evaluating all of our options for growth. Both the acquisitions of Dahlman Rose in 2013, ATM in 2012 are strong examples of our ability to source and integrate robust businesses into the Cowen platform and deliver meaningful products and services to our clients. We look forward to our new partnership with the teams at Concept and Conifer as we continue to push our efforts to serve our clients’ basic needs to outperform. Before we open the call to questions, I would like to say thank you again to all of our colleagues for their passion and focus and making it happen every day at Cowen. Operator, we can open up the line now for questions.

[Operator Instructions] Our first question comes from the line Devin Ryan from JMP Securities, your question please.

Hi, great. Good morning everyone.

Hi Devin.

I guess just maybe starting on the prime brokerage question with the two acquisitions here and just maybe want to dig a little bit more into how this business fits strategically with kind of both businesses, both brokerage and Ramius, I know that there is more focus on emerging managers, is that the way it will continue, do you expect to try to go after some of your kind of existing brokerage relationships. And then I also suspect there could be some benefit to on-boarding new managers in Ramius just given that you could have some introductions to a number of new emerging managers, so I would love some thoughts there?

I am going to let Jeff answer this question. It’s got multiple tentacles to it in terms of what we think its impact on the firm can be. But Jeff, why don’t you just run through it.

So I think to start with the core benefit to the business has been as we have solved for really catering to the top 200 institutional accounts and building a platform to distribute our research and capital markets transactions to those clients, we see an opportunity to expand that audience significantly both in the new and emerging manager POD that we developed here as well as through these two acquisitions. So this is an underserved market. The larger institutions we know have been really not doing business or looking to not do business with smaller accounts and in fact some of the larger banks have actually exited the many prime business for smaller accounts and have forced significant amount of realignment, both Concept and Conifer have been beneficiaries of that move as the larger banks have really kicked out smaller managers. And we feel like with our content that we provide capital markets transactions that we do and really our electronic offering, our algorithmic capabilities, there is just a lot of things that we can be selling into that channel to really help those clients perform better and our organization is more sort of in tune with what the needs are. I think that’s partly reflective of the fact that so many of us grew up as emerging managers. So, I think we have the senior management here has an innate feel for what it means to try to scale your business. It’s certainly something that we do at Ramius a lot as we have lot of high-quality teams. I think anytime you can build connectivity into that marketplace, there is option value around being able to find really talented managers. So, I don’t want to say that we are going to be using that as a screen for identifying alpha managers to become part of the Ramius platform, but we are certainly going to have enough connectivity with them. And if we see managers who are looking to scale who can benefit from having a more wholesome relationship with us where we can aggregate capital and really do more of a sponsorship, then that’s a great thing to do. And so I think there is option value associated with that, but the two transactions really stand on their own as being accretive and certainly just from the Cowen & Company side I think provides significant growth opportunity.

Got it. That’s helpful. I mean, I guess just maybe to summarize is there the view that this business is just one more service to offer clients maybe some new clients or on a standalone basis, you guys see pretty big potential with where this could be and maybe not immediately but down the road?

I think it’s both, Devin. It’s not insignificant additional revenue without the overhead, because we have got all the infrastructure. It helps, really helps absorb overhead at the firm. So, it’s very – as Jeff said, it’s accretive. It’s for us going to be fairly high ROE business, incrementally high ROE business. We think it’s scalable, because under the Cowen franchise, we think it’s an attractive place to come given our distribution capabilities, our meaning our calendar capabilities, our research capabilities. And then on top of that we think that it will identify perhaps opportunities on the asset management side, where we can sort of pluck and grow some of these unique new managers and scale them into something more significant. As Jeff said, the big banks are shedding because of all the capital requirements being in this business, they really – they are scaling back on all the smaller prime brokerage clients and these firms are becoming orphans. They have no place to go and we have now created what we think is a great platform to attract them that has all kinds of benefits for us long term.

So just to pick up on that thread, so at Ramius, we have had a long-term relationship with the prime brokers, so two decades worth. And we have really actually productive relationships with the larger prime brokers and so we are leveraging that connectivity with them to really look at some of their smaller managers that they just can’t service adequately as they focus their business. And they are viewing us in many respects as an aggregator of smaller accounts, so they really only have to face off with one counterparty. We are happy to engage with smaller managers, because our product offering is a little bit more in tune with what their needs are and we can really focus on the ones that help to drive revenue and the revenue that we derive from them is meaningful for us, but not necessarily meaningful for the bigger banks. And so as we engage with the prime brokers, the larger ones, they are actually encouraged by the fact that we have entered this business and a few of them have actually reversed into us and said we would like you to look at some of the smaller managers we have as we look to transition them off of the platform and still maintain connectivity with them. So, I think we are starting to see that already even before the transactions close and we are obviously taking great care to make sure that we do that the right way.

Great. I will appreciate all that perspective. Maybe moving on to Ramius, asset gathering just continues to be a really nice story for you guys. And so I don’t know if you can give any more perspective of what the flows were in the quarter. I know AUM was up about $400 million, but what the flows were and then what products you are seeing had the most momentum in?

So, without being specific, I mean too specific in terms of the actual dollars, we launched this new macro product with Nancy Davis and that’s off to a very sort of robust start in terms of AUM that’s been committed and some of it’s in, much more to come. Our RASL group, the solutions group, while they didn’t grow in the quarter have some significant mandates that will come in the fourth quarter. The activist Starboard group continues to grow. Our merger arb fund, which has had phenomenal performance, best-performing merger arb fund in the country last year, is now starting finally after a slow start to attract a lot of attention. So, it’s kind of across the board that it’s happening.

Just to echo Peter, the launch of Quadratic actually is more than just gathering assets, it’s really a validation of the strategy we started to do last year when we on-boarded this new team and really began to seed them with our own capital towards the end of last year and begin to build that capability. Obviously, it’s taken off really nicely as we have won a few significant mandates there from high quality institutions. And I think it’s more than just gathering assets, these are assets that really validate the ability for us to identify and count the individuals and teams and then scale them into meaningful businesses. And so it’s unusual frankly for a new fund to launch effectively and scale so quickly, but I think it’s really a great case study for what we aim to do when onboard new teams.

Okay, great. And then just a modeling question for Steve just on the, I guess, the incentive income reversal, what business drove that? And then secondarily are you guys working on Luxembourg reinsurance deals that could boost investment income in the coming quarters?

Well, it was a combination of our activist strategy in RASL and it was affected by on the activist side mostly by the merger arb spreads that Peter and Jeff both talked about. So, we book unrealized on a quarterly basis and obviously we hope to recover that as merger arb recovers in the second half of the year. And we are working on a Lux captive. We are in discussions with the regulator, but it’s still too early to tell what’s going to happen with that. So, hopefully we can give more in the third quarter earnings call as to what’s going on in that situation.

I think I want to clarify what Steve said. Merger arb was up for the quarter. The last few days in June at the height of the Greek crisis kind of derisking went on, merger arb gave back, but they are up for the quarter. It was on the incentive piece it was much more the activist group that where the effect was felt.

But because of merger arb because of one of the large positions they hold was affected by the Sysco, U.S. Foods merger and not being approved that, that….

Yes, that had an effect on some activist positions that are also merger arb positions.

Yes.

Got it. Okay, thanks a lot guys. I will hop back in the queue here.

Thanks, Devin.

Thanks, Devin.

Thank you. Our next question comes from the line of Joel Jeffrey from KBW. Your question please.

Hey, good morning guys.

Good morning.

Just thinking about uses of capital, I mean, you clearly I think you guys have indicated you are in growth mode with the acquisitions, but as you think about your repurchase activity and with the stock below tangible book, are you guys thinking about potentially being more aggressive with your repurchase activity at these levels?

Well, I think Steve spoke to it in his script when he talked about the fact that the Board has just re-upped. We bought back about 5 million shares in the second quarter, well, second quarter and some in the third quarter in private transactions. So, our authorization was down to just a few million dollars and the Board re-upped it. If you look at the last few years, our capitalization continues to shrink. And with the stock price where it is, I think that it’s not unreasonable to think it will continue to shrink.

And Joel, when we did our preferred bid we talked about the fact that we have it puts us in a really optimal situation to look at how to optimize capital better, the preferred is really it is equity, it never has to be repaid but it really financially levers in a very intelligent way the common equity. And so as we look to either do acquisitions that are accretive to EPS or scale new investment teams we think it will be accretive to EPS or shrink the capitalization, it really helps to drive EPS. We have all those tools in the toolkit and so we have been refining internally here how we are optimizing that and we have a lot of financial flexibility. The balance sheet is – it’s not a levered balance sheet, we just – we don’t believe in using leverage to drive ROE. It’s never been what we have done. So we have been extremely consistent about the way that we are going to approach it. And in our ROE optimization models we are just – we are constantly looking at uses of cash which can boost our EPS in the short-term, but also making sure that we keep enough capital around it to continue to have the kind of growth that we expect in the future in both our businesses.

Is that clear enough or did we just sufficiently confuse you?

No, that clears some things up. Thank you for that. Just going back to the prime brokerage business for a minute there, I appreciate the comments, but clearly you guys can sort of take on a lot of their costs and then get some synergies out of that, can you give us any sense for the kind of magnitude of the revenues we are talking about with these businesses?

Well, we will answer it by its accretive this year and we do expect to grow that business and have it be more accretive in the future. But we have some idea what the revenues are, but I can’t really share that right now.

So we are not disclosing that, I think it will manifest itself in sort of beginning really we hope to close these by the fourth quarter. So I think you will get a little bit of a glimpse into that in the fourth quarter and then certainly in 2016. Suffice it to say that we wouldn’t be doing this if we didn’t think it was meaningful enough on its own relative to the size of our equity book, our current book of business. The real opportunity here is what we think we can do with it once it’s here and whether or not we can continue to grow it. It makes sense, even if we don’t grow it, it’s accretive. So we feel like we have got a lot of upside from there. And we do expect it to be a significant contributor to our equity business.

Yes. Just again without being specific on the revenue but when we looked at these acquisitions we have a pretty good idea in our heads of what our benchmark return on equity has to be if we are going to spend capital, because we know what we have historically earned on capital and believe what we can earn on cash capital gross over the long period of time. And as we measure our opportunities we just compare are we better off continuing to hold on the balance sheet that liquidity for the right opportunities or is this the right opportunity that has returns substantially in excess of what we have been doing on the balance sheet and these met those tests. So I don’t think you should think so much about revenues, so they will benefit themselves when they do. And I think they build – we believe that they will make an impact. But from a return on equity we think they are very accretive.

So Peter mentioned something earlier and I think it’s worth noting on this. So if you take a look historically at what our non-compensation fixed costs were. We did a lot several years ago to try to get – trying to get ourselves more lean in terms of the non-compensation fixed costs. We have recognize that we weren’t going to be able to shrink our way the profitability. So it’s been for us growing the business organically. This is one of the first chances we are going to get to add meaningful revenues through acquisition. And we are really not adding a lot of fixed costs. So there will be some fixed costs that comes along with this, but relative to what our current – our fixed cost ratios are, it actually brings it down. And so Peter is absolutely right, this is about driving margin at the bottom as much as it is about growth at the top and we are in a very unique position we can do that because the infrastructure is here and there are just aren’t a lot of other firms like ours who can do that integrated as well as we can.

Okay, I appreciate that color. Just thinking about this business the opportunities clearly sound good, what are the risks of getting into this business?

Well, so just to be really clear to everybody we are still an introducing broker. So I think there is some maybe just to clear up any misimpressions. We are not in the prime brokerage business, we are self clearing. So we are going to continue to be an introducing broker in this business. And so from a financial standpoint there are actually very few risks associated with it because we are really standing in between counterparties that we underwrite which are our clients and our obligation to basically stand behind their settlement and clearance with the counterparties that ultimately hold the accounts similar to the way that we do it in the rest of our business, that’s really the financial risks. Look, there is operating risk. If we are wrong about the notion that these accounts will continue to grow and if we are wrong about the idea that there are that we can serve them well, then it’s always possible those accounts could go somewhere else or shutdown. And just in looking at the dynamics of that, if you look at the dynamics of what’s happening in an industry a fewer people are there to actually service these accounts even as the number of new accounts is increasing. So the dynamics suggest that this is going to be around for a long time and our skill is going to be in being able to back people that we think are ultimately going to be winners and scale them. And this is very much in thinking of this idea which I know we have talked about. If you can do great things for people when they don’t have a lot of people calling on them you can build long-term client relationships and we have talked about this philosophically internally and externally. We think that a lot of our competition just doesn’t have the time or the intestinal fortitude to build those over a long period of time. This is a great opportunity for us to really start up early on scaling really talented people and as they get bigger we will have the bigger share of their wallet simply because we are ingrained in their daily investment process. And so this is a multiple year effort that we will make. But from a strategic standpoint fits right into this idea, the DNA of the firm is trying to figure out ways to help all of our clients outperform and that’s really at the center of this.

Yes. I mean I will be a little less philosophical than Jeff. We have a fixed cost. We have a pipe here that can process business. It can process a lot more business than its processing without adding any diameter to the pipe. This was the key – this is what made Shearson so successful in the ‘70s into the ‘80s is that we figured that out and we kept building on technology. This is very much a technology play. Build technology, put more revenue through a constant or shrinking pipe and you get more ROE out of it. This could lead us to the prime brokerage, full-blown prime brokerage business as it scales. So there are places where you could go to get the services we provide. Now, these two organizations, it’s very limited and getting more limited. Some of the other people who do it don’t have research footprint, don’t have calendar to work with, we do. So we offer a lot and if it scales appropriately maybe we will become a full-blown prime broker. And that’s a very, very profitable business when it’s run right. This low interest rate environment we have been in for 6 years, 7 years now has kind of masks what that business’ potential is and what it has been in the past. I could tell you the single most profitable business isn’t Shearson Lehman Brothers consistently over the years, was the stock loan business. It’s not a particularly profitable business now because there is no spread. Spread comes back, it gets very profitable again. There are a lot of things about this that sort of have robust potential for the future.

Alright. Thanks for taking my questions.

Thank you. Our next question comes from the line of Steven Chubak from Nomura, your question please.

Hi, good morning everyone.

Hi Steve.

So I appreciate the volumes that you spoke Jeff and Peter on your foray into the prime services space, I suppose it maybe my effort to try and read the tea leaves a bit in terms of your broader strategy, but Volcker’s introduced a few years ago, we see the banks scale back their services to or their willingness to commit capital to emerging managers and you look to build out that capability. We now see that the leverage ratio is introduced, the banks no longer find it profitable to service a lot of the many prime clients, you see an opportunity there and you pursue that growth inorganically, I just wanted to get a better sense as to whether there are any other opportunities in terms of the broader regulatory landscape that’s driving your long-term investment strategy?

Well, yes, there are. And if you look at the Volcker Rule and where banks continue to be constrained, continue to have the requirements for additional capital, all of those that they are shredding and they are shrinking, all of those represent and a lot of them are let’s say flow-related business, proprietary trading businesses that creates enormous opportunity for us. And one of the things banks used to do is they used to invest in funds. They used to seed funds and get them on their platform. They can’t do that anymore. We actually sort of had a setback in our mezz lending business in our last fund, which we raised two years ago, it’s irrelevant today, but we had $150 million of commitments from banks. Those banks no longer can make those commitments to a fund. We raised the money around absent that and it fills up a whole new base of clients that as we do sort of real estate lending fund 6, which we will do in the fall we will start, we will do without the banks. So yes, it’s an opportunity for us to fill in a lot of places where we can put capital that the banks no longer are allowed to. And again, we don’t have any leverage. So, our capacity to sort of put money to work is I won’t say unlimited, but it’s substantial. We will probably be sort of making further announcements along the lines of how we are advancing our ability to deploy capital in the reasonably short future.

Nice, Peter. That’s extremely helpful. And I didn’t know if there were any other identifiable areas beyond the ability to seed capital as well as your decision to enter the prime services space, whether there are other businesses where you are seeing the bulge brackets retrench and there are clear identifiable opportunities to grow?

I would say that look we are looking at all of that. This is the first one, where we see a really obvious opportunity to take advantage of the dislocation of the Volcker Rule. I would say if you take a look at our balance sheet, obviously the fact that we have a significant exposure in merger arbitrage, which is a strategy we know exceedingly well and have done for multiple decades. A big part of that business as Peter alluded to earlier in the call was done by banks. I mean, every bank had its own proprietary merger arbitrage desk and now none of them do. And so one of the things we are seeing is that merger arbitrage spreads are very wide, because there is just not a lot of bank participation in that market anymore. Now, we also know that there will be capital that eventually flows in as some of those teams re-look at each other and reengage. But at the time being right now, they are actually in that business, which is a great spot for us to be in as we look to deploy our capital and things we understand really well where we can make good outsize risk-adjusted returns. So, we are doing that I would say selectively where the bank dislocation fits where we think we are good at doing something. And I think so you have got to look at both. It’s not just getting into businesses, because banks are getting out of them. It’s getting into businesses that banks are getting out of where we understand exactly how we can drive performance and so we will continue to look at all of them.

Yes, I mean, the question was asked a little while ago that we didn’t really ask answer about Luxembourg and we continue to sort of look at opportunities in Luxembourg. I have been there twice this year. Steve has been there twice or three times this year. We have an ongoing dialogue. But at this point now, it’s how to turn what we have done in Luxembourg, can do in Luxembourg into a new business that is a very low risk, high ROE business and that would be kind of the next step for us in that. One of the businesses that we are looking at is I think this comes right out of the banking sort of world is the leasing business, specialty leasing though, not your general run-of-the-mill, very bespoke-type leasing business with very high ROEs, pre-tax and very, very high post adjusted – post-tax adjusted ROEs. And I can tell you that we are swamped with things that we are exploring as opportunities to sort of grow around the core business on top of growing the core business. It’s probably never been a more exciting time for us right than it is right now.

Thanks Peter. Certainly a good problem to have at your end, just wanted to close things out with a couple of modeling questions, maybe this one is best for Steve, but just looking at the management fee rate we have seen that continue to come down. I know that there are some dynamics surrounding the timing of capital deployment as well as the mix of which strategies are growing more, but just want to get a sense as to what’s driving that decline and how we should be thinking about the trajectory going forward?

Steve, it depends on where the assets come in. As we have talked about in the past, we have some products that are lower management fee paying and higher performance fee and vice-versa. So, it does depend on the mix, although assets that are coming in currently which Jeff talked about are in higher fee paying products. So, we should see that start to tick up. Although in the second quarter, we also talked about Ramius Alternative Solutions business having a large mandate that may come in, in the third quarter that would be lower fee management fee paying. But so I know it’s difficult to model and that’s why we give just the aggregate number, but we do expect that to tick up.

Okay. And then just one final one, Steve, on the comp ratio, Jeff did mention a couple of new additions on the marketing side and I just want to get a sense as to whether we should still be thinking about 59% to 60% as the target range for the full year?

Yes, that’s what we expect.

Okay, perfect guys. That’s it from me. Thank you for taking my questions.

Thanks.

Thank you. [Operator Instructions] Our next question comes from the line of Mike Adams from Sandler O’Neill. Your question please. Mr. Adams, you might have your phone on mute.

Good morning, guys. Sorry about that.

Good morning.

So, a couple of questions on the deals that you announced, so the purchase price isn’t material, but in terms of valuation without getting into specific deal terms, can you at least walk us through your thought process on how you valued the franchise? Is it off earnings power some percentage of book, just any sense on return assumptions that you are making relative to what you are paying for the business?

So, definitely not book because these are not book intensive businesses. These are earnings driven and I think we have been pretty vocal about what we think we would like to be able to achieve with ROE as we move into the double-digits on ROEs. So, you can assume that any acquisitions that we are looking at will be accretive way in excess of what our current ROE is, otherwise why would we do this. So, I feel this is definitely earnings play here for us as we mentioned. So, when we looked at evaluating businesses we look at what we thought the net contribution would be and value them accordingly.

So, we have said in response to questions over the years that we think that our business should be, our target should be in mid-teens ROE return business in pre-tax economic income ROE in this environment, zero interest rate environment. If rates go up we think we should be able to do better than that. So, we have as you all know a lot of cleanup to do, a lot of rebuilding to do, we did that and now we are starting to march forward. So, I am pleased to say that as we looked at these, these have to be greater than our threshold expectation by a fairly substantial amount to get our interest, which then implies that the multiple of the EBITDA as is or adjusted for what we think is a fairly modest one. And that’s about all I can say about it.

Okay, great. And then Jeff following up on your commentary about the balance sheet, can you give us any sense of how this is going to impact Cowen’s tangible book value once the deals are closed?

These transactions?

Yes.

We will definitely see an increase in goodwill, because we are paying franchise value and we will see an uptick in goodwill.

Goodwill and intangibles.

Goodwill and intangibles, yes.

We will be amortizing some of the excess purchase price or the intangibles over time.

Both transactions, they have upfront payments and earn-outs. So, the teams that we are bringing on are adequately incentivized to continue to grow the business and they have got a lot of economic incentives to do that. The key individuals are tied up. It is very much a part of the organization. We have done a lot of what I would say pre-merger integration discussion. So, this is sort of the special sauce of how we have been able to do this. So, in addition to just being wonderful businesses in their own right we have had extensive conversations about how we grow and scale the business and with the right economic incentives aligned as part of the deal structure to ensure that the teams that we are bringing on will do even better as the business progresses.

I mean, we have as this expands our addressable account universe very substantially, very, very substantially.

Alright. And then Steve, a couple of questions for you, first when I am looking at the economic income, is this before the preferred dividend of $750,000?

Yes.

Okay, got it. And last one here, I hate coming back to the management fees again, but I guess ignoring the average yield on assets or however we are talking about, I guess, I am just looking at the management fees in absolute dollar terms declining and I am trying to reconcile that with really strong growth in AUM, just sequentially that number coming down. Can you explain that for me?

Yes, there was a distribution fee in the second quarter, which reduced our management fee. So, the run-rate is actually higher and it is getting higher in the third quarter as well based on the AUM of $13.2 billion that we talked about. But in the second quarter, there was a distribution fee that gets netted against management fees, that’s why it showed that it was it didn’t show the increase that really should be there.

Okay. And how big is that distribution?

It was a few hundred thousand dollars.

Okay, got it.

$200,000 to $300,000.

But fee income is growing, it’s not shrinking.

Got it. Yes, that makes sense. Okay, thank you guys. That’s it for me.

Thank you. Our next question is a follow-up from the line of Devin Ryan from JMP Securities. Your question, please.

Yes, thanks. Just a quick follow-up here. Linkem, which is your largest private equity style investment and I know you own that in some of the funds as well, so the absolute firm is larger. Can you give an update on where that investment stands? I know that maybe there are some interesting opportunities longer term in Italy. So, would love just any thoughts around timeline of monetizing and where you see the opportunity given that it is the largest?

Sure. So, Linkem has currently reached profitability in the fourth quarter of last year, profitability in the EBITDA line sense and continues to grow kind of on budget for its first full year of profitability. We continue to invest. We have very, very good long-term financing in the company. We will end this year with about 310,000, 320,000 subscribers. This was a year of very, I would say, dampened marketing activity on purpose, because when you are going through an LTE conversion, which is probably halfway done. And by the end of the year, first quarter of next year, we will have our entire system converted to LTE across Europe. And we are adding new cell sites, antenna sites across the country. We ended last year with 1100, we will be about 1,500, 1,600 by the end of this year. Then next year, the end of ‘16, we will be north of 2,000 sites. We expect the end of ‘16 to have a customer base approaching 450,000 customers. And it’s kind of our plan that as we look at sort of the infrastructure in place at the end of ‘16, your pro forma is what that is going to turn into steady state as early ‘17 would be the right time to take this company to the public markets. What I can tell you is that Italy continues to not have – to be sort of confused as to what it’s trying to do there. The government is desperate to try and figure out how to solve this problem of broadband connectivity in the country. For those of you who don’t know, Italy has 60 million people, 26 million households. Half the country is connected to broadband and it’s all through DSL. And as a kind of benchmark, DSL will deliver 5 megabits of download. We are currently delivering 20 through our LTE sites and about the same through our old WiMAX sites. So, as we get – we will be the first fully LTE deployed broadband – wireless broadband company in the country. And we already see the drawdown on the LTE customers growing three, four times – or being three or four times what the WiMAX customers are using. They are starting to stream movies. There was an announcement in Italy that the one company who has spectrum like ours, but a lot less, called Aria is merging with Tiscali, which is a DSL reseller, has about 500,000 customers. Tiscali has been losing a lot of money. Aria is losing a lot of money. And what we envision here is kind of like a desperation merger between the two that we think is highly, highly problematic that they can make this work. And the idea was that Tiscali would use the Aria spectrum to deliver broadband services to their DSL customers, but it’s not going to really work, because they just don’t have enough spectrum. We have 65%, 70% of all the 3.5 gigahertz spectrum in the country, which is now becoming the standard around the world for high-speed wireless. It’s being done – Softbank is doing it in Tokyo. They are replacing 2 million DSL customers with 3.5 gigahertz wireless broadband. It’s happening in the – China Mobile is doing it. It’s being done in Brazil. It’s being done by Dish. It’s being done in England. It’s really kind of why Clearwire was acquired by Sprint, was to get at that spectrum and that was financed again by Softbank who sees the future as wireless. You know, we will start to see the fruits of all this in the fourth quarter as we are going to start having got a lot of infrastructure to the LTE conversion done, we are going to start to ramp up our marketing. And if I had to certainly give you the progression, it will be 330 this year, 450 next, 750,000 the year after and then north of 1 million. Our goal is to get this company by kind of 2018, 2019, up to 1.8 million to 2 million subscribers. We would expect to be public long before that, but the EBITDA associated with that is quite, quite substantial. And any kind of reasonable valuation on that given our stake, it would have quite an impact, meaningful impact, on our investment value.

And just to follow-up, the percentage that you guys have owned either on the balance sheet and through the funds is what percent?

About 32% of the whole company.

Got it. Okay, great. I really appreciate that update.

Our partner here is Leucadia. It’s Leucadia and us really own 83% or 84% of the company. And our ownership is likely to grow because we will probably be doing another look at the capital infusion and the other Italian investors who are in there are not going to be able to keep up with us. So, our stake will grow in the company.

Great, thanks a lot.

Thank you. And we have another follow-up question from the line of Mike Adams from Sandler O'Neill.

Hey, guys. Just following up on that last line of questioning about Linkem, you mentioned that there was a merger in the space. I don’t know if you can share any of the deal terms or how that was valued on. I guess they are not profitable maybe in terms of numbers of subscribers, what they are paying per subscriber, but anything you could share would be helpful?

I mean, you can’t really glean anything out of it, because they just – they put these two companies together. And Aria is controlled by a group of Eastern European investors, some from Ukraine, some from Russia and as part of the deal they had to put more money in to help pay down debt on the Tiscali side. So, I mean, this is more of a restructuring of two companies than it is a merger where you can point to metrics and say here is a valuation. I mean, look what I will point to is there hasn’t been – other than the U.S. auctions which took place in the fall which yielded $45 billion – that was of course a broad range of spectrums. There hasn’t been an auction of 3.5G spectrum anywhere for a long time. Now, there is likely to be one in the UK later this year. If we had a guess, we would kind of say our spectrum is probably worth €0.20 per megahertz POP. To put that in perspective, we have 3.5 billion POPs that we own directly and another 1 billion that we own through a long-term lease, so 4.5 billion POPs. So, if you applied that metric, if you apply even a lower metric, it’s substantially in excess of our carrying cost.

Got it. And what is the carrying cost today?

$26 million, $27 million.

Yes. Well, Houlihan value – we deal through Houlihan and Lokey to have it valued on a quarterly basis. With the funds, as Peter said, it’s about $27 million…

No, with the fund.

With the fund it’s...

It’s $110 million, but the first portion is about $26 million, $27 million. It’s not even significant in our equity anymore at its current level. It could be very significant at a future level.

Got it. Okay, thanks guys.

For those of you that don’t know, Italy is very unique in that, there is no cable in Italy anywhere and so that’s why there is no broadband penetration. There is fiber backbone. There is fiber in some of the cities, central cities like Milan, mostly for businesses. There is only about 400,000 fiber subscribers in the entire country. So, I mean, this really is – and Italy talks about here, they talk about wiring the country, providing fiber to the curb, fiber to the home. I mean, they keep trying to figure out what to do and what we know is it will cost them €1,200, €1,300 per home passed to build any kind of fiber network, which by the way the consumer won’t pay for, because it’s going to be too expensive. We have €25 a month unlimited service. We pass a home for €25. We put up an antenna. The number of homes we pass if you amortize that or spread it across our cost is about €25 a home passed.

Thank you. This does conclude the question-and-answer session of today’s program. I would like to hand the program back to management for any further remarks.

Well, guys, thank you so much for listening in. I know everybody has got to get back at it as do we, but good quarter and more to come. So, thank you very much.