Piper Sandler Companies [PIPR] Conference call transcript for 2022 q3
2022-10-28 15:52:02
Fiscal: 2022 q3
Operator: Good morning, and welcome to the Piper Sandler Companies conference call to discuss the Financial Results for the Third Quarter of 2022. During the question-and-answer session, securities industry professionals may ask questions of management. The company has asked that I remind you that statements on this call that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements that involve inherent risks and uncertainties. Factors that could cause actual results to differ materially from those anticipated are identified in the company's earnings release and reports on file with the SEC, which are available on the company's Web site at www.pipersandler.com and on the SEC Web site at www.sec.gov. This call will also include statements regarding certain non-GAAP financial measures. The non-GAAP measures should be considered in addition to and not a substitute for measures of financial performance prepared in accordance with GAAP. Please refer to the company's earnings release issued today for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measure. The earnings release is available on the Investor Relations page of the company's website and at the SEC website. As a reminder, this call is being recorded. And now I'd like to turn the call over to Mr. Chad Abraham. Mr. Abraham, you may begin your call.
Chad Abraham: Good morning, and thank you for joining us. I am here with Deb Schoneman, our President; and Tim Carter, our CFO. We will go through our prepared remarks and then open up the call for questions. While the global economy continues to face headwinds, Piper Sandler delivered solid results during the third quarter. As I've stated before, our diversified business model continues to perform well and I'm particularly pleased with the results we've achieved in our equities business. While we remain focused on adding scale and increasing market share in our financing and brokerage businesses, our number one priority remains growing our advisory business through sector and product expansion. Thus far in 2022, we have completed three acquisitions and made multiple senior hires, which has moved us forward on both objectives. To that point, in October, we closed on our acquisition of DBO Partners, a technology investment banking firm. DBO roughly doubles the number of senior producers and provides additional scale to our technology practice. DBO's franchise also enhances our credibility with both large cap corporate and large cap sponsor clients within the technology landscape, given their established track record of working with market leading clients on high profile transactions. In addition, DBO adds a general partner advisory practice that is highly complementary and increasingly important to our private equity clients. We're excited to welcome the DBO team to the Piper Sandler family. Turning to our financial results. During the third quarter of 2022, we generated adjusted net revenues of $335 million, a 17.3% operating margin and adjusted diluted EPS of $2.32. During the first nine months of 2022, we recorded adjusted net revenues of $1 billion, an 18.6% operating margin and adjusted diluted EPS of $7.93. Our results, although lower compared to the exceptional prior year period, reflect the increased earnings capacity of our platform, driven by the investments we have made over the last several years. Next, let me review our corporate investment banking business beginning with advisory services. Advisory revenues of $175 million during the third quarter of 2022 increased 3% sequentially and declined 18% from the strong third quarter of last year. Our revenues improved compared to the second quarter as we advised on more transactions with larger fees. However, market volatility continues to impact transaction time lines. Performance during the quarter was diversified across our business sectors. Our Energy and Power team had a particularly strong quarter benefiting from renewed interest and increased activity in this space. In addition, our revenues continue to reflect meaningful contributions from our healthcare and financial services teams. More broadly, Piper Sandler was the number two adviser for US M&A deals under $1 billion based on a number of announced transactions during the first nine months of this year. Our advisory pipelines across verticals remain strong, and we expect the fourth quarter of 2022 to be stronger than the prior two quarters. However, conversion of these pipelines is being increasingly impacted by the more challenging market environment. Turning to corporate financing. We generated $40 million of financing revenues during the third quarter of 2022, an increase of 37% compared to the prior quarter and down 49% from the third quarter of last year. Although the equity capital markets remain largely shut, we improved on a sequential basis, driven by a brief window in August when the market was more accommodating. Overall, we underwrote 20 equity deals during the quarter, serving as bookrunner on 18. We also completed several preferred and debt capital raises for financial services companies. Despite the improved performance during the quarter, market conditions continue to remain challenging. However, in the coming quarters, we expect increased capital markets activity as clients that require access to capital will take advantage of market window opportunities or more stable conditions. Turning to Investment Banking Managing Director headcount, inclusive of the DBO acquisition, we now have 159 managing directors, the most in our history. Our success and momentum continue to resonate in the marketplace, both our recruiting efforts and the development of our own talent continue to be priorities. In closing, there is no question that market conditions remain challenged and have had an impact on asset prices and market activity. That said, we remain focused on factors that we can control and executing on our growth initiatives. We've transformed our business model significantly during the past five years, which has put the company in a position of relative strength that should drive growth in the coming years. Client engagement remains strong, and we're enthusiastic about the opportunities in front of us. I am confident in our ability to navigate the market environment and deliver long term value to our shareholders. With that, I will turn the call over to Deb to discuss our public finance and brokerage businesses.
Deb Schoneman: Thanks, Chad. I'll begin with an update on our public finance business. We generated $27 million of municipal financing revenues during the third quarter, down 25% from the second quarter of 2022. Higher nominal interest rates and increased rate volatility negatively impacted activity for us and the market. In particular, refinancing activity has essentially come to a halt. Overall market issuance during the quarter declined to approximately $94 billion, with the number of issues down 33% from the second quarter of 2022. We've seen investor demand weaken as the market experienced significant municipal fund outflows. During the third quarter of this year, we underwrote 93 municipal negotiated issues with an aggregate par value of $3.4 billion and ranked as the number two underwriter based on a number of issues in this market. Activity for us was led by our governmental business. Looking ahead, we expect the fourth quarter of 2022 to be similar to the third quarter based upon current market conditions and investor sentiment. Our backlog of specialty sector financings is significant, and we could experience upside if market conditions allow for execution of this pipeline. Turning to equity brokerage. Equity markets continue to experience elevated volatility and volumes during the third quarter. Our equity brokerage business generated record quarterly revenues of $53 million, benefiting from the elevated volumes and the addition of Cornerstone Macro to our platform. Performance during the quarter was broad with our high touch, derivatives, program and algo trading, all generating increased activity highlighting our robust trading platform. We are experiencing strong momentum across our platform and client votes and market share metrics have been increasing. We maintained the fourth largest US active client base and rank as one of the largest research platforms in the mid-cap category based on companies under coverage. In addition, our market leading macro research franchise, combined with our full suite of trading capabilities, make us an attractive destination for clients. We continue to pursue opportunities to deepen client relationships and cross sell products across the platform. From an outlook perspective, we expect to finish 2022 strong, driven by continued volatility, market share gains and clients positioning their portfolios for 2023. Lastly, turning to our fixed income business. Market conditions became extremely challenging during the quarter, driven by increased rate volatility as well as aggressive Federal Reserve monetary tightening and expectations for further tightening. Inflation has remained elevated and the market has begun pricing in a recession, resulting in an inverted yield curve. For the third quarter of 2022, we generated fixed income revenues of $37 million, down 31% from a strong second quarter this year as market dynamics have significantly muted client activity. Our depository client activity was particularly soft, driven by lower deposit levels combined with an increase in bank lending. Activity among our municipal centric clients has been reasonably solid given the relative value in municipal securities. While the near term outlook for fixed income is challenging and difficult to predict, over the long term, our business will benefit from interest rate stabilization at higher rates. Now I will turn the call over to Tim to review our financial results and provide an update on capital use.
Tim Carter: Thanks, Deb. As a reminder, my comments will be focused on our adjusted non-GAAP financial results. We generated net revenues of $335 million for the third quarter of 2022, driven by solid performances across corporate investment banking and equity brokerage. Compared to the second quarter, net revenues decreased 3% as lower fixed income and municipal financing revenues offset the increase in corporate investment banking revenues. Net revenues for the third quarter of 2022 decreased 24% from the prior year quarter due to lower corporate investment banking revenues as well as lower fixed income and municipal financing activity, offset in part by higher equity brokerage revenues. Net revenues for the first nine months of 2022 totaled $1 billion, down from the year ago period which benefited from record corporate investment banking activity. Turning to operating expenses and margin. Our compensation ratio was 62.5% for the third quarter of 2022 in line with the compensation ratio for the second quarter of this year as well as the first nine months of 2022. Based on our current outlook, we expect our full year compensation ratio to be near the current year-to-date level. Non-compensation expenses, excluding reimbursed deal expenses, for the third quarter of 2022 were $60 million, flat compared to the second quarter of this year and consistent with our expectations. During the third quarter, we generated operating income of $58 million and an operating margin of 17.3%. For the first nine months of 2022, operating income totaled $194 million with an operating margin of 18.6%. Our adjusted tax rate was 27.4% for the third quarter of 2022 and 25.1% for the first nine months of the year, which included a $5 million tax benefit related to restricted stock vesting at prices higher than the grant date price. Excluding this tax benefit, the adjusted tax rate for the year-to-date period was 27.9%. We continue to expect our full year adjusted tax rate will be within our targeted range of 26% to 28%, excluding the impact from stock . During the third quarter of 2022, we generated net income of $41 million and diluted EPS of $2.32. On a year-to-date basis, net income totaled $141 million and diluted EPS was $7.93. Let me finish with an update on capital. We continue to generate significant levels of cash to deploy through corporate development, share buybacks and dividends to drive shareholder returns while maintaining our capital-light business model. We have deployed capital during the year to build out our platform capabilities and drive long term growth through the acquisitions of Cornerstone Macro, Stamford Partners and DBO Partners. During the third quarter of 2022, we repurchased approximately 199,000 shares of our common stock or $22 million. On a year-to-date basis, we have repurchased approximately 1.4 million shares of our common stock or $186 million, which more than offset the share count dilution from this year's annual stock grants and acquisitions. Combined with our dividends paid, we have returned an aggregate of $285 million to shareholders during the first nine months of this year. In addition, today, the Board approved a quarterly cash dividend of $0.60 per share to be paid on December 9th to shareholders of record as of the close of business on November 23rd. With that, I'm going to stop there and open up the call for questions.
Operator: We will take our first question from Steven Chubak with Wolfe Research.
Brendan O'Brien: This is Brendan filling in for Steven. So just to start, one of your peers noted that they've seen some improvement in M&A conditions this quarter. Based on your commentary, it sounds like you have a little bit more of a measured take on the overall environment. But at the same time, the sequential pickup in your advisory business would suggest that you are seeing at least some improvement in the overall financing conditions and buyer seller expectations narrowing. So just wanted to get a sense as to how you see the environment today relative to last quarter.
Chad Abraham: I would say, to be honest, not much has changed. I mean we had a small sequential pickup. I mean that can be from just a couple of larger fees at close, I mean, we continue to see things a pretty difficult market. Deals are getting done, they're taking longer, longer to get announced, longer to get closed. Financing marketâs still tough. Maybe as with the passage of time, buyer and seller expectations start to line up. But I think we just -- we sort of view it as more of the same, and that's sort of the trend we've seen into Q4 here.
Brendan O'Brien: And then on your equity trading business, momentum there is quite impressive. While year-on-year comps are obviously skewed by the Cornerstone acquisition, I believe they're one of the only names to actually see revenues growth quarter-on-quarter. So just want to get a sense as to whether you're seeing greater synergies from the Cornerstone acquisition than you previously anticipated, or what has driven these share gains and whether that impacts your view on the overall run rate for the business going forward?
Deb Schoneman: At the end of the day, we're seeing the benefits, I mean, clearly, of Cornerstone, which you just announced, but it's really the combination of that with the overall platform that we've built. So the trading platform that we've built over time and having those come together. So it's just -- we're seeing from our clients, our ability to add more value, where a lot of this is the collaboration that's happening between these teams single stock, macro views, liquidity and trading, what we're doing relative to getting corporate access and insight and out there for our clients. So I would agree that this has been positive relative to Cornerstone coming on board. And I think we're additionally helped by the volatility in the marketplace, which is giving us a little more of a tailwind. So we feel good about the business and where it's going, going forward.
Operator: We will take our next question from Devin Ryan with JMP Securities.
Michael Falco: This is actually Michael Falco standing in for Devin. I wanted to start with fixed income brokerage. Revenue is obviously down quite a bit sequentially and you noted muted activity among depository clients. How should we be thinking about that business going forward? Is this quarter a good jumping off point in the current environment or could there be another leg down here as depositories have less excess liquidity?
Deb Schoneman: I would say as we look into what visibility we've had so far into this quarter, which is one month, we see more of the same from what we had been seeing in the third quarter. The bottom line is, though, there's been significant volatility in rates start move upward. No sign that, that's necessarily stopping near term and a lot of actually uncertainty in the market, which is probably the biggest thing that's been driving the softness in that business. So yes, a significant part of our business is depositories, which as you know, much less liquidity for banks and credit unions now as well as they had seen some increase in loan demand. I would say on the other client verticals that we have, we had seen some strength in those, maybe in second quarter offsetting depositories, that has not been the case as you saw in Q3. So again, see that somewhat continuing here as they're dealing with this inverted yield curve and uncertainty in rates. And I guess the other thing I would just add, at the end of the day, I mean, if we just step back and think about the business, we are doing work to continue to build out products and the client verticals so that when we get to a more conducive and receptive market, we feel confident in the platform to take advantage of that.
Michael Falco: And then maybe shifting gears a little bit. Obviously, growing the advisory business remains a priority. You closed DBO earlier this month. Can you talk about the capacity for additional M&A from here? We're hearing there are still some middle market advisory firms in the market potentially for sale. And assuming that it's a better time for consolidation than a year ago, what are you seeing and what's the level of appetite? And then maybe remind us as well what your top priorities are right now for sector and geographic expansion as well.
Chad Abraham: I mean we've had a lot of success, obviously, with Simmons and Sandler and Valence and really adding those verticals. We're really excited about DBO. I think that's been the priority internally from our internal partners from leadership. It's just a big sector. Obviously, it's a tougher time in the software and tech M&A market. But frankly, that's when we like to build the platform. So I would concur some of the best things we've done is when things are a little more difficult. What I would say about the market is pretty much every boutique, every investment bank had a record in 2021. I think reality is setting in a little more in 2022. That takes time just like some of our clients on the buyer seller expectations. You need to see that in the boutiques. But we expect next year to be a good time to be in the market and looking at transactions. I would say our priorities are the same. We're still very interested in building our tech business to be as big as our financials and healthcare business. I would say, geographically, even given the challenges in Europe, we think there's still just low hanging fruit for us is relative to other middle market banks were underpenetrated in Europe. Again, we're not going to stretch too far, but in the areas, healthcare, financials, some of the things we're really good at, consumer, obviously, we added Stamford Partners. So we're going to continue to look to grow in Europe. And then there still are white spaces for us. We've looked more and more at just with all of the things we do in public finance and real estate, all the things we do in financial services and real estate, is there more we can do collaboratively across the organization in the real estate vertical, can we build a bigger business there just as an example.
Operator: We will take our next question from James Yaro with Goldman Sachs.
James Yaro: Maybe I'll start with you, Chad. We've seen a much faster pace of rate hikes than I think people expected earlier in the year. How is this factored into your client dialogues? And then is there sort of an absolute level of rates that you think would more significantly impact M&A activity going forward?
Chad Abraham: I mean it obviously depends so much on the various business lines relative to rates. I would say one of our biggest business lines obviously, with -- in the sponsor business, it's a lot more expensive to finance some of the deals. I think if you look over a longer time, it's still okay on financing, but it takes a while to set those expectations. So that is certainly, one example, I would say, in Financial Services, we were doing a lot of sub debt deals in the bank space and frankly, other areas of financials. Obviously, those rates have changed quite a bit. And so that's affected that business. Part of financial services, the question will be, will that then prompt people to raise more equity capital markets, which is possible. So it's a very different outcome. Obviously, you saw we had tough public finance results. It's taken a while for those clients to reset. I do think -- the bigger question is just where are rates going, how fast sort of people trying to get an understanding. And certainly, if the absolute rate is much higher from here, there will be certain parts of the business that will be long term impacted. There will also be other parts that will be helped, like I do believe, per Deb's comments, in fixed income, once we get to higher rates and it's sort of stable, I think that's going to be a very good run for fixed income. So your crystal ball is as good as mine.
James Yaro: Deb, maybe if we just turned to muni financing. Is there any way to think about -- how would you sort of think about helping us with sort of the KPIs or key drivers for that business over the long term? Is it focusing on the absolute level of rates or market volatility? And is that sort of what's driven the lower activity in the near term? And just over the long term, how should we expect that to sort of recover?
Deb Schoneman: So I would actually break it into two parts, James. I'd say, on the governmental side, I think it's more of the investment grade business. That had been helped over the last number of years, really many years with refinancing opportunities. So being able to look at just market dynamics on new issue versus just refinancing. So we have seen, I would say, this year where the new issue had helped to offset really, I think, new money year-to-date is probably flat year-over-year. So there hasn't been a decline there. It's been all the refinancing that, as I had mentioned previously, has pretty much come to a halt. So in that business, that's really where the rates matter. And I think with new money, many times, as long as they don't -- the rates don't go up to too significantly, deals can still get done as there's new projects. On the specialty side, whether that's special district health care, education, et cetera, those areas itâs really right now being impacted by because these are high yield impacted by flows. And I guess I would say across the board, you can look at muni flows, but in particular, high yield flows have made that much more challenging to get deals done is there's just not the liquidity in the marketplace. And the last thing I would say is, again, as Chad just mentioned, its stability of rates. So if you think about -- we've had these situations where we've been working with clients on deals, thinking it's one market environment and very quickly rates increase and now we're in a very different market environment, and so then you're back to the drawing board. So I do think just stability in rates is going to help significantly. But right now, it's stuck out there.
Operator: We will take our next question from Mike Grondahl with Northland Securities.
Mike Grondahl: Chad, in the press release, it talks about the advisory pipeline being strong, but conversion is tough. Can you just help us understand what strong means with the advisory pipeline sort of relative to what period of time, like last year's peak or kind of before that area? And then secondly, any comments on October, should we think of October just kind of a continuation of the third quarter?
Chad Abraham: What I would say about the advisory business, it's not like other, you can just look at our results relative -- obviously, relative to last year, our advisory results are down, but look back four, five, six years, I mean, it's still good revenue levels as we built the capacity and we've built this MD count to 159 MDs. What I would say is we're still pitching business. We're still putting deals in the pipeline, which have clients now that sort of say, hey, should we launch or should we start in Q1? And so launches are taking longer, people are more cautious. When we used to get a whole slate of bidders on a private equity deal, maybe it's a few and then trying to get one of them to close is much more difficult. So I would say relative to the last five or 10 years, where you get long periods of M&A shutdowns or what happened in the beginning of COVID, it's nothing like that. But every deal is harder, every deal takes longer. The financing for sponsors has certainly changed the pricing. You're starting -- the longer this goes on, the sellers aren't going to wait forever. They'll come into line on pricing expectations. And I would just say that's more of what we're seeing in October. We said in the script, we expect our advisory business could be a bit better than Q2 and Q3. But that's lower than what it would be in a normal year. Normally, Q4 is quite strong. And I think just given the environment, while it could be one of our better quarters of the year for advisory, the step up won't be like usual as we continue to see deals push out and deals not closed, but it will be a good quarter for advisory.
Operator: We will take our next question from Michael Brown with KBW.
Evan Hall: This is Evan Hall filling in for Mike. Most of them have been asked, but just talking about the DBO team coming on to the platform. You noted the GP advisory practice that they bring. Can you just talk about the potential there in the medium term and as it relates to Piper's broader capabilities?
Chad Abraham: Yes, we're excited about that. I mean, obviously, some of our competitors have big businesses working with private equity firms on other things besides M&A for their clients, DBO has a history of doing some of these transactions, frankly, with even some large cap sponsors Obviously, what we bring to the table is hundreds of other sponsor relationships to get those guys introduced. I think we're still in the early innings of opportunities. I mean, private equity was selling maybe part of their GP. You can think about will there be more partial sales, will there be full sales, the impact of continuation funds, other vehicles that these folks set up. So I just think there's a big opportunity for us as we've really expanded this MD base and our sponsor relationships and it's a pretty specialized capability that, frankly, some of the talent at DBO has that we didn't have. And so we're excited about where we can take this segment as we continue to believe private equity will be one of the biggest parts of our total advisory business.
Operator: We will take a follow-up question from Devin Ryan with JMP Securities.
Michael Falco: This is Mike for Devin again. Just wanted to ask how you're thinking about more normalized revenue and earnings levels. Obviously, 2021 wasn't normal, but a lot of aspects of 2022 aren't normal either. Are there any frameworks we should have in mind, especially as you've added a lot of talent over the last year, I think banker MD headcount is up 15% or so from 2020 and also made acquisitions on the brokerage side, so the baseline keeps moving higher?
Chad Abraham: What I would say is just the way I at least look at the investment banking part of the business, obviously, we haven't had -- we just had the DBO team. We haven't -- we did Stamford in the middle of the year. It's not like -- we did some pretty good hiring this year. So it's not like we've had those 159 MDs all year. New MDs on the platform take time. The way I look at, at least the investment banking part, which is two thirds or more of our businesses, you look over time for a while, we were kind of averaging $4 million, $5 million, $6 million per MD. Obviously, as we've grown the platform and the products and we're doing bigger deals, that productivity got in the good times to $8 million or $9 million per MD. So I think some range in there is the opportunity of where total banking can go. Obviously, relative to equities, we think we're at a pretty good run rate. And then on fixed income, you sort of have to have a view on when rates stabilize. But the one other segment of the business that we don't think is sort of a long term run rate is we're -- our ECM business, even though it's at least open with a trickle now and certainly better than the first couple of quarters, it's still way below historical means. So we're not saying it's going to march back to 2020 or '21 levels, but we're pretty confident that we'll do more ECM business next year than we did this year.
Operator: Thank you. There are no further questions at this time. Mr. Abraham, I will turn the conference back to you for any additional or closing remarks.
Chad Abraham: All right. Thank you, operator, and thanks, everyone. We look forward to updating you on our fourth quarter and full year results. Have a great day.
Operator: This concludes today's call. Thank you for your participation, and you may now disconnect.
