Fitch Affirms BGC and Cantor at 'BBB-', Stable Outlook after Successful Tender for GFI
At the expiration of the tender offer on Feb. 26, 2015, BGC owned approximately 56.3% of GFI's outstanding common shares, exceeding its minimum tender offer of 43%, and had gained effective control of GFI by appointing six directors to the expanded eight-member GFI board. As a result, all outstanding conditions of BGC's tender offer were reportedly met. Effective immediately, GFI will be a controlled company and will operate as a separately branded division of BGC reporting to the president of BGC, and its financial results are expected to be consolidated as part of BGC.
KEY RATING DRIVERS - BGC
The affirmation of BGC's ratings reflects Fitch's view that the acquisition of GFI will be accretive to BGC as it will increase its market share in the inter-dealer brokerage (IDB) space, diversify its product offerings, and create potential cost synergies, particularly at a time when the operating environment for IDBs remains challenged due to subdued trading volumes. Fitch notes that leverage, interest coverage and liquidity levels on a consolidated basis will be impacted temporarily as GFI is currently operating with relatively higher leverage and lower interest coverage and liquidity levels. However, BGC had strong liquidity levels and modest cushion relative to Fitch's investment grade thresholds for leverage and interest coverage prior to the acquisition, which allowed BGC to absorb GFI without affecting the ratings. Fitch also expects BGC will act quickly to integrate GFI's back office, technology and infrastructure operations, resulting in cost savings and increased cash flows, which should help reduce leverage, improve interest coverage and increase liquidity over time.
As of Dec. 31, 2014, BCG had \$732.4 million in available liquidity comprising cash, marketable securities and unencumbered securities (excluding the GFI stock position already owned), which is expected to materially decline in the near term. Fitch estimates that BGC will immediately require approximately \$333.1 million to fund GFI's tendered shares (54.6 million shares tendered at \$6.10 per share), \$100 million to fund the Tullett Prebon litigation settlement by the end of first quarter 2015 (1Q'15), and \$150 million to repay senior convertible notes due on April 15, 2015. As a result, available liquidity is expected to decline to \$150 million, all else equal.
Fitch notes that the above calculation does not include GFI's cash position, which it defines as cash, cash equivalents and cash held at clearing organizations excluding customer cash, of \$222.9 million as of Sept. 30, 2014, nor does it include approximately \$625 million in NASDAQ OMX stock which BGC expects to receive in earn-out payments over the next 13 years. Fitch believes that BGC has adequate liquidity to fund GFI's tender offer and meet its own upcoming obligations.
Fitch notes that although BGC will retain control of GFI and GFI will be consolidated as a part of BGC for accounting purposes, the two companies will not immediately merge, as that would require the approval of a two-thirds majority of GFI's outstanding shares. Jersey Partners Inc. (JPI), which owns 36.4% of GFI's shares, has entered into a support agreement with the CME Group (CME) to not sell their shares until the earlier of the cessation of the restrictions under the support agreement or one year from the closing date of the tender offer agreement, which means that a formal BGC-GFI merger cannot occur at this time. As a result, BGC will not be formally assuming GFI's outstanding debt at the close of the tender agreement. GFI management has represented that there is no impact on change of control provisions in GFI's senior notes as a result of BGC gaining control of GFI.
BGC's leverage, as measured by gross debt-to-adjusted EBITDA, excluding the non-cash, non-dilutive, partnership unit-exchange-related charges and the one-time litigation settlement with Tullett, was 2.42x at Dec. 31, 2014, compared to 2.22x at Dec. 31, 2013. The increase was primarily a result of \$300 million in additional debt issued in December 2014 to fund GFI and other acquisitions. Interest coverage, as measured by adjusted EBITDA-to-interest expense, was 7.85x at year-end 2014, compared to 4.98x at year-end 2013, due to increase in EBITDA levels and lack of incremental interest expense associated with the 5.375% \$300 million notes which were issued in December 2014.
Factoring in \$250 million of GFI's debt (\$240 million of senior notes and \$10 million of bank credit facility draws), \$74.8 million of GFI's trailing 12 months (TTM) adjusted EBITDA, and full-year interest expense on BGC's \$300 million notes issuance, consolidated leverage increases to 2.61x and interest coverage declines to 4.37x. Both ratios fall outside of Fitch's threshold for the 'BBB' rating category (maximum leverage of 2.5x and minimum interest coverage of 6x).
However, pro forma for the \$150 million convertible notes paydown in April 2015, factoring in run-rate EBITDA from recent acquisitions, including Apartment Realty Advisors, RP Martin, Cornish and Carrey, HEAT, and Remate, and without giving credit to potential cost synergies from the GFI acquisition, pro forma leverage declines to 1.97x and interest coverage improves to 5.79x. Given the overlapping business models of BGC and GFI, Fitch believes some level of cost synergies is achievable, which would further improve leverage and interest coverage levels, all else equal. Fitch expects the company to carefully manage its leverage, interest coverage and liquidity position. Sustained increases beyond Fitch's articulated leverage and interest coverage levels would result in a negative rating action.
RATING SENSITIVITIES - BGC
The Stable Rating Outlook reflects Fitch's expectation that BGC will maintain sufficient liquidity for near-term debt maturities/obligations and adequate leverage and interest coverage levels. The Stable Outlook also reflects Fitch's expectation for modest cash flow and margin improvement as a result of integrating GFI's back office operations and rationalizing costs. The ratings contemplate, but are not dependent upon, the possibility that BGC may look to sell portions of the GFI business, such as the Trayport and Fenics technology platforms. As such, failure to sell either or both of these businesses would not, on its own, adversely impact BGC's ratings.
Failure to achieve planned cost synergies, inability to sustain EBITDA or reduce debt levels, which leads leverage to increase above 2.5x or interest coverage to fall below 6x, on a sustained basis will have a negative impact on ratings. Increased shareholder-friendly activities, including increased dividends or outsized share buybacks that materially impact the company's liquidity before the successful integration of GFI, would also be viewed negatively from a rating perspective.
BGC's ratings are equalized with those of its parent, Cantor, as Fitch considers BGC to be a core subsidiary of Cantor due to the significant operational and financial linkages between the two companies. As a result, any changes in Cantor's ratings could also result in changes to BGC's ratings.
Positive rating momentum, although limited in the medium term, could be driven by the successful integration of GFI and a sustained increase in profit margins, while maintaining conservative leverage and interest coverage metrics.
KEY RATING DRIVERS - Cantor
The affirmation of Cantor's ratings reflects its established position in the middle-market brokerage space, moderate risk profile, controlled leverage, and adequate liquidity levels. Ratings are constrained by the cyclicality of and dependence on capital markets activity for most of Cantor's businesses, and its exposure to non-core ventures, which could potentially introduce financial/reputational risk.
Cantor's operating performance was mixed for the nine months ended Sept. 30, 2014 (9M'14) as weakness in its core institutional brokerage business was offset by improved results at BGC and Cantor Commercial Real Estate (CCRE). The institutional brokerage business, particularly fixed income trading, continues to be challenged in line with the broader industry and peers. Fitch notes that Cantor's 9M'14 results also benefited from a \$132.5 million settlement received in 1Q'14 from American Airlines over the September 2011 lawsuit filed by Cantor, which Fitch considers as a non-recurring item.
Cantor's leverage has been an underpinning strength of its ratings. While the company does not publicly disclose its financial position given its private partnership status, leverage remained at the lower end of management's articulated target of 8x to 12x, which compares favorably to its peers. Fitch adjusts the leverage for reverse repurchase agreements, as Cantor operates a matched repurchase book to provide financing for its customers as well as its assets/inventory, which is primarily (98%) backed by highly liquid assets, including U.S. government Treasuries, agencies and agency MBS securities.
Liquidity at the parent level declined year-over-year between 9M'14 and 9M'13, due to increased regulatory requirements, expansion efforts, and challenging operating conditions in its core institutional brokerage business. Earnings contributions from BGC and CCRE, while meaningful, are limited by Cantor's minority stakes in these two entities. Fitch notes that Cantor faces a \$300 million debt maturity in June 2015, which could potentially introduce liquidity/refinancing risk, particularly if core operating performance continues to be stressed. In April 2015, Cantor expects proceeds from the maturity of the \$150 million convertible note it previously issued to BGC (\$221 million value at March 2, 2015, based on BGC's share price of \$9.21). However, Cantor will have to generate liquidity or refinance the remaining portion of its upcoming debt maturity. Failure to generate adequate liquidity or refinance a portion of the debt maturity would pressure the ratings.
RATING SENSITIVITIES - Cantor
Cantor's ratings could come under pressure if the firm is unable to maintain adequate liquidity or refinance a portion of its upcoming debt maturity prior to June 2015. Continued deterioration of operating performance in its core institutional brokerage, a material increase in leverage levels, adverse changes in the reverse repurchase book composition, material loss or reputational damage from Cantor's non-core ventures and/or key man risk associated with Cantor's CEO would also pressure ratings. Ratings also remain sensitive to changes in BGC's ratings.
Positive rating momentum, although limited in the near term, could be driven by sustained improvement in core institutional brokerage business margins, increase in parent company liquidity levels, sale or closure of some non-core and non-viable ventures, while addressing key man risk and maintaining moderate risk appetite, low leverage, and sufficient capital.
Fitch has affirmed the following ratings:
BGC Partners, Inc.
--Long-term Issuer Default Rating (IDR) at 'BBB-';
--Senior unsecured debt at rating at 'BBB-';
--Short-term IDR at 'F3'.
Cantor Fitzgerald, L.P.
--Long-term IDR at 'BBB-';
--Senior unsecured debt at 'BBB-';
--Short-term IDR at 'F3'.
The Rating Outlook for both entities is Stable.