Cohen & Steers, Inc. Q2 2008 Earnings Call Transcript

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Cohen & Steers, Inc. (NYSE:CNS)

Q2 2008 Earnings Call Transcript

July 25, 2008 11:00 am ET


Salvatore Rappa – SVP and Associate General Counsel

Marty Cohen – Co-Chairman and Co-CEO

Matt Stadler – CFO

Bob Steers – Co-Chairman and Co-CEO

Joe Harvey – President


Cynthia Mayer – Merrill Lynch

Mike Carrier – UBS

Erin Caddell – Hovde Capital


Good morning. My name is Sharon, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cohen & Steers second quarter 2008 financial results conference call. At this time, all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator instructions) Thank you.

It is now my pleasure to turn the floor over to Salvatore Rappa, Senior Vice President and Associate General Counsel. Sir, you may begin your conference.

Salvatore Rappa

Thank you and welcome to the Cohen and Steers second quarter 2008 earnings conference call. Joining me are Co-Chairman and Co-Chief Executive Officers, Marty Cohen and Bob Steers; our President, Joe Harvey; and our Chief Financial Officer, Matt Stadler.

Before I turn the call over to Marty, I want to point out that during the course of this conference call we may make a number of forward-looking statements. These forward-looking statements are subject to various risks and uncertainties, and there are important factors that could cause actual outcomes to differ materially from those indicated in these statements. We believe that some of these factors are described in the Risk Factors section of our 2007 Form 10-K, which is also available in our website at I want to remind you that the company assumes no duty to update any forward-looking statements.

Also, the presentation we make today may contain pro forma or non-GAAP financial measures, which we believe are meaningful in evaluating the company’s performance. For detailed disclosures on these pro forma metrics and their GAAP reconciliations, you should refer to the financial data contained in our previous earnings releases.

Finally, this presentation may contain information with respect to investment performance of certain of our funds. I want to remind you that past performance is not a guarantee of future performance. For more complete information about the funds we will discuss today, including charges, expenses and risks, please call 800-330-7348 for a prospectus.

With that, I'll turn the call over to Marty.

Marty Cohen

Thank you, Sal. Good morning and thank you for joining us today. Let me just go through the headline numbers and I’d like to talk about some business trends that we’ve noticed in the first half of this year and then look at the balance of the year. As we reported last night, we earned $0.32 per share in the second quarter of 2008 that compares with $0.44 per share a year ago and $0.31 per share in the first quarter of 2008.

Our assets under management were $27 billion that compares to $34.6 billion a year ago and $28.6 billion in the first quarter. With respect to our assets under management, the decline that we suffered this year has been entirely due to market depreciation. Our net flows in the past quarter were exactly zero. As you are probably aware, US real estate has been in a bear market since early 2007. And that bear market has now spread to most foreign real estate markets and stock markets in general.

Our largest investment category is global and international real estate securities, and that has done so far more poorly than in 2007 this year. The US market has actually held up quite well with only modest depreciation of 3.6% in the first half of the year. In that same period, the Asia real estate market was down 22.8% and Europe was down 18.4%. We can’t control or affect the tide of a bear market, of course, but we are nonetheless pleased with our asset flows.

Retail net outflows were 158 million in the second quarter. That’s less than the first quarter and I think they are surprisingly low number when you consider the current state of market sentiment with respect to real estate in general. Moreover, we had net inflows into our institutional business of 158 million, exactly offsetting those retail outflows. And we added during the quarter three new – net three new client relationships.

Our asset diversification efforts continue to pace. We recorded 367 million of net inflows into our large cap value portfolios in the second quarter. We think this is a very good development and we have already secured two large cap value mandates, not included in our current numbers that will be funding before year-end. Importantly these are accounts that are in platforms, which have we think a substantial amount of growth potential.

We’ve mentioned in the past, really for the past couple of years that we expected this sector to be an important contributor to our asset growth and we are delighted that this is indeed happening today. I should mention as well, of course, that we also have institutional mandates for real estate that will be funding in the second half of this year.

As we announced earlier this year, we’ve modified the focus of our utility efforts to include global infrastructure companies. Q2, we’ve enjoyed modest but positive net flows into our open-end fund. This is bucking the industry trend of net outflows from utility fund, something that has persisted for a number of years. It’s also encouraging that we are seeing some sign of institutional interests in this area.

Finally, in the area of alternatives, we have now begun marketing our global long-short fund, whose objective to achieve good absolute returns with low volatility. Our initial investment returns using current capital have fully met our expectations, and the level of preliminary interests from outside investors is encouraging. We hope to report to you the initial results of our marketing efforts in our next quarterly call.

Investment banking, our major segment, recorded only modest revenue in the quarter and modest loss. This is somewhat inline with the rest of the banking industry, the one we hope will improve as the markets do. As we said repeatedly, this is a business that is unpredictable from quarter to quarter, but (inaudible) contributor to our process.

Now let me spend a minute or two on how see the balance of the year from a business standpoint and how we are dealing with this challenging environment. While we can’t predict when the equity markets will recover, we are very encouraged by the relative performance of the US REIT market this year. By the way, as of today or this morning, US REITs are up for the year while just about every major market averages down.

Influencing our performance, of course, will be the foreign market and we expect that as is usual, the foreign markets will rotate into a positive territory as time goes on. It’s very clear to us that valuations worldwide are today discounting many of the concerns that are currently knowable. When sentiment shifts, we have never been better positioned to benefit as the market leader in this sector.

We are only one of a handful, a small handful, of firms that can boast a five-year record of managing global real estate securities portfolios. Our marketing efforts will continue to concentrate on our non-REIT and alternative strategies that are demonstrating excellent performance. With respect to large cap value, we now have almost a seven-year composite record and a full three-year performance record for our open-end fund, which I should mention is in the top decile of performance on the one, three and five-year period and is attracting a great deal of attention, as I mentioned earlier.

While we are vary of adding considerably to our headcount, we are finding that the turmoil on Wall Street is presenting us with the ability to make some very opportune strategic hires. Clearly having a strong balance sheet and a growth plan is very helpful. This situation is very helpful for our company.

We’ve always been very cost conscious at Cohen & Steers, but we continue to look for ways to save money without doing any harm to our business. There is a mentality here and a culture where all of our employees know how important it is to maintain profitability.

Finally, our strong financial position will continue to enable us to incubate new strategies real time and to take advantage of any opportunities to expand our business that may come out of the chaos. It seems to be gripping so many parts of the financial market.

And with that, I’d like to turn it over to Matt Stadler for the financial details.

Matt Stadler

Thanks, Marty. Good morning everyone. Yesterday we reported earnings of $0.32 per share compared with $0.44 per share reported in the prior year and $0.31 per share sequentially. The decline in earnings from the 2007 period was primarily due to lower average assets under management and investment banking fees. We reported revenue for the quarter of $55.3 million compared with $69.3 million in the prior year and $53.6 million sequentially. Net income for the quarter was $13.6 million compared with $18.6 million in the prior year and $13 million sequentially.

As a result of extremely challenging market conditions, our assets under management decreased to $27 billion from $28.6 billion at March 31. Market depreciation accounted for the decline, as net flows and open-end funds were offset by net inflows and institutional separate accounts.

US REIT common stocks comprised 44% of the total assets we manage, followed by non-US REIT common stocks at 27%, preferreds at 11%, utilities and listed infrastructure at 9%, and large cap value at 5%.

Turning to our two business segments, in our asset management business, we recorded quarterly revenue of $54.4 million, down 18% from the prior year, but up 2% sequentially. The year-over-year decline was primarily attributable to lower average assets during the quarter. Average assets for the quarter were $29.2 billion compared with $33.7 billion in the prior year and $28.5 billion sequentially.

Our effective fee rate for the quarter and on a year-to-date basis was 65.5 basis points, down 1.5 basis points from the comparable prior periods. The decline was primarily due to lower fee rate in our institutional business, particularly offset by higher fee rates in our closed-end funds.

Pretax income for the quarter was $22.7 million, down 23% from last year but up 2% sequentially. Asset management's pretax margin was 42% for the quarter and is 42% on a year-to-date basis.

Now let's review the changes in assets under management. Assets under management in our closed-end mutual funds totaled $9.5 billion at June 30, a decrease of $193 million or 2% from the first quarter. The decrease in assets under management was the result of market depreciation.

Our open-end funds had assets under management of $7.6 billion at June 30, a decrease of $788 million or 9% from the first quarter. The decrease in assets under management was attributable to market depreciation of $630 million combined with net outflows of $158 million. I should note that we are in the process of adding a distribution partner in Europe and that we recorded net inflows into our non-US open-end mutual funds. Gross subscriptions for the quarter totaled $660 million, and more importantly, we continued to see a deceleration in the level of outflows.

Assets under management in our institutional separate accounts totaled $9.8 billion at June 30, a decrease of $629 million or 6% from the first quarter. The decrease was comprised of market depreciation of $787 million, partially offset by net inflows of $158 million. We recorded net inflows of $236 million into global and international realty portfolios, and had net outflows of $443 million from domestic realty portfolios. And as Marty said earlier, our large cap value portfolios recorded net inflows of $367 million.

In our investment banking segment, we recorded quarterly revenue of $840,000, down from $2.9 million in the prior year, but up from $51,000 in the first quarter of 2008. The current quarter represented one of our lowest quarters of banking fees and last quarter represented our lowest quarter. Investment banking revenue remains very unpredictable. The banking segment reported a $783,000 pretax loss for the quarter.

Moving to expenses. On a sequential basis, expenses were down about 1% in the quarter. Lower amortization of deferred commissions and depreciation and amortization were partially offset by higher employee compensation and G&A. Amortization of deferred commissions decreased 49% from the first quarter. The decrease was primarily due to lower subscriptions in our open-end load mutual funds.

At the end of January, the intangible asset attributable to non-compete agreements established when we went public fully amortized. This resulted in the sequential reduction in depreciation and amortization. Since our compensation-to-revenue ratio remained at 32.5% for the second quarter, the increase in compensation expense is in line with the growth in revenue. G&A increased 3% sequentially. This increase was primarily attributable to higher technology costs associated with our continued global expansion.

Now turning to the balance sheet. Our cash, cash equivalents, and marketable securities totaled $185 million compared with $180 million last quarter. The $185 million excludes approximately 17 million utilized during the quarter to seed our global real estate long-short fund. Since we are currently the sole investor in our global real estate long-short fund, the balance sheet in our 10-Q will reflect $26 million of assets and $9 million of liabilities related to the consolidation of the fund onto our books and records. This investment will be deconsolidated after we accumulate sufficient outside investors into the fund. Our stockholders' equity was $278 million compared with $272 million at March 31.

Let me briefly discuss a few items that will have an impact on our second half results. The first item is our effective tax rate. Last quarter, we mentioned that our effective tax rate for 2008 would be between 37% and 38%. Our rate for the second quarter was 38% and we expect to maintain that rate throughout the second half of the year.

With respect to employee compensation, we expect to maintain our compensation-to-revenue ratio at approximately 32.5%. Although we continue to maintain control over our expenses, as Mary mentioned, we will also selectively take advantage of opportunities the current market environment presents. We have committed to expand our global investment and institutional sales teams and have taken additional space in our Hong Kong office. These initiatives will add about $0.01 per share of G&A costs to the third quarter. We recorded a loss from marketable securities for the quarter versus a gain in the prior year. Please keep in mind that as we continue to commit firm capital to seed additional investment strategies, there may be more volatility in this line item.

As you know, it is quite difficult to predict fees from our banking segment. Although the pipeline remains active, the closer we get to year-end, the potential to record fees from M&A or restructuring transactions, which typically generate higher fees, lessen due to the long lead time associated with these activities.

And finally, we do not expect to record any meaningful revenue from the alternative business, which includes our global real estate long-short fund and our private global real state fund of fund until next year. Now I'll turn it back to Marty.

Marty Cohen

Thanks, Matt. And with that, why don’t we open it up for questions.

Question-and-Answer Session


(Operator instructions) Our first question is coming from Cynthia Mayer from Merrill Lynch. Please go ahead.

Cynthia Mayer – Merrill Lynch

Hi good morning. Just a couple of questions. One, just to follow up on what you were mentioning about seeding new products. I’m wondering if you have in mind a certain amount of cash that you want to commit to seeding new products? What kind of size portfolio could you end up with?

Marty Cohen

Cynthia, we don’t really have a target. It’s been a great use of capital on our balance sheet and the opportunity to start new initiatives and get track records going. That’s really what dictates how much we invest rather than having some set number.

Matt Stadler

Right. I mean, the 17 million that we put into the long-short fund is probably one of the bigger amounts that we’ve done. Typically when we seed our open-end funds, or we put some money in the close-end funds for lesser amounts. But the amount that we invest will be dictated in part on what the expectation is to market the fund so that we show a competitive amount of “skin in the game.”

Cynthia Mayer – Merrill Lynch

Okay. You guys have such a strong balance sheet. Do you want to talk a little about what you want to use it for aside from seed investments? What opportunities are you seeing, or would you consider – I don’t know what your distribution arrangement, whether that would cost something somehow, but do you see opportunities to expand using your balance sheet?

Marty Cohen

Well, we are very comfortable with our cash position. And right now, we are very happy to be using it as we are today. But clearly we hope it doesn’t happen, but if this environment in the financial markets and some of the other asset managers, if there are opportunities to expand our business, we certainly are open for looking at that. But we don’t have a capital plan right now to do anything specifically, but really we look for – wait for opportunities either internally or externally. I know that sounds very generic, but it’s exactly where we are today.

Cynthia Mayer – Merrill Lynch

Okay. And then just couple of quick questions on flows, you had nice inflows at that large value fund, but outflows from REITs on separate accounts. I’m just wondering what you attribute that outflows from REIT products to separate accounts at this stage? Is there a sense among institutional clients that REIT underperformance is likely to continue or come back or they are just being risk-averse, or are they going to passive vehicles?

Bob Steers

Cynthia, it’s Bob. I think the sentiment institutionally is still fairly discipline that they're adhering to the asset allocation. You are continuing to see institutions who don’t have international exposure, taking some money out of US REITs and putting them into non-US strategies. So non-US REIT strategies continue to gain share from US only, and that’s a trend that’s in place. Frankly, we have started to see an increase in enquiries about our views on, is the US REIT market looking cheap now and things like that. So I’m not sure where that’s going to – how that’s going to manifest itself, but we don’t really see institutionally any concern about the viability of the strategy or the asset class. And as you’ve seen, we’ve been – the flows to US REIT strategies, both industry-wide and for us in particular, have under the circumstances been quite muted. I’d add, what you don’t see at the aggregate level is the fact that we have a five or six US clients who are disciplined asset allocators add to their accounts over the quarter as REITs went down.

Cynthia Mayer – Merrill Lynch


Bob Steers

Correct, yes.

Cynthia Mayer – Merrill Lynch

Okay. And just last question is, in the mutual fund space, it seems like the ETFs and index funds have held their own pretty well over the last few months. And I’m wondering what you think – whether you think they will continue to gain share and what would cause the pendulum to swing the other way?

Marty Cohen

I think it’s not only for us, but for across the spectrum of the asset management industry that the trend is very clear, that if you consistently add alpha, you are going to get lots of assets. If you are not, you are going to be losing assets, and ETFs and passive strategies somewhere in between. So I think the small group of asset managers that consistently outperform in passive will continue to gain share at the expense of the rest of the industry.

Cynthia Mayer – Merrill Lynch

Okay, thank you.


Thank you. Our next question is coming from Mike Carrier with UBS. Please go ahead.

Mike Carrier – UBS

Matt, you mentioned the new distribution partner in Europe and, Marty, you kind of hinted at it. If you look at the institutional market both in the US and then outside the US, just trying to get a sense on when you look at the opportunity, where are you in terms of penetrating like all those accounts?

Marty Cohen

Is the question, how far this opportunity are we?

Mike Carrier – UBS

Yes. Right. In the US I guess it’s easier to gauge because if you look at that top 100 or 200 pension plans, internationally it’s a little bit more difficult. But just when you are looking at the size of the institutional market and those that are investing in real estate or value or the infrastructure funds you guys offer, just trying to figure out like you’ve been focused on distribution hiring more relationship managers and just when you look at the opportunity in that institutional market, like what percentage of the market are you talking to today versus the opportunity that’s out there?

Marty Cohen

Sure. I would say that outside of the United States, institutions are about – where institutions in the US were in early ‘90s, which is to say there has been – outside of certain pockets like the Netherlands would have long been investing in real estate stocks. Most of Europe, the UK, and Asian institutions are at the extremely early stage of embracing securitization. And to the extent they have significant allocations to real estate, it tends to be in sort of the old fashioned bricks and mortar approach. And so I would answer your question by saying, we are very pleased with some of the institutional intermediary relationships that we are lining up. And they are both in Asia and in Europe and they are going to be very powerful, but they have been giving us access mainly to retail high net worth type investors. And I would say that the penetration of real estate security strategies with institutions outside the US has barely occurred. Does that answer your question?

Mike Carrier – UBS

Yes, thanks. Just a follow-up on the cash question. You mentioned kind of what your priorities are right now, but also mentioned that there is opportunities out there. You guys have been focused more on the income oriented types of products, whether it’s the REITs, the preferreds, the value, the infrastructure, the utilities. I’m just trying to figure out is there anything else out there that, if you had a good opportunity, would fill a gap that you think that you have, or is it just more – if there’s opportunity that come just across the board that you may consider?

Marty Cohen

I would say that what we are not looking for is to just buy something that is cheap or to add something simply because it doesn’t cost that much. You’ve identified the types of related investment strategies that we have focused on, and our criteria is income oriented equity strategies that we think are and will be in strong demand. And if we can add similar strategies and extend our brand in this regard while still doing in a way where the team that’s managing it is among if not the best-in-class, that those strategies are things we would consider.

Mike Carrier – UBS

Okay. And then, Matt, just one for you. Given the decline in the market in June and this is pretty much across all asset classes and all asset managers, just the average AUM levels going into the third quarter and the back half of the year are going to be in the low end. Anything on the expense side? You know, you kind of mentioned the compensation ratio and G&A going up, but anything else that you feel like you have a little bit more room to manage in the near-term?

Matt Stadler

We are constantly looking at controllable expenses. And obviously we are going to, as the second half starts to unfold, constantly revise and reassess requirements to expend money. That said, we don’t want it to be at the detriment to growing the business. So there are opportunities and there are things, and the only way that we can deliver new distribution partners and get new institutional mandates is to be active and be visiting them. So it’s a tough balance. I mean, I know the captions G&A and embedded in G&A are a lot of controllable and non-controllable expenses. I think the third quarter is going to see despite – I don’t know necessarily that the fourth quarter would be – we are hoping that the fourth quarter would obviously be lower because there are certain things embedded in recruiting of some of the individuals that I mentioned that would not reoccur in the fourth quarter, obviously the rent will, but – you know, we are doing the best we can.

Mike Carrier – UBS

All right. Thanks guys.


Thank you. (Operator instructions) Our next question is coming from Erin Caddell from Hovde Capital. Please go ahead.

Erin Caddell – Hovde Capital

Hi. Erin Caddell, Hovde Capital. Can you hear me okay?

Marty Cohen

Very well.

Erin Caddell – Hovde Capital

Thank you for taking my question. I was just wondering if I could follow up on your earlier comments, just kind of about the overall market, and over the years you’ve talked about kind of the correlation between just kind of the overall health of the REIT sector, commercial real estate with employment. And I guess – do you have kind of an overall macro view of whether we are in a recession, heading into a recession, the depth of that, if it occurs, and then kind of how at least the fundamentals of the sectors in which you invest, be it office or apartments or I guess the different sectors, are kind of holding up in your view in terms of occupancy rates, renewal rates, all that kind of stuff?

Joe Harvey

Sure. This is Joe Harvey, let me take a crack at that. Clearly we are in a very uncertain and volatile environment. And I think the question about whether technically we are in recession or not really misses the point. It’s becoming much more challenging economy and things are – considering that that’s the most important driver for the real estate business, fundamentals have been decelerating. And I think there are certain property types where they could turn negative for a while. Now the stocks started turning down at the beginning of last year. So the market has been anticipating this. And just to give you a sense on a global basis, the market is trading at about a 25% discount to what we think the underlying real estate is worth. But in terms of our view, we see the global economy slowing. One of the factors with inflation around the world is it has stopped central banks from being able to ease. The good news about the US is that we’ve already eased a lot. That said, I think the economy is going to be tougher for probably a longer period of time. The part of the equation just as it relates to fundamentals and real estate values is the credit markets. We’ve also been in an extremely difficulty, probably one of the worst credit crisis ever. I guess it’s our view that we are working through it. Maybe we are two-thirds of the way through that process. And there is going to be a point in time over the next, say, six months where the strongest banks will know what their situations are and they are going to want to start lending again. That capital is going to go to some of the best positioned real estate companies out there, the companies we call the realty majors. And so our portfolios are positioned – highly concentrated in those with the strongest balance sheets, which is both a defensive position and an offensive position, because once we work further through this, there are going to be some pretty good acquisition opportunities for the companies that we invest in. And that will help rejuvenate the cycle in terms of the companies beginning to gain market share once again.

Erin Caddell – Hovde Capital

Okay, that’s very helpful. Appreciate it.


Thank you. At this time, I’d like to turn the floor back over to management for any further remarks.

Marty Cohen

Well, once again thank you for joining us today and we look forward to reporting to you and hearing your questions in our next quarterly conference call.


This concludes today’s Cohen & Steers conference call. You may now disconnect and have a good day.

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