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Edited Transcript of GLXY.V earnings conference call or presentation 28-Aug-19 1:00pm GMT

Q2 2019 Galaxy Digital Holdings Ltd Earnings Call

Sep 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Galaxy Digital Holdings Ltd earnings conference call or presentation Wednesday, August 28, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Mike Novogratz

Galaxy Digital Holdings Ltd. - Founder, CEO & Chairman

* Chris Ferraro

Galaxy Digital Holdings Ltd. - President

* Donna Milia

Galaxy Digital Holdings Ltd. - CFO

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Presentation

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Operator [1]

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Good morning and welcome to Galaxy Digital's shareholder update conference call. We're joined today by our Founder and CEO, Mike Novogratz; President, Chris Ferraro; and Chief Financial Officer, Donna Milia.

Before we begin, please note that our remarks today may include forward-looking statements. Actual results may differ materially from those indicated or implied by our forward-looking statements as a result of various factors, including those identified in our filings with the Canadian Securities Regulatory Authorities on SEDAR and available on our website.

Forward-looking statements speak only as of today and will not be updated. In addition, none of the information on this call constitutes a recommendation, solicitation or offer by Galaxy Digital or its affiliates to buy or sell any securities, including Galaxy Digital securities. With that, I'll now turn it over to Mike Novogratz.

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Mike Novogratz, Galaxy Digital Holdings Ltd. - Founder, CEO & Chairman [2]

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Good morning, everyone. It's the end of the summer, the last I spoke the second quarter was well underway. I'm happy to report we had a great second quarter. We made $114 million, we grew our book 38% to $448 million. Crypto really came back in the second quarter, the liquid market prices did. A lot of significant events that I think are promising for the long-term evolution and institutionalization of the space.

Our broader goal since the outset of Galaxy is to play a key role in pulling the space --- for its institutional adoption. To that end, I think the near-term goal through the market drawdown was to kind of get the right pieces in place, build the right team and build the right platform.

And we believe we're accomplishing a lot of this and I'm positioning Galaxy as a leader in the space. I think we have the best talent and infrastructure, we're well-capitalized, we're well-connected. Now that the market has hit an inflection point, we're in much better position.

That said, I think this is going to be the beginning of a long-term and a more disciplined, rational growth expansion for digital assets. We're not going back to 2017. And so, while it felt really great when Bitcoin went from 4,000 to 11,000, just urging some sobriety, while Bitcoin prices have come back because the rest of the market is literally in a growth stage, but it's in a grinding growth stage.

I'm going to real quick hit on what I think of the four opportunities that we focus on. Bitcoin as digital gold has really carved out its place as a safe haven asset. I think it's the one cryptocurrency that is already finished in its development in lots of ways. And so, you don't need to change Bitcoin for it to continue to be adopted. We see more and more ways of people buying Bitcoin and more and more adoption. And so, we remain really constructive on Bitcoin.

Payments and transactions, I think the market is accepting the payments (inaudible) use case. That's a big deal. Lieber got people's attention and, whether it's implemented or not in the long run, in its current form is really a game changer to have Facebook as one of the largest companies in the world heavily invested in this space, building a solution for global payments. And there is going to be lots of other competition. We're really excited to see the telegram launch as kind of the next big event in the crypto space.

I think Web 3.00, the Ethereum transition, lots of developer activity, lots of other platforms ---- my sense is Web 3.0 is going to take longer than we'd all hoped. This is a venture bet and there are lots of protocols competing to be part or all of what will in the long run be this global decentralized supercomputer.

What's interesting there is -- I think in the long run where the really interesting kind of global change has happened. I just caution that that's not happening in the next few months. And so, we look at that really more like we look at venture.

And then I would say the tokenization of everything ---- to me this is going to be very exciting. It hasn't happened yet. We're doing lots of work, there's lots of work going around around space of tokenizing art, tokenizing real estate, tokenizing sports memorabilia. Work with the SEC, working with various platforms in some short time I think, 6 to 18 months, you're going to start seeing the development of those markets in a real big way.

And so, where positioning Galaxy to capitalize on this. You can see the impact of the improved [market] conditions and longer-term progress in our second-quarter results. The impact on the liquid book was immediate ---- our traders were well-positioned, we were longer Bitcoin than any other coin, at times we were longer Bitcoin and short some of the other coins. And so, our group way outperformed Bitcoin itself even inside a big quarter.

I would just say long-term I'm bullish as I've been about the space. Our book value at the end of the quarter was CAD2.07, which has us trading at a discount to book. And so, one of my grand frustrations is we haven't been able to convince the public market that there should be enough liquidity in our stock for people to buy it.

We're going to work on that in a pretty strong way in the next three to six months, trying to tell our story and getting people to understand that you're buying book, which is a diversified book, and then a call option, quite frankly, on what we think will be building one of the better franchises in the space.

Excited to announce we promoted Chris Ferraro to President. He's been a key member of the Galaxy leadership team since day one. He's been instrumental in building the Company, managing our principal investing, research and corporate M&A functions over the last year. He's really going to help me out in running the day-to-day biz and allowing me to focus more on both telling our story and investing.

And so, with that I'm going to turn it over to Chris to give a little more insight into our current operations and go-forward strategy.

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Chris Ferraro, Galaxy Digital Holdings Ltd. - President [3]

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Thanks, Mike. I'd like to start out by saying that I couldn't be more proud of the entire team here at Galaxy for their commitment in helping the Firm emerge from what was a pretty challenging period in the market, delivering a productive second quarter marked by promising business innovation, a strong and healthy balance sheet, and increasingly robust and more scalable platform.

As many of you already know, Galaxy benefits from a diversified approach that enables us to participate in the growth and institutionalization of the digital asset and blockchain space across a broad range of activities. The Firm is organized across three distinct but synergistic operating business lines: trading, asset management and advisory services, as well as maintains a diverse and flexible balance sheet that we have utilized, and we intend to continue to utilize, to build out and scale these businesses further as well as to make strategic principal investments.

To make this earnings call as helpful as possible to our investors, I plan on touching briefly on each one of our businesses and our progress in 2019. And after that, I'll hand the call over to Donna to review our financial results. And finally, we will end by providing answers to the questions that we've been hearing most frequently from our shareholders and new investors out in the market.

First, let me turn to our trading business where we've made significant strides in growing our reach and taking market share as a number of actively trading OTC counterparties increased 60% quarter-over-quarter, while our average daily volumes traded increased in excess of 300% in the second quarter relative to the first quarter.

Furthermore, and most prominently, not only did we benefit in the year-to-date period from positioning our trading book net long going into the significant rise in cryptocurrency prices, but our active trading strategy also immeasurably outperformed the market in the second quarter, which we believe, based on internal analysis, added an estimated $49 million of incremental profit to our earnings relative to having simply held our underlying basket of cryptocurrencies.

During the quarter we also began offering coin borrowing and lending, as well as corporate derivatives, to select counterparties, further enhancing the product offering and diversifying the return streams of our trading business. These are all activities that we intend to further put people and capital behind in the coming quarters and then provide significant margin enhancement opportunities for the business.

Finally, in August we completed an investment in DrawBridge Lending, a complementary business focused on providing bespoke lending, derivative and structured product solutions to the digital asset marketplace. We're excited about the prospects of this partnership and we look forward to launching a set of jointly developed products with the DBL team in the coming months.

Second, let me turn to our asset management division where we ended the second quarter with $393.9 million of AUM, down 5.7% sequentially from the $417.9 million we reported at the end of the first quarter. Unpacking this a little, the $24 million decline in AUM was attributable to a $34.5 million decline in the AUM of our cash management fund of one, which was a legacy low fee product that we've historically run for a single digital asset company.

Consistent with our growth priorities, we will be shutting down this account during the third quarter, which will result in a further incremental decrease in AUM by $51 million in the next quarter. However, specifically to put this into context, the estimated net financial impact to Galaxy from this reduction will be a de minimis decline in revenues of approximately $250,000 on an annualized basis.

Excluding the wind down in this legacy account, we saw a net increase in AUM for the quarter driven by a $10.4 million increase in assets under management in our passive fund that seeks to track the Bloomberg Galaxy Crypto Index, or the BGCI. Importantly, our passive fund marked its first anniversary during the second quarter now has a one-year track record.

While we of course would have liked to have seen better market performance overall in 2018, we've been pleased by the way that BGCI has captured, as intended, a diversified exposure to the largest and most liquid digital asset since inception. And were pleased to see it up 56% in 2019 as of August 26.

As we previously noted, our strategy in developing the asset management business to date has been to focus primarily on institutional allocators ---- pension funds, endowments, foundations, fund of funds, wealth managers, large family offices. As we believe that over the long run establishing these partnerships will result in larger and more scalable outcomes for the Firm.

By their very nature, these relationships take time to cultivate and catalyze into active allocations, particularly in a new asset class. I'm confident that our work throughout 2018 and 2019 in this regard will position Galaxy to be an asset manager of choice as these investors work their way through their investment processes and begin allocating to the digital asset space.

In Galaxy's third and newest operating segment, advisory services, our mission is to become the most knowledgeable and interconnected team in the industry in order to provide the most valuable, timely, strategic advice to our corporate sponsor and investing client. We've been pleased to see the advisory team continuing to make significant strides in this regard.

Our team has the clear mandate to develop systematic coverage of the largest digital asset and blockchain companies globally, as well as to initiate strategic dialogue with companies in established industries who are beginning to consider acquisitions and not control investments in the space. Trusted advisor relationships do not develop overnight, but we are pleased with the progress we are making, and we expect this to become an important revenue segment for us in the future.

In terms of key milestones, in July we announced that Galaxy's advisory group received formal approval from FINRA in July to act as an underwriter to registered offerings of equity, debt and other corporate securities in the US. This significantly expands the scope of work that our advisory team can take on and further positions Galaxy as the clear first mover specialist advisor to the digital asset and blockchain sector.

Going to the last four months of the year, the advisory team has several active mandates in its backlog covering both financing and potential strategic M&A. We monitor a mandated pipeline of future capital markets and strategic advisory engagements as the best barometer of the forward opportunity for this business and were pleased to have seen this mandated backlog grow quarter-on-quarter this year and each quarter since the fourth quarter of 2018.

Fourth and finally, let me just briefly touch on our balance sheet. During the second quarter we made substantial progress in diversifying our exposures and realigning our portfolio in order to position the Firm to be able to fund ongoing business needs while simultaneously taking a proactive approach toward deploying new capital into growth and partnership initiatives.

Galaxy remains one of the best capitalized companies in the digital asset space and we fully intend to leverage this strong position to both organically build and opportunistically acquire best-in-class talent, technology and ideas. I cannot stress enough that our financial position with a large and diversified strategic investment portfolio, plus in excess of $250 million of cash, cash equivalents and digital asset holding, positions Galaxy with an incredible amount of flexibility going forward to strategically scale and grow our team, product offering, portfolio and reach.

Lastly, I want us to recognize that no organization of value in any industry can scale and thrive without a strong foundation. To that end, over the last year we've invested in building world-class teams in our finance, legal, compliance, technology, human resources and other shared services functions. And we believe that our people and our infrastructure will play a critical role in driving future growth and success in the business.

And with that, I'd now like to turn it over to Donna to walk everyone through our financial performance during the second quarter. Donna?

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Donna Milia, Galaxy Digital Holdings Ltd. - CFO [4]

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Thanks, Chris. I'll now provide some color on our financial results for the quarter. Our comprehensive income for the three months ended June 30 was $114 million, bringing year-to-date comprehensive income to $127 million. These amounts include equity-based compensation expense of $7 million and $17 million for the three and six months ended June 30 respectively, which are non-cash charges and have no effect on equity. This brings our total equity or net book value to $448 million as of June 30 or CAD2.07 of net book value per share, USD1.57 of net book value per share.

In April, we tendered a portion of our investment in the ordinary shares of Block.one. When the transaction closed in May, we received $71 million in cash, representing a 123% return on the realized investment. The accounting treatment for this sale at this standard involved the recognition of a realized gain of $39 million on this position and also triggered the related reversal of the previously recognized unrealized gain of the same amount.

So, on our P&L the $23 million unrealized loss on investments during the second quarter can be understood as primarily reflecting a reclassification of income from unrealized to realized, which resulted in no net P&L impact in the quarter. This reversal of a previously recognized unrealized gain on an investment, which has now been successfully and subsequently realized, is presented net of additional positive appreciation on other investments that generated $15.4 million of additional book value during the quarter.

The accrual for equity-based compensation decreased to $6.8 million during the second quarter, down $3.5 million from the prior quarter due to the settlement of equity awards which we account for on a graded basis. As of June 30, the number of compensatory Class B units and stock options outstanding were $22.3 million and $18.1 million, respectively. The aggregate compensatory awards have a value of $29.3 million remaining to be amortized over their life.

Operating expenses for the three and six months ended June 30 were $18.8 million and $42.3 million, respectively, inclusive of equity-based compensation of $6.8 million and $17.1 million over the same period. The $25.2 million year-to-date total of cash settled OpEx brings our estimated annual run rate expenses to approximately $50 million.

Regarding our balance sheet, $12.4 million of new and follow-on investments during the second quarter taken in conjunction with $15.4 million of net unrealized appreciation due to valuation, and the cash we received back from the partial tender of Block.One shares, brought the quarter end investment balance down to $151.9 million.

As of June 30, we held more than 40 individual investment positions, excluding our cryptocurrency holdings, with no single investment position representing more than 4% of our net asset value.

Partners' capital stood at $435.9 million as of June 30, a decline of 17.9% from initial contributed value at inception inclusive of private placement proceeds. However, we performed well relative to broader markets. This compares to declines of 56% in the cryptocurrency market capitalization, 26% in the price of Bitcoin and 78% in the price of Ethereum over the same period.

We're pleased to report that even after accounting for forward commitments and $50 million of projected future expenses, we had $203.8 million of liquidity as of quarter end, inclusive of net digital assets, providing ample liquidity with which to continue to operate the business.

With that, I'll now turn the call back to Mike and Chris to address investor questions and for some closing comments.

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Chris Ferraro, Galaxy Digital Holdings Ltd. - President [5]

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Thanks, Donna. Before we end the call we wanted to answer a question that we've been receiving from shareholders and investors out in the marketplace. Next quarter we intend to do a live Q&A, but here we wanted to address a number of questions that we've had come in house. First question ---- why is owning $10,000 of GLXY stock better than owning $10,000 of Bitcoin?

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Mike Novogratz, Galaxy Digital Holdings Ltd. - Founder, CEO & Chairman [6]

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Let me take a shot at that, Chris. First of all, I talked about this earlier, our stock is trading, if you look at quarter results, below book. It has bounced around between below book to book to a little bit of a premium to book. And when you think about our book, our book has some beta to Bitcoin, which we think is one of the big stories in the crypto space. But it has also got a lot of exposure to the other stories. And we think we've got a diversified book where you're going to get a broader bet on the crypto space.

We also have a franchise that we think is going to be world-class and that we're building that right now the market is getting zero value to ---- actually negative value. So, the way I look at this is you're getting beta to Bitcoin, you're getting diverse and you getting a free call on us building a world-class franchise. And so, to me it's a much safer risk/reward and better bet than Bitcoin. With that said, I still like Bitcoin; I just think as a risk-adjusted bet this is a better one.

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Chris Ferraro, Galaxy Digital Holdings Ltd. - President [7]

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Next question ---- what can you tell us about your cash position and ongoing burn? Do you have the liquidity you need to execute on your plans? I'll take this one, Mike. As we've said a couple times so far on the call, we have significant liquidity today. We made some strategic decisions on realigning our balance sheet to get us in that position and we did that for a very specific reason, because we're dedicated towards building a franchise that Mike just articulated that we think is going to be world-class.

At the end of June we had over $250 million of cash and liquid cryptocurrency assets on balance sheet. And as we report in our MD&A, and as Donna highlighted, over $200 million of net liquidity after taking into account all the commitments, as well as a full year's run rate currently of operating expenses attributing no revenue associated with it.

And so, when we look at that liquidity profile and what we want to do, we think we've got in order of magnitude more liquidity in place than any other early stage venture capital business out there. And so, we're pretty excited about not just defensively using that capital but often offensively using that balance sheet to build the business.

Since going public and the declining crypto, what have been the biggest strategic and tactical mindset changes amongst Galaxy's leadership team?

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Mike Novogratz, Galaxy Digital Holdings Ltd. - Founder, CEO & Chairman [8]

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If I made a mistake, even though we were a little bit cautious when we went public, was not understanding just the severity of what a bear market does to overall business. And so, the real mindset change was at the bottom, when it really looked bleak, was to have a view that you've got to continue the business and size it properly to sustain in a lower period of activity. And I think that even though things have bounced back, that's still the mindset.

I'm positive of the destination of where this kind of crypto decentralized tokenized revolution goes. I'm not positive on the timing. And I think my lesson is it's probably going to take longer than we thought. And so, we want to be in a position that we survive that and that we're surviving when the markets really do pick up.

Some of that is just regulation, right? The SEC has been slower than we would have hoped. And so, the regulatory environment has been tougher. We haven't seen a lot of token offerings yet. I do think that's falling and we will get there.

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Chris Ferraro, Galaxy Digital Holdings Ltd. - President [9]

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The other thing I'll add tactically from the management team perspective is we've positioned the business to be focused on the highest standard of the institutional client base for the future of the business and we're committed to sticking to that.

That being said, I do anticipate that we will be expanding the team and be thinking about [other] markets down in the ultra-high net worth and high net worth sector and different products that we could bring to market and monetize with those channels as well. So, I expect you'll see more product and more thoughts from us on that perspective going forward, just to address what other business in the market is happening today.

We have another question about our trading business. What is the competitive landscape for the OTC trading business? I'll take this one. I think pretty candidly, it's the easy money had been made in trading in late 2017 and early 2018. And now that the easy money has been made, I think we've seen actually a pretty significant exodus from the market of what were big, large profitable trading businesses.

Some of our competitors who really had strong market share during those periods of time have had pretty public significant decreases in their team members leaving, team members being fired and significantly scaling down of the business.

On the other hand, we've conservatively but proactively added people to our trading desk, and we intend to do so on a go-forward basis as well. Because now that the easy money is gone, we feel like our skill set is one where we can actually significantly benefit and build a scalable platform that's going to make money even in a pretty tight market.

So, the answer is, the competitive landscape has actually declined and decreased in that market, albeit it's a tougher market. And so -- so the people who are still involved need to be better, faster and more nimble and better capitalized.

We've had a lot of questions around one of our portfolio companies, Xapo, which recently sold its institutional custody business to Coinbase, which was publicly announced. The question was what effect did this have on Galaxy's P&L and balance sheet? I think as Donna articulated, in general now our balance sheet is pretty well diversified in terms of private illiquid investments with no investment representing more than 4% of our balance sheet. Xapo wouldn't be one of those largest investments.

Our valuation policy as a Firm is to have a third-party external valuation firm mark our book for illiquid investments. And those firms tend to be pretty conservative and we tend to agree with them from a conservative perspective. A good example of how conservative businesses get marked is Xapo, for instance, the valuation policy for Xapo would look at only Xapo's Bitcoin holdings and give that the only value for the business.

And while Xapo has significant Bitcoin holdings, we currently ascribe zero value to its enterprise from our valuation experts. Coinbase's purchase of part of Xapo's custody business, not their whole custody business, represents a sizable acquisition in cash for part of the enterprise to which we were giving no values.

But to give everyone just a little bit of context on that, that sort of -- while it won't have a huge impact on our balance sheet one way or another because of the size of our investment in Xapo, it represents an accretive transaction relative to the way we are viewing that investment. That's about all we had. I'll turn it over to Mike for concluding remarks.

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Mike Novogratz, Galaxy Digital Holdings Ltd. - Founder, CEO & Chairman [10]

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I just want to say we're excited that we had a great quarter. It's been a long time coming. And I think while it's not going to be a V recovery for the industry or for our Company, it was a big, nice jump getting our book back within striking distance of where we started before the crypto winter feels good. And morale is good, we are sober in our outlook, but optimistic that the businesses are going to grow in time and the opportunity is going to be there.

And so, we'll be back next quarter. Like Chris said, we're going to take questions live. And until then, have a great last week of summer.