Onex Corp

TSX:ONEX

Earnings Call Transcript 2018-Q1

[Operator]

Welcome to Onex' First Quarter 2018 Conference Call. My name is Nicole, and I'll be your operator today. [Operator Instructions] As a reminder, this conference is being recorded.I will now turn the conference over to Ms. Emilie Blouin, Director, Investor Relations at Onex. Please go ahead.

[Emilie Blouin]

Thank you, Nicole. Good morning, everyone, and thanks for joining us. We're broadcasting this call live on our website. With me today are Gerry Schwartz, Chris Govan and a number of our managing directors.Earlier this morning, we issued our first quarter press release, MD&A and consolidated financial statements, which are all available on the Shareholders section of our website and have also been filed on SEDAR. Our supplemental information package, which includes the How We Are Invested schedule, schedule of fees and expenses and additional information is also available on our website.Before we get started, just a reminder that all references to dollar amounts on this call are in U.S. unless otherwise stated. I must also remind everyone of the usual disclaimer related to any forward-looking statements contained in today's presentation and remarks. Please refer to our webcast presentation for cautionary factors related to these statements. One last announcement before we discuss our activity this year. We're hosting our Annual Investor Day on June 14 in Toronto. Please feel free to contact me for more details.With that, I'll now turn the call over to Gerry.

[Gerald Wilfred Schwartz, Chairman, President & CEO]

Thanks, Emilie. Good morning, everyone. I'll start as usual with an update on what we're seeing in the market, followed by commentary on our activity in the first quarter and some developments since then.We had a lot of change in the market since we spoke last. We continue to see elevated valuations and lots of dry powder chasing private equity transactions. Looking at U.S. private equity buyout multiples, the 2017 average was 12.6x, and that compares to 9.4x just 5 years ago. And in Europe, we're seeing almost similar pricing. Although U.S. interest rates have continued to rise, credit remains readily available to fund leveraged buyouts. Surprisingly, the higher cost of oil has not yet impacted multiples being paid for buyouts. As we look for opportunities to deploy capital wisely in this market, we've been spending more time trying to find and to create proprietary opportunities. As always, our focus remains on identifying investments that will deliver long-term growth for our shareholders.I'll now turn to some of the highlights from this year. It's been a good start to the year. We've returned $790 million to Onex and our partners, primarily from the sale of Mavis Discount Tire. Our thesis was to leverage Mavis' infrastructure and operating systems to build a larger, more graphically diversified retail tire business. Over our 3.5 years of ownership, the business has more than tripled its number of locations and its earnings.Our sale achieved a return of 3.5x our invested capital, resulting in a 48% IRR. This, of course, would not have been possible without a great team of investment professionals and company executives. We owe a real thank you to Evan Hershberg and the team at ONCAP, who led this investment, and to Mavis' Co-CEOs, David and Stephen Sorbaro. We wish you all continued success.We also invested or committed to invest nearly $1.3 billion in 2 private equity transactions, SMG Holdings and PowerSchool. We spoke with you about SMG last quarter, so let's focus on PowerSchool, a leading education technology platform for K-12 schools. We're partnering in this investment with Vista Equity Partners with a 50% stake in the business for each of us. Concurrent with this transaction, PowerSchool will acquire PeopleAdmin, an industry-leading provider of cloud-based talent management solutions for the education sector. This creates K-12's most comprehensive and integrated suite of products. Our investment in PowerSchool is noteworthy as it's our first acquisition in the technology sector. Our efforts in this space ticked up considerably and quite intentionally with the hiring of Laurence Goldberg about a year ago. Since that time, our team has been diligent seeing opportunities and focusing on a few things that we believe will create attractive investments. One area is in education technology, which is in general being a lead adopter of technology, specifically in the K-12 sector.Spending within these public schools is resilient and seems to grow even in the most difficult of economic times. PowerSchool has many of the attributes we look for in a business. It has a strong market position in an attractive and growing market. Its financial performance is predictable due to its recurring revenue model and very low customer churn. And it has an attractive free cash flow profile. Our thesis is to work with Vista and company management to leverage the current platform to grow both organically and by acquisition. We're particularly pleased to be partnering with Vista given its long experience and successful experience in software investing. Our half of this investment will be about $850 million and will be funded through Onex Partners IV. Once the PowerSchool transaction is closed, we anticipate room for one more smaller investment in Fund IV before we turn our attention to Fund V.Turning now to talk to a bit about our credit platform. I point out that we started warehousing for our next U.S. and our next European CLOs. We've accumulated approximately $240 million of assets to date for these CLOs. Risk retention rules governing U.S. CLO managers will return earlier this year, while the European risk retention rules remain unchanged. It's still unclear whether or not smaller, less well-capitalized U.S. managers will be openly received by the marketplace. As a highly regarded, well-capitalized issuer, in fact, the 20th largest CLO manager in America, Onex is very well positioned to continue to grow regardless of the impact of changing rules.Our funding efforts continue for our private debt fund. As is often the case with a first-time fund, we have to seek the help of investors to get our story out. We're helped now by having invested in about $475 million of loans. And thus, potential investors can see parts of their future portfolio, and we believe that should make the balance of fund-raising a little easier. Finally, one of the key pillars of our story is our team's meaningful personal investment in everything we do. Today, we have $2.1 billion invested in our shares, operating companies and credit platform. We believe this distinctive ownership culture creates strong alignment with our shareholders and our limited partners.That's about it for me for now. Let me turn the call over to Chris Govan to give an update on our balance sheet and asset management businesses.

[Christopher A. Govan, Chief Financial Officer]

Thanks, Gerry, and good morning, everyone. My comment will provide an update on Onex' performance in Q1 relative to our shareholder value model. As a reminder, we target being about 75% invested, earning blended returns from private equity and credit in the high teens and generating positive operating leverage from our asset management platforms. I'll start with the change in our asset mixture in the quarter. Changes in our asset mix are driven by Onex' net investment activity, both in private equity and credit. As Gerry mentioned, we closed on SMG and put $139 million of Onex' cash to work during the quarter. Our PE platforms also had another good quarter of returning capital to limited partners, with Onex IV proceeding $235 million of distributions, primarily from the sale of Mavis.At credit, our CLO business continued its steady growth. Onex invested $75 million in support of 2 warehouse facilities and the refinancing of CLO-5. Our CLO investments also continue to provide Onex with a steady stream of cash flow, with $12 million of regular quarterly distributions. So overall, our net investment in CLOs increased by $63 million in Q1.Our remaining Onex real estate investment, Skyview, continues to make meaningful distributions now that all of the project financing has been repaid. Onex received $17 million during the quarter, and I'm also happy to note that Onex received an additional $34 million from Skyview in April. Overall, Onex' asset mix was essentially unchanged in the quarter, with 72% of its capital invested at March 31. Adjusting our asset mix for the recently announced PowerSchool investment in which we expect Onex Corp to invest approximately $275 million sometime in Q3 and for the additional Skyview distribution from April, moves Onex to 76% invested on a pro forma basis, slightly above our target.Next, I'll discuss our investment returns by reviewing the changes in the How We Are Invested schedule. Our private equity funds generated a 1% quarterly return for Onex and a 12% return on an LTM basis, which are below our targeted returns. However, we always tell investors to look at our returns over a longer time horizon. And if you look back over 5 years, Onex' PE assets have generated a 20% CAGR.Looking at the schedule as a whole. Onex' Q1 hard NAV per share was $64.01, down 1% in the quarter but up 6% over the last 12 months. Now the first quarter is typically a weaker quarter for growth in our NAV due to the timing of variable compensation payments to our team. In effect, the payment of the 2017 bonuses in Q1 of '18 offset the small value increase from our private equity investments. So while we didn't make progress compounding NAV in Q1, the Onex team and the talented executives that manage our operating businesses remains hard at work implementing our investment thesis: standing up corporate functions and carveouts, improving platform businesses through accretive acquisitions and steering operational restructuring efforts. And we're confident that these efforts will create meaningful value for Onex shareholders in the long run. Moving on to our asset management business. We manage $24 billion of third-party capital and expect that, that business will provide a positive contribution to NAV growth over time. We use our schedule of fees and expenses to measure this contribution. On this basis, our private equity platforms contributed $78 million in the LTM period, up slightly from calendar 2017. As Gerry mentioned, given the announced investment in PowerSchool, we are likely one new investment from beginning to draw fees from Onex Partners V. All other things being equal, at that point, our annual PE management fees will step up from their current run rate of $98 million to just over $150 million. That step-up in fees will materially improve our operating leverage and the contribution of our asset management business to NAV growth going forward.The overall contribution from our asset management platforms came in at $58 million in the March 31 LTM period. I don't have to remind you; this positive contribution was achieved while managing Onex shareholder capital free of fees. We're focused on generating strong long-term growth in both our NAV and our AUM. Over the past 5 years, our hard NAV per share has grown at a 9% CAGR while our fee-generating AUM has grown 18% per year. This performance has translated well for our shareholders, with the stock compounding at 14% per year in U.S. dollars over the same 5-year period.That completes my comments, and we'd now be happy to take any questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Geoff Kwan of RBC Capital Markets.

[Geoffrey Kwan, Analyst]

Just my first question was, I know, Gerry, you mentioned at the beginning, talking about the dry powder and the elevated valuations. It's just a question sometimes I get from investors as to see observation of, to your point, a lot of dry powder out there, and there seems to be fewer deals done in prior cycles, and does that -- the implications for Onex in the context of, does that potentially mean maybe a slower capital deployment than what people have seen over, say, the past couple of decades and therefore how that might impact NAV growth? Just wanted to get your thoughts to that kind of question/statement.

[Gerald Wilfred Schwartz, Chairman, President & CEO]

It's a really good question. Clearly, at these higher prices that businesses are being sold at, we're more cautious. We need to have a little more cushion room in making our investments because we're always focused on not losing money, not making a serious mistake. I think probably on the margin, slower than certainly the average of the last 20 years. On the other hand, it kind of surprises you, we -- PowerSchool came along, SMG came along. We have a couple of other things we're pretty close to right now. So even though I think my easy answer is, yes, should be a little slower, we seem to be in a particularly fruitful period right now.

[Geoffrey Kwan, Analyst]

And maybe just as a follow-up there. The PowerSchool is an example there. Is that maybe one way that you're looking at dealing with the capital that you have in terms of on the balance sheet but also within your private equity funds in terms of looking at larger deals that you have in the past where you may do a coinvestment that's bigger than usual or it's maybe partnering with another investor there? And then similar to that, given you've historically owned a lot of companies that have competed in numerous geographies outside North America and even Europe, is that at all a possibility to look geographically into new areas? Obviously, you did the London opening, I think it was in 2012. But just any thoughts there?

[Gerald Wilfred Schwartz, Chairman, President & CEO]

Well, we've been building London up significantly in personnel. I'm not sure of the exact number, but I think we have, if I remember right, 11, maybe 12 people there now. That's up from -- starting from the standing scratch with one person 5 years ago. So I think we're laying the base to do more, see more, be more active in Europe. We've kind of made an internal decision to not look seriously at other geographies for the -- like Asia, for example, or South America, for the home office of companies. What we really like are companies in America and Europe that are global businesses where they typically would have about half of the revenues coming from those geographies, but the other half are purely global. And that's -- if you look at our history, that's pretty accurate. And I don't see that changing.

[Geoffrey Kwan, Analyst]

Okay. And just the other question I had for Chris, just a clarification. When you were talking about the How We Are Invested, this Q1, you mentioned seasonally weaker. And that was just because the compensation gets paid out of the cash that drops, and that would be a little bit of an offset relative to, call it, the increase in value from the private companies that you wouldn't necessarily seen out of the quarters throughout the year. Is that correct?

[Christopher A. Govan, Chief Financial Officer]

Yes, that's right, Geoff. I think the way you can think about this, our How We Are Invested schedule is a pretty simple snapshot. And so as it relates to our operating expenses, it's essentially on a cash basis. And so Q1 on a cash basis is always a weak quarter from an operational perspective because of the timing of compensation payments.

[Operator]

[Operator Instructions] Our next question comes from the line of Nik Priebe of BMO Capital Markets.

[Nikolaus Priebe, Analyst]

Just had a quick question there. It's an interesting chart towards the start of the presentation that just showed the buyout multiples and also had a bit of a breakdown on the capital structure as well. And it looks like debt-to-EBITDA multiples have also trended up along with the buyout multiples. So I guess my question is, I'm just wondering, in the context of current environment that's kind of characterized by available credit, rising buyout multiples and rising interest rates as well, how does that affect your philosophy on leverage? Does the proportion of debt in the capital structure change at all? Are you trying to stay disciplined on that? Or any insight on your views on that would be helpful.

[Seth Mitchell Mersky, Senior Managing Director]

This is Seth Mersky. I'll take that question. Up until very recently, the leveraged markets had really stayed pretty stable and muted as it -- as regards incremental leverage multiples. And that was largely driven by the regulatory environment under the Obama administration. The environment has loosened a fair bit very recently, and we are starting to see credit multiples creep up somewhat, consistent with growing purchase price multiples. So that'll probably dribble into the market somewhat and probably will cause multiples to at least stay where they are despite the increasing underlying LIBOR rates or base rates. And our philosophy on leverage really hasn't changed because we still look for very strong interest coverages. We try our best not to have financial maintenance covenants in our capital structure so that they're well insulated from occasional volatility. And we generally aren't taking state-of-the-art leverage levels across the portfolio. I hope that answers your question?

[Nikolaus Priebe, Analyst]

Yes, no, that's helpful. One other question, this one for Chris. I was just wondering, with the dividend raise this quarter, does that kind of signal a bit of a shift in your preference between buybacks and dividends? Or how do you think about return of capital considerations right now?

[Christopher A. Govan, Chief Financial Officer]

Yes. I don't think it signals any shift in our views. I think we think of the dividend as something that should be related to the growth in our recurring cash flows. And our recurring cash flows are really made up of our asset management activities, and also, an ever-growing component of that is our quarterly returns from our CLO portfolio. That's sometimes masked by the expenses associated with investing all of Onex' capital as well. But we just think of the dividend as being related to the overall growth in the size of our asset management activities and related to that as opposed to being any change in mix between dividends and share buybacks.

[Gerald Wilfred Schwartz, Chairman, President & CEO]

Chris, let me just add to that. It -- the signal is that we're confident in our business.

[Operator]

Our next question comes from the line of Paul Holden of CIBC.

[Paul David Holden]

So given the activity you're seeing in the buyout space, is your assumptions regarding U.S. tax implications for LBOs -- seems like they're holding true. It's not really having any impact on activity, and maybe you can confirm that. And maybe there's some sort of smaller niche impacts one way or another that you can identify?

[Christopher A. Govan, Chief Financial Officer]

Yes. I think that's right, Paul. And I can't recall how much we spoke about this on the year-end call. But maybe to reflect upon our portfolio, first of all, we had a pretty thorough exercise around year-end. In fact, we kind of redid all of our valuations subsequent to the passing of tax reform to look at things pre- and post-tax reform. And there really was no change across the portfolio as a whole, some small winners and some small losers. I do think, in the market, there's going to be some businesses that were hurt by tax reform, and there's going to be some businesses that were winners. But big picture, I don't think we're seeing tax reform as a large negative or negative overall for the private equity industry, and we really haven't seen it affect deal flow as of yet. The other thing I'd point out is the acquisitions we did late last year, all of those were diligenced and modeled pre- and post-tax reform as well. And so again, that -- the possibility of those changes was fully baked into our thinking.

[Paul David Holden]

Okay, good. And then going back to the discussion on rising debt costs, I know Onex had extended duration at a lot of its underlying operating companies. So maybe you can just give us a little bit of a refresher on that and if there is any kind of rising borrowing costs impacting the bottom line for your operating companies.

[Gerald Wilfred Schwartz, Chairman, President & CEO]

Let me start with that, and then, Chris, you can add a bit. It's interesting that with rising interest rates and with the rising -- or the perception is that they will rise, which, quite frankly, has almost the same impact, we haven't seen it affect the -- anything at all in terms of the amount of borrowing capability, the willingness of lenders to provide capital. And we also haven't seen it affect -- which is maybe a little stranger, but it's correct, we haven't seen it affect covenants at all. Whatever modest level of covenants have been around for the last year, kind of continuing. Basically, there's a lot of capital available, a lot of borrowing capacity available covenant free or near covenant free related only to use of a revolver. Chris, do you want to add to that?

[Christopher A. Govan, Chief Financial Officer]

Yes. Only -- and to pick up on Gerry's comments, only that refinancing in these markets is a constant conversation around this firm, and it's something we talk about almost every Monday. In fact, we -- it's something that's ongoing and we take advantage of whenever we can. I'd point to as well, we've got some MD&A disclosure you can look at in terms of our debt maturities. And not to get precise with percentages, but if you have a look at that schedule, in essence there's no material amount of debt across our whole portfolio really coming due until 2022 at this point. So I think we feel really good that we know we've taken advantage of these markets to their full advantage.

[Gerald Wilfred Schwartz, Chairman, President & CEO]

We refinanced last year -- I'm just going by memory, somebody will correct me if I'm off, but I don't think I'm off much. We've refinanced $7.9 billion of debts last year. And I would bet that the cost to -- the period of time it takes for payback of the cost of those refinancings is probably 6 months or less. Those are -- that's pretty attractive.

[Paul David Holden]

Yes, no, that's great. And that's what I was looking to clarify, so perfect. And then just a couple sort of smaller housecleaning-type questions. Is OP V now earning fees or you have to make that one more small investment to get across the line?

[Christopher A. Govan, Chief Financial Officer]

Yes, that's the latter, Paul. So we have not closed out the commitment period on Onex Partners IV. And until we make that decision as a GP to close that commitment period out, the fees in OP V do not start to accrue.

[Paul David Holden]

Got it. And then last one with respect to Skyview. So I recognize you're receiving pretty attractive distributions off that investment, but I'm assuming the intention is still to sell that?

[Christopher A. Govan, Chief Financial Officer]

Yes.

[Robert M. Le Blanc, Senior Managing Director]

Yes.

[Christopher A. Govan, Chief Financial Officer]

So the way to think of -- sorry, go ahead.

[Robert M. Le Blanc, Senior Managing Director]

Oh, sorry, go ahead, Chris.

[Christopher A. Govan, Chief Financial Officer]

No, go ahead, Bobby.

[Robert M. Le Blanc, Senior Managing Director]

No. Yes, we expect to sell the remaining condos out in Flushing over the next sort of 12 to 15 months. So you'll see those continue to -- the loan's been fully repaid. The rest of distribution is going back to the -- to equity.

[Operator]

[Operator Instructions] That concludes our question-and-answer session today. I'll now turn the conference back to Gerry Schwartz.

[Gerald Wilfred Schwartz, Chairman, President & CEO]

Thanks, everyone, for being part of this call. We appreciate your support. And as always, feel free to contact Emilie if you have any questions in addition to what you've already had a chance to ask. We're looking forward to seeing many of you at our Investor Day and speaking with you again next quarter. Thanks.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Everyone, have a great day.