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Welcome to Onex's First Quarter 2022 Conference Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded.
I will now turn the conference over to Jill Homenuk, Managing Director, Shareholder Relations and Communications at Onex. Please go ahead.
Thank you. Good morning, everyone, and thanks for joining us. We're broadcasting this call on our website. Hosting the call today are Gerry Schwartz, our Founder and CEO; Robert Le Blanc, Onex's President and Head of Onex Partners; and Chris Govan, our Chief Financial Officer.
Earlier this morning, we issued our first quarter 2022 press release, MD&A and consolidated financial statements, which are available on the Shareholders section of our website and have also been filed on SEDAR. Our supplemental information package is also available on our website.
As a reminder, all references to dollar amounts on this call are in U.S., unless otherwise stated. I must also point everyone to our webcast presentation for our usual disclaimer and cautionary factors relating to any forward-looking statements contained in today's presentation and remarks.
With that, I'll now turn the call over to Gerry.
Thanks, Jill. Good morning, everybody, and thanks for being with us today. I'm pleased to report -- I'm very happy to report that Onex had a solid start to the year with continued progress in our plan to grow the business and increase shareholder value. Our investing capital per share or as we used to call it NAV per share grew for the eighth straight quarter ending at USD 92.94, up 3% in the quarter and 19% over the last 12 months.
Bobby and Chris are going to provide more detail about those results. Recently, we held our limited partner annual meetings in Toronto. They were really robust, well-attended and informative. And that was the first time in 3 years since our last in-person event. It was really nice to see so many of our longstanding LPs as welcoming new ones. It was also a time to reflect on how much has happened since the pandemic and how much challenge and uncertainty we've all managed through. And I might add, continue to endure to some extent, lesser, but to some extent. Through it all, the Onex team has remained resolute in our commitment to driving value for our clients and of course, for our shareholders. I'm very proud of our team and their accomplishments during this difficult period.
Our team's success, I think is directly linked to our values and consistent principles. One of Onex's earliest principles has been to be a responsible investor and I can remember that being right on the top of our agenda as early as 1984. More recently, we've expanded on that foundation as we continue to evolve our ESG program. That was really evident in our LP meetings where our investors heard how we're creating more discipline with how we track and report our ESG efforts as well we're using ESG more effectively. For example, within our PE platforms, we see it as an opportunity to identify and to execute on value creation for our operating companies, and we've seen it in several instances already.
Another area where Onex has been making real progress is diversity and inclusion. It's important that we continue to build on our commitment to increase diversity and to prioritize inclusion. Our objective is to create a program that's inclusive of all Onex locations and all forms and aspects of diversity. We have a D&I leadership council and it's co-chaired by Bobby and Jill and it's setting an active agenda, which includes advancing our engagement with external stakeholders. Shareholders, of course, are an important part of that engagement, and we look forward to updating you to keep you abreast of our progress. Let me stop there, and I'll turn it over to Bobby for more on the quarter. Bobby?
Thank you, Gerry, and Good morning, everyone. Onex had an active start to 2002 (sic) [ 2022 ] with progress across all of our businesses. Our invested capital per share was up 3% in the quarter, reflecting the resiliency and diversification of our portfolio. We're making headway in expanding fee-generating assets under management, which I'll provide an update on shortly. We updated our financial reporting in this quarter to present fee-related and distributable earnings, part of our commitment to increase transparency and comparability with our alternative asset management peers. Chris will focus more on the results in his remarks.
Most importantly, we remain committed to the strategy we presented at Investor Day. I feel confident that we're on the right path to create value for our shareholders. With that said, there is no question that we are operating in a challenging geopolitical, economic and market environment. But that doesn't diminish the solid fundamentals of our business. We believe we're in a stronger position today than we have been for years, which is reinforced by the following: one, we have a great team, and we're attracting the right people to expand our expertise and diversify our skills. It might seem cliche to say that our success is driven by our people, but it's true. We have the people, the culture and the commitment to deliver.
2, our private equity portfolio is well-positioned with good diversification. Today, we have active investments in 41 companies, one of the highest numbers in our history. Our company is managed effectively through COVID and are now executing on plans to drive future value. Since before the pandemic, our private equity returns are more than double that of the most relevant mid-cap index. Like all of you, we're closely watching the situation in Ukraine and our thoughts are with those directly impacted, including the family and friends of our Onex team members.
The human impact is immense, and the economic considerations are real. From a portfolio perspective, we have limited direct exposure. We continue to monitor the broader secondary impacts, but currently expect any exposure to be immaterial in the context of our overall portfolio.
3, Onex has weathered many market cycles before, making us a preferred partner in tough market conditions. Not many firms can say they've been in business for 4 decades. We bring that experience to bear every day in the decisions we make on behalf of our clients and shareholders. This experience is important as we navigate the current inflationary environment. Until now we've been able to manage price pressures and have felt limited direct impact across the PE portfolio. This is a result of investing in businesses with resilient value propositions. With pressures ongoing and the expectation that price increases may eventually impact demand, we remain cautious and continue to seek out additional ways to mitigate impacts.
4, recent industry consolidation reinforces our understanding of the value of our asset manager. Our CLO business is just one example. As we saw with Carlyle's acquisition announcement of the C-band portfolio of assets, acquirers are willing to pay a premium to acquire CLO businesses with strong earnings. Ours is a leading CLO business, which we will continue to grow. We priced our 24th U.S. CLO last month and ranked 16th for CLO managers for global issuance in 2022. But these types of transactions are important reminders of the value Onex shareholders already own.
Finally, we have operational momentum. Over the past year, we significantly enhanced our ESG program, accelerated progress in D&I and put an increased emphasis on employee engagement. Although these are often viewed as behind-the-scenes initiatives, they are critical to our ability to drive business and financial performance and attract and retain the best talent. We are making progress in all areas of our plan. The team is united and wanting to continue to grow our business and increase shareholder value. Here are examples of how we're doing that.
As you heard from Gerry, we recently hosted our limited partner annual investor meetings in Toronto. It was an important opportunity to get people back together and engage directly with LPs as we move forward with fundraising. In PE, we continue to anticipate a first close for Onex Partners VI in late Q2 or early Q3. ONCAP will formally launch fundraising in the fall. As I commented last quarter, it's a crowded fundraising environment. Recently, we heard more industry participants acknowledge how this is impacting fundraising timelines. We remain confident in our own plans and our ability to grow fee-generating AUM through our PE platforms.
Over time, Onex has succeeded by staying true to our investing DNA. We invest in complexity and dig deeper to search out businesses with long-term resilient value, all in a disciplined way within our chosen verticals. These messages continue to resonate with our LPs. For the first time, the PE and credit investor meetings were fully integrated, a clear indication of the One Onex approach becoming embedded in our culture. Following the meeting, we closed on a long-term credit investing partnership with Mercer. It's a customized cross-platform solution, allowing investments to be dynamically allocated by our team. Mercer considered 50 firms in their process, choosing Onex as one of its 5 partners.
The arrangement is for $165 million in fee-generating AUM in 2022, with the opportunity to meaningfully grow the partnership in years to come. This is a first of what we expect to be many bespoke arrangements for clients, made possible by the breadth of the full credit business we are building. As we told you at Investor Day, we're also exploring other new opportunities to add fee-generating AUM. I'm pleased to share that we are forming a new platform focused on investing in transportation-related assets used for land, air, marine and industrial applications. The strategy will focus on investments involving hard assets with long lives, contractual cash flows and an element of inflation protection.
We think it will appeal to infrastructure and cash yield-oriented investors looking to rebalance into the physical economy. To launch the fund, we brought on board Wes Dick, a former senior executive at BBAM, a world leader in aircraft investing and asset management. We know Wes well, and we're pleased to have him join the Onex team. This initiative is very much aligned with our strategy of building our new businesses that leverage our sector knowledge and add value to our growing asset management business. We expect to officially launch the fund later this fall, and we'll share more details with you as they are confirmed.
If I have a message for our shareholders today, it's a consistent one. We have the right people, plan and foundation to execute on our strategy. Over time, we will grow our asset management business and our NAV with the goal of increasing shareholder value. We'll keep working to ensure that the price of Onex shares reflect not only the full value of our investing capital, but also the inherent value of our future growth expectations.
With that, I'll hand it over to Chris for more on our Q1 performance.
Thanks, Bobby, and Good morning, everyone. Segment earnings in the quarter were $0.76 per share, included are $0.69 from our investing capital and $0.07 from asset management. Starting this quarter, the pro forma adjustment for fees on Onex Capital is no longer reflected in our investing and asset management segment earnings. We've adjusted prior year comparatives to be like-for-like on this basis. This change is connected to our broader shift in focus to fee-related earnings, or FRE and distributable earnings as the primary measures for the asset management segment. For the quarter, we had a fee related loss of $15 million and distributable earnings of $25 million.
I'll dig into those numbers when we get there, but let's start with our investing results for the quarter. Our PE portfolio was up 2%, very good considering the challenging and volatile market conditions in the quarter. A large component of the return came from ONCAP driven by a mix of factors across the portfolio, including a number of companies with strong operating performance, real earnings and cash generated in the quarter. These businesses did a terrific job managing inflationary pressures through price increases supported by strong end market demand. We're also seeing strong demand for our Canadian-based businesses as the opening of the economy here catches up with the U.S. However, as most of you would suspect, margin management is likely to be more challenging going forward.
Onex experienced positive contributions across most of its core PE verticals. Industrials and healthcare both delivered strong returns in the quarter, 9% and 7%, respectively. As was the case for the ONCAP portfolio, these returns at Onex Partners were driven by operating performance, with market factors having an overall negative impact on Q1 valuations, as you'd expect. The negative return from the services vertical was attributable to the significant decrease in Clarivate's trading price. You'll recall that we've already returned 2x our original investment in Clarivate, including a large secondary just last year that left us with about 30% of our original investment.
Despite the recent sell-off, Clarivate continues to be a great investment and we expect to see meaningful value generated from the recent lows. Overall, in the context of a difficult market backdrop, we're very pleased with our resilient and diversified PE portfolio. Turning to our credit investments. We experienced a modest loss in the quarter, substantially all from CLO equity, a reflection of the risk-off markets that developed in Q1. Of course, we focus on our CLO's long-term cash returns and in this respect, the CLOs continue to perform with Onex receiving $19 million in regular quarterly distributions. All told, our investing capital per share ended the quarter at $92.94, returning 3% since year-end. That return includes the benefit of buying back some of our shares at a hefty discount.
Q1 represents our eighth consecutive positive quarter, with investing capital per share returning 75% over those 2 years. We're pleased with the investing results this quarter with the PE portfolio's strong operating performance, managing to offset broad-based market weakness. Now let's look at the asset management side of the business. Our fee-generating AUM was up 2% in the quarter. The increase was driven by over $700 million of incremental CLO AUM, which importantly required minimal incremental capital from Onex. In addition, we priced our 24th U.S. CLO in April, which will add another $400 million to fee-generating AUM and secured the first commitment from the Mercer strategic partnership that Bobby described earlier.
We continue to expect consistent fee-generating AUM growth throughout the year in credit with increases in private equity ramping up over the second half of the year. As you recall, our goal to grow fee-generating AUM 15% this year is part of the 5-year plan from Investor Day. As we focus on raising capital to build Onex's capacity to generate FRE and distributable earnings, let's turn to where we're at on those measures today. As a quick reminder, the difference between our Asset Management segment earnings and FRE is the exclusion of carried interest from FRE. Carry is reflected in distributable earnings on a realized basis, as you can see towards the bottom of the table.
In the quarter, we had an FRE loss of $15 million, which included a loss of $7 million from the asset management platforms directly and $8 million of costs related to the public company and investing Onex's balance sheet. This compares to an FRE loss of $4 million in Q1 last year. The year-over-year change was driven by lower management fees at PE, the lack of performance fees at credit, which is not a surprise given the market, and our investment in an expanded credit team. The decrease in PE fees was tied to the expiration of fee periods for OP III and ONCAP II late in 2021 and the decreasing fee basis from realizations in fully invested funds. We expect PE fees to continue to decline as we move towards final closings of OP V and ONCAP V in 2023, but expect a step function increase at that point.
Compensation expense in the credit business, which as a reminder, includes wealth management operations, reflects the fully annualized level associated with the team we've built to ramp up AUM. As credit's AUM and underlying invested capital grow, we expect an unusually high percentage of the incremental management fees to fall to the bottom line. By and large, our results are in line with where we expected to be at this stage of the Investor Day road map. As we continue along that path, we also expect to exploit additional levers for growth that were not part of the 5-year model.
A good early example is the transportation-focused platform Bobby introduced. Given our fundraising expectations, the platform will make a positive contribution to FRE with its very first fund. And like any of our platforms, we expect to benefit from a growing series of successor funds. I plan to come back to our 5-year plan as part of the Q2 call in August to provide updates on our progress and midterm targets, especially for fee-generating AUM. Turning quickly to distributable earnings, a relatively quiet quarter for realizations resulted in $25 million of distributable earnings. We expect Onex to consistently generate DE in the coming years, which is an important foundation to our growth plan.
While realized carried interest is included in DE, on a mark-to-market basis, we generated $20 million of carry in Q1 compared to $96 million a year ago. Given the broader market's weakness, the year-over-year decline isn't a surprise. However, with $25 billion of carry paying AUM, we expect carry to contribute meaningfully to shareholder value in the coming years. While we're happy with our Q1 results in this challenging environment, we are reminded of the discipline and tenacity that has seen us through choppy periods before. As Bobby mentioned, we're known as a partner for tougher markets, and that's a reputation we plan to maintain.
That concludes our prepared remarks. So we'll be happy to take any questions.
[Operator Instructions] Our first question comes from the line of Geoffrey Kwan from RBC Capital Markets.
Just had a question on -- in terms of both on the deal pipeline and monetization, given what we've seen in the markets, kind of within your portfolio because if there's anything that you think you might be able to monetize in the next, I don't know, next year? And then also, like I said on the deal pipeline, how that might have changed in the past couple of months.
Hi Geoff, it's Bobby. Good to hear from you. The new deal pipeline, I'd say, compared to 2021 is slower. I wouldn't say it's meaningfully slower, but it's slower. On the monetization side, I can't get into details, but I would expect us to have some announcements over the coming couple of quarters of a couple of realizations.
Sorry, just on the deal pipeline, is that because of what's going on in the market? And then also, 2, is for stuff that you're looking at, have there been kind of changes in expectation on price or prices still elevated?
Yes. I think those 2 things are actually correlated a bit. When you have near-term volatility like we've seen since the beginning of the year, people who were sellers had price expectations in their minds in December. When the cost of capital changes, interest rates rise, you have geopolitical risks, bidders may not be willing to pay today what they're willing to pay in December. It depends on the company, too. Like it depends on the cash profile, it depends on how much of these things are inflation, whether things are impacting a given business. But for certain businesses, there tends to be a pause in periods of volatility, and we've seen a bit of that on the new deal pipeline. Again, even with that on the realization side, I expect us to see a couple in the coming quarter, a quarter or 2 because of the type of businesses that we're looking at, but realizations are less impacted by these types of things.
Our next question comes from the line of Graham Ryding from TD Securities.
I guess just you mentioned that you had a meeting with all your LP investors regarding fundraising for Onex Partners VI. Just maybe some commentary on sort of how you're feeling the confidence towards like the size and the timing of that potential fund raise? Any changes to sort of where your head is at before you went into those meetings?
No. So again, we're expecting a first close in early Q3. We're hopeful that, that close will include several long-term partners of OP that are sort of brand name LPs, including ourselves, by the way, within that first close. But look, I said it last quarter, and I think you've seen a lot of our competitors say it this quarter, it's a very crowded fund market -- fundraising market. I expect the duration of the fund raise to be longer than the typical for prior funds. As an example, OP V was a 7-month fundraise.
I expect us to be fundraising well into the first half of 2023, particularly because a couple of our long-term LPs have said they don't have the capacity this year to fund this year, and they want to be with us, but they prefer to be in sort of Q1 or early Q2 of next year. So I do expect it to be a longer process. I do expect it to be more difficult than prior fundraises, but I do expect that we will be able to maintain many of our current partners and other new partners, including distributing our OP through Gluskin and potentially other retail channels, which we're actively exploring.
Bobby, just to add on to that on the timing point. We're well positioned leading up to that first close in terms of having room to do probably one good-sized investment left in OP V. And in terms of our expectations around that first close, it will be kind of seamless in terms of our ability to continue on investing at our normal deal size. The other thing I think I mentioned on a prior call, but just to make the point again, that ultimately, regardless of the timeline to the final close, from a management fee perspective, LPs pay fees back to the first date we start investing from OP VI. So you'd like the fund raise to be shorter because it takes up less energy and less time. But kind of from an economic and operational perspective, it's sort of a bit of a nonevent.
Okay. Understood. And then FRE was negative this quarter. It sounds like it's going to continue to be that way until these private equity fees ramp up and also fees on the credit side ramp-up. Reasonable to expect positive FRE in 2023 once that sort of catch-up occurs that you're talking about?
Yes, I think that would be a reasonable way to think about it, Graham. And yes, and to your point, what we're seeing -- what we're going to see over the next 12 months or up to 18 months is, one, from a credit perspective, for the most part, and I think we've talked about this before on these calls, fees are earned on invested capital. And so there's a bit of a lag even between fundraising and fees on the credit side. And then on the private equity side, although we ultimately get fees back to the effective date of OP VI from a GAAP perspective, you can't record those fees until you've actually got the commitments.
So there will be -- I think, if you think about our private equity business between now and mid-2023, probably be a pretty consistent and at some point, a pretty significant temporary decline in fees until we get to that final close. But yes, I think I agree with everything he said in terms of expectations.
Okay. Great, and just to follow up on your comment there. On the credit side, you've been having some pretty good momentum there in growing your fee-generating credit AUM, but your management fees have been going sideways over the sort of past 4 or 5 quarters. Is that because you're investing capital has not really changed that much, even though you're fee-generating AUM is going up?
Yes, I think that's a fair statement. And there's also a bit of -- particularly in our mezz business, much like private equity, there's also the impact of realizations and distributions. The mezz business is a bit more like private equity in that regard in terms of closed-end funds and callable capital. So it's kind of those 2 things that play out, say, in the credit business at the moment. But with good momentum raising AUM, it's really kind of just a matter of time to get the revenue to catch up with the asset raising.
And that managed product is in market right now looking for to raise its next one, which will be larger than last one.
Scott, you might have your phone on mute.
Can you hear me?
I can hear you.
Sorry, I didn't hear my name. Sorry about that. So just on the new fund vertical, the transportation, because I know it's very early, but do you anticipate like a target raise of like Onex Partners or an uncapped size or somewhere in between?
No, we haven't rounded out of what we're going to target internally yet, but it will be nowhere near an Onex Partners type size fund. I would say it would be somewhere in the ONCAP size range give or take.
Okay. And then just in terms of your private equity remarks this quarter, when I looked at your -- like all manager peers, it was very similar. Can you remind us kind of your marketing process because some of the companies that came out kind of really delayed it a couple of quarters, especially the public market impact on the multiple. So maybe an update just on kind of the private equity marks and kind of what went into it this quarter.
Sure. Yes, our process is a quarterly process, Scott. So we do -- the valuations that you see flowing through into our public reporting are March 31 valuations. On the private equity side, particularly on the large cap private equity side that makes up the vast majority of the balance sheet exposure. We have an independent valuations team within finance that leads that process, obviously, with lots of input from the portfolio companies and the investment teams that oversee them. And ultimately, those valuations come forward to a valuation committee and are reviewed and audited by our auditors.
We have many different approaches to valuation depending on the company, the industry, its peers. And quite frankly, depending on the model or thesis under which we bought the company. So it's kind of hard to kind of describe one methodology, but we do have a pretty even mix overall between the use of current market multiples that can include reference to the private market multiples that we see and more long-term DCF models but ultimately, as you know, still depend upon an exit multiple. So it is fresh, and it does reflect the state of the markets at March 31, 2022.
Okay. And just lastly, just on the ONCAP performance this quarter, up 16% quarter-over-quarter. Was there any kind of themes or specific investments that [indiscernible] performing?
It was actually pretty widespread. The portfolio did well as a whole. I couldn't draw one name out of a hat at all to tell you that's where the value generation came from and I think it just reflects perhaps a little bit of caution at year-end, but being proven out in Q1, where those teams and those companies just did a really great job from an operating perspective. The other thing to keep in mind is we're never going to follow the market directly, right? Because we do invest with a thesis. I don't know, Bobby, if you want to give a little color in terms of how we think about value creation and Wes' role.
Yes. No, but that's exactly it. So look, we have to grow the valuations in numerics, DCF and comparables every quarter. To the extent that we're tracking against our underwriting plan and the business is going well, other than the cost of capital and a higher discount rate, which obviously you have to take into account for valuations. If we're tracking better than we're expecting, that's often offsetting the higher cost of capital and the comparable analysis rate.
And it's important we're doing a much better job with Wes and that team, creating those value creation plans and having KPIs, just a handful by a company to really know what drives the business. So there's total transparency. And if you do see a problem, we're able to attack it quickly. Like again, we were always all over these things. I just think we're much more systematic in our approach to the data analytics and the KPIs with Wes and the team than we have been in the past. It's just all part of continuous improvement.
Just to clarify -- just to clarify, Bob is talking about Wes Pringle and his operations group, not Wes Dick and its transportation group.
Okay. And I appreciate the enhanced disclosure specifically related to the credit performance this quarter.
And our next question is a follow-up from the line of Graham Ryding from TD Securities.
Yes. I just wanted to follow up on that theme a little bit in Q2. We've obviously seen a pretty material pullback here in public equity markets. We've seen a very, very material move higher in interest rates. So it's reasonable to assume that that will be a factor in your sort of valuation process for your private equity investments? And then whatever is happening at the company level operationally that will sort of either -- that will be another factor that could offset or could also have a big influence on your NAV and your private equity performance.
Yes, I think that's exactly right, Graham. And what we hope to see quarter-over-quarter regardless of whether the market is going up or the market is going down is as the teams execute on those value creation plans, what we typically see is our view of value narrowing relative to the comps. What we're often doing is marking our companies at a discount to public comps and larger comps, while we are executing on a plan to deliver value. And as we execute on that plan and improve margins or grow the business, create additional moats in the business from competition, we see narrowing of those discounts to multiple. So we do expect to see valuations for our businesses not to line up directly with the market. But yes, what's happening in the market is definitely a headwind to value creation in Q2.
Okay. Perfect, and then I apologize, I didn't get all of the info you mentioned this partnership with Mercer. Could you maybe just revisit the details on that comment?
Yes. So the credit team formed a partnership with Mercer, whereby our whole suite of credit products will be put into a comingled fund. And within rules that we're creating with Mercer, our team will figure out how to allocate the credit products within that structure. It's a very exciting new platform within credit, and it's one that we're hoping to replicate with other Mercer types in the world. And in particular with Mercer, who's been a great partner so far to date, we expect the dollars that we're managing on their behalf to grow pretty meaningfully over the coming years.
This does conclude the Question-and-Answer Session of today's program. I'd like to hand the program back to Mr. Gerry Schwartz for any further remarks.
Thanks, operator, and thanks to everybody for participating today. We really appreciate deeply your continued support, and we look forward to seeing you -- speaking with you again in August. In the meantime, I wish you all the best as we head into the summer months and let's enjoy some of this good spring weather we're seeing today. Thanks, everybody.
Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect.