Onex Corp

TSX:ONEX

Earnings Call Transcript 2019-Q2

[Operator]

Welcome to Onex's Second Quarter 2019 Conference Call. My name is Shannon, and I will 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 of Investor Relations at Onex. Please go ahead.

[Emilie Blouin]

Good morning, everyone, and thanks for joining us. We're broadcasting this call on our website. With me today are Bobby Le Blanc, Chris Govan, and a number of our managing directors. Earlier this morning, we issued our second quarter 2019 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 you may recall, at the beginning of this year, we determined Onex met the definition of an investment entity as defined by IFRS 10. This change in status has fundamentally changed how we prepare, present and discuss our financial results. It's important to note that periods ending on or before December 31, 2018, have not been restated to reflect this change.Accordingly, readers of our second quarter materials should exercise significant caution in reviewing, considering and drawing conclusions from period-to-period comparisons and changes as the direct comparison between dates or across periods can be inappropriate or not meaningful, if not carefully considered in this context.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.Lastly, I wanted to share that we'll be hosting our Investor Day on October 10th in Toronto. Should you wish to receive further information about this event, please feel free to reach out to me.With that, I will now turn the call over to Bobby to discuss our recent activity.

[Robert M. Le Blanc, Senior Managing Director]

Thanks, Emilie. Good morning, everyone. I'll start by providing an update on what we're seeing in the market, followed by commentary on our activity in the second quarter and some developments since then. Not much has changed in the market since we last spoke with you. It continues to be a challenging investment environment. Competition is intense, interest rates are low, credit is readily available and valuations are high. In light of this, our large-cap private equity platform is focusing on key themes in the various markets we cover. We're using those views to help determine the right opportunities to proactively spend our time on it, which we believe our areas where we have a competitive edge, which brings me to our recent private equity investment activity.So far this year, our PE Funds invested or committed to invest in 2 terrific businesses, Convex and WestJet Airlines. Both were truly proprietary transactions, meaning no auction process and no competing bidders. This is pretty rare in today's private equity market. We believe it's a testament to the strength of our team and our brand.We spoke about Convex in our last call. So today I'll spend some time on WestJet. We're a bit limited in what we can say at this point given the transaction hasn't closed. With that said, we're excited about this acquisition and didn't want to let the opportunity pass without briefly introducing the company.As many of you will know, WestJet is the second-largest airline in Canada, operating out of a hub in Calgary, where it was founded in 1996 by Clive Beddoe and his partners. Known for its iconic brand and award-winning guest experience, WestJet also happens to be one of the most consistently profitable airlines in the world and flies to more than 100 destinations in North America, Central America, the Caribbean and Europe.Aerospace is one of our core areas of focus. And we've had an investment in this sector in every business cycle since our founding. Over the years, we've seen an enduring investment thesis centered on demand growth as well as proprietary insights gained from our experience throughout the aerospace value chain. We've been following WestJet for literally years and were drawn to the company's brand value, competitive cost structure and long record of profitability within the stable and growing Canadian marketplace.As with many of our investments, WestJet's various strategic initiatives present a number of operational levers through which to create value. We expect this transaction to close later this year. On the realization front, last month, we reached an agreement to sell Jack's Family Restaurants, a leading regional quick-service restaurant chain in the Southern U.S. Jack's said all the characteristics we look for. A market leader in this geography, a defensible market position with the unique brand and loyal customer , and then attractive free cash flow profile.Our value creation opportunity was not only to reduce cost as we traditionally do, but also to turn Jack's into a restaurant growth concept by accelerating new unit development. This is exactly what we did.Over our 4 years of ownership, we recruited and replaced 6 of the top 8 executives, including the CEO, CFO and COO. We designed and put into place the company's first incentive program to align management with us. We made significant investments in systems and people to support a faster growth trajectory across a wider footprint.And finally, we work with management to build an analytical site selection process that help deliver consistent and predictable new unit performance. Upon close later this quarter, we will achieve return of 3.6x our money and a 38% IRR. This is a terrific outcome. I'd like to take this opportunity to thank Jack's founder, Benny LaRussa Sr. for entrusting us with this business, as well as Todd Bartmess, our CEO partner and the entire Jack's team for their hard work over the years. We wish them every continued success.Within our remaining operating businesses, there are 2 updates worth noting. First, Clarivate completed its merger with Churchill Capital Corp and is now listed on the New York Stock Exchange. It has performed exceptionally well so far, which is a contributing factor to the growth of our PE portfolio in the quarter.Second, we reached an agreement to merge York Risk Services with Sedgwick Claims Management Services, the largest independent insurance claims management firm in the world. We expect the combination of the 2 businesses to create a more robust platform and enhance the value proposition for clients. The Onex Group is retaining all of its equity and will own 7% of the combined business. We believe this transaction represents the best risk-adjusted opportunity to grow our equity value through synergies and improved financial metrics. The transaction is expected to close later this year.Looking across our portfolio of more than 35 operating businesses, our investments have increased by 11% year-to-date, largely driven by OP IVs operating companies, namely Clarivate, SIG and Jack's.Moving on to our credit platform, we continue to increase our assets under management with the issuance of 2 new CLOs during the quarter. Total AUM at Credit is now $11.7 billion, which is up $1.5 billion or 13% so far this year. As a reminder, we first invested in Onex Credit in 2007 through a partnership with co-founders, Mike Gelblat and Stuart Kovensky.Today, we want to share with you, Mike's planned to retire later this year. Mike has been instrumental in growing Onex Credit from $150 million in AUM and inception to $11.7 billion today. Under his leadership, Onex Credit developed several new strategies, including CLOs, senior loan funds and a private debt platform.One of Mike's most important accomplishments is the development of a strong and highly experienced team. Mike's role as CEO has been transitioned to Stuart. We have every confidence that Stuart and the team will continue to grow Onex Credit, while always focusing on delivering attractive risk-adjusted returns to Onex and its credit investors. On behalf of everyone in Onex, I want to thank Mike for his tremendous contributions.Moving onto our wealth management platform, Gluskin Sheff + Associates. At quarter end, Gluskin managed fee-generating assets of CAD8.1 billion or $6.2 billion. As a reminder, Onex Corporation bought Gluskin, so it's not a fund investment, it's a permanent part of Onex. Our goal is to build a leading institutional caliber wealth manager, with best-in-class financial plan offerings that serve high net worth clients. It's been just over 2 months since we bought Gluskin and we're off to a good start.We had early success by offering a unique private equity co-investment opportunity with Convex that was made available to Gluskin clients. And in the fall, we'll launch our credit strategies more broadly to their client base. As a reminder, the core of these products offer current income yields that are attractive in today's low rate environment.From a financial perspective, which Chris will review further, Gluskin has been immediately beneficial to Onex's recurring fee revenue and profitability. Once we see the impact of a full-year contribution from Gluskin and Onex Partners V, we believe the profitability of our asset and wealth management platforms will be undeniable. This is value we don't see reflected in our share price today.To wrap up, it's been decent first half of the year. We've achieved success in all aspects of our business and we're well positioned to grow in the years to come. Today we have more than $7 billion of committed uncalled capital available to deploy in new private equity investments and our asset and wealth management platforms are geared for growth.Finally, one of the key cultural facets of Onex is our team's alignment in personal investment and everything we do.Today, the team manage $1.8 billion invested across our private equity platform, Onex Credit, [indiscernible] products and Onex shares. We all share in the risk rewards of our decisions and we're all focused on growing shareholder value.I'll now turn the call over to Chris.

[Christopher A. Govan, Chief Financial Officer]

Thanks, Bobby, and good morning everyone. This is the second quarter we're reporting under investment entity accounting. As a reminder, the fundamental change from prior years is Onex's financial statements no longer consolidate the private equity funds underlying operating companies. On last quarter's call, I discussed this accounting change in quite a bit of detail and I'm not going to repeat myself today. However, if you have any questions, as always, feel free to reach out to Emily and we'll happily walk through things with you.So now let's turn to the financial results for the quarter. Onex reported net earnings of $258 million or $2.58 per share in Q2. As I noted last quarter, my focus during these quarterly calls will be on segment earnings as we believe they best reflect Onex's operating results. Onex's segment earnings are computed before deducting stock-based compensation and the amortization of intangibles and most of our PP&E. As well, segment earnings exclude certain one-time items, including a large transitional gain we recorded in Q1 and some integration and acquisition costs in Q2.We've defined segment earnings this way to be comparable to the basis on which many of our publicly traded peers report and to be consistent with how we manage our business. Q2 segment earnings were $299 million or $2.90 per share, up over 50% from the $1.91 per share reported in Q1. The improvement in our segment earnings was driven by our investing segment, which contributed $283 million or $2.76 per share. Onex has almost 70% of its investing capital at work in private equity, so our investing segment earnings will usually be driven by the performance of our private equity funds. In Q2, Onex's private equity portfolio generated a 7% gross return resulting in $255 million of net investment income. As Bobby mentioned, these returns were primarily from value increases at Onex Partners IV.So far, 2019 has been a strong year for our private equity investments, with a gross return of 11% in the first 6 months. Credit investing also contributed to Q2 earnings, with net gains of $19 million. Most of this is attributable to mark-to-market gains on CLO equity, which benefited from a positive quarter in the broader leveraged loan market. Investing segment earnings will always be difficult to project particularly on a quarterly basis, but our asset mix is an important leading indicator.This next schedule details Onex's capital at each of the last 3 quarter ends. Onex's overall exposure to private equity increased in the second quarter to just over $4.3 billion. The increase was primarily due to the value generated at OP IV and new capital invested through Onex Partners V in Convex. Onex's capital allocated to credit increased slightly in the quarter as mark-to-market income and new investments in CLOs and OCLP outpaced the amounts returned from a CLO warehouse facility and $17 million of regular quarterly CLO distributions.Now historically. I know many of you tracked our investing performance through the growth in our hard NAV. Although I believe Onex's investment segment earnings are the right measure to focus on going forward, I want to take a moment to bridge the 2 approaches because I'm a little concerned some one-time items are masking our strong year-to-date investment results.Looking here at the bottom of the schedule, you'll note that there has been a slight decline in our investing capital relative to the hard NAV we published at year-end. This decrease is the result of 2 one-time factors. First, in Q2, we invested almost $350 million to grow our asset management platform through the acquisition of Gluskin Sheff and the consolidation of minority interest in the Onex Credit platform. In effect, we transfer this capital to our asset management segment to grow those earnings going forward.Second, there was a $145 million of one-time adjustments to our investing capital from the new basis of accounting on January 1. Most of that was the result of moving from a cash basis to accrual basis for some expenses and a little over $50 million was due to our decision to apply a discount to the trading value of public companies in our PE portfolio consistent with the underlying fund reporting.Once you make those one-time adjustments, the balance of the change in our investing capital is the result of our operations, principally $466 million of investment segment earnings, which represented 8% return on our investing capital year-to-date, a strong start to the year.With that, I'll move on to the asset and wealth management segment, which generated net earnings of $16 million or $0.14 per share in Q2. The private equity asset manager contributed $17 million in Q2, down slightly from the prior quarter. This decrease was the result of a $6 million swing in mark-to-market carried interest and higher running expenses, offset by a lower variable compensation accrual.The other item of note in the quarter is a $4 million contribution from wealth management as a result of the Gluskin Sheff acquisition on June 1. If we had owned Gluskin for the entire quarter, the contribution would have been about $10 million, bringing asset and wealth management segment earnings to $22 million in Q2.Looking forward, Gluskin Sheff added run rate management fees of about $77 million and $6.2 billion of AUM subject to carried interest or performance fees. These additions should contribute to a step function increase in our asset and wealth management segment earnings this year. But more importantly, we believe the addition of an exceptional high net worth wealth management channel will accelerate growth for all of our asset management platforms.That completes my comments on the quarterly results, and we now be happy to take questions.

[Operator]

[Operator Instructions] Our first question comes from Nik Priebe with BMO Capital Markets.

[Nikolaus Priebe, Analyst]

I just wanted to start with a question on Jack's, which was clearly a successful investment for you guys. The sale there was announced subsequent to quarter end. Maybe this is just a question for Chris. I just wanted to clarify whether the transaction value that was crystallized, it was reflected in the mark-to-market gains that we saw in the second quarter and in the fair value changes that were recognized for OP IV or would -- should we expect there to be a corresponding adjustment made in the third quarter to bridge the gap from the last quarter it marks on that investment to the realized transaction value?

[Christopher A. Govan, Chief Financial Officer]

Sure, without getting into specific details there, I'd tell you that and we've talked about this before more generally, I think we've got a very thorough valuation process and policy at Onex. And so, you should expect that our June 30 mark was reflective of what we thought the business was worth, but given the timing of the signing, it's not as if our valuation tie in directly to the transaction.

[Nikolaus Priebe, Analyst]

Got it, got it. Okay, that's helpful. And then just shifting gears, I did want to ask a question about one portfolio company, Schumacher or I guess SCP Health. Now, I was just wondering if I could get a bit of an update on that one. I'm just looking at the statistics presented here. It looks like EBITDA is up, net debt is down and there is a rebranding initiative recently. I was just wondering if you could provide a bit of an update on maybe some of the factors that have been affecting the performance of that investment and just what provoked the branding change there?

[Joshua Hausman, Managing Director]

Yes. So this is Josh. 2 things. On the branding, really the change was reflective of the fact that the business has expanded into more service lines and so we thought we'd move away from the original brand, which is really tied to the emergency department services in particular. So that was the reason for that decision.In terms of the performance, there was improvement -- underlying improvement in the operational performance in the quarter though about half of the $10 million increase that you see in the underlying earnings are related to some one-time items and the other half related to some operational improvements, which we'd expect to build on throughout the course of the remainder of the year.

[Nikolaus Priebe, Analyst]

Okay, that's helpful color. And then I also want to go back to one of the comments in the prepared remarks just with respect to the Convex co-investment opportunity that was offered to Gluskin clients. I would think investor participation in those types of deals could have positive implications for the retention rate of client assets. I'm just wondering if you could maybe comment on the uptake you saw in that or some of the feedback that you heard from Gluskin clients on that opportunity?

[Seth Mitchell Mersky, Senior Managing Director]

Sure, this is Seth. It was extremely well received quite frankly. And I think the clients that we spoke to about it, appreciated that it was a fairly -- an opportunity that was fairly non-correlated to macroeconomic activity generally. And I would agree with you. I think that kind of opportunity increases client loyalty and hopefully results and better stickiness and happier clients going forward.

[Operator]

Our next question comes from Geoff Kwan with RBC Capital Markets.

[Geoffrey Kwan, Analyst]

I had a question on Clarivate. I mean this has also been one that's been I think a very good investment for you given also how much are the size of investment, but I'm wondering if you have like kind of even a ballpark number given how much Clarivate analytics [indiscernible] share price has been up year-to-date. Like what the IRR on that investment has been to date? And because I think the multiple capital is north of 2x already. Just, I mean, if you're able to give any update on either one of those metrics?

[Konstantin Gilis, Managing Director]

Sure. It's Kosty speaking. We're limited in how much detail we can provide for many reasons, namely the company is public, but your rough numbers are directionally correct. We invested in the business in October of 2016 and your view on the approximate multiple capital is right. So I'm sure you can run the math and calculate what the mark-to-market paper gain.

[Geoffrey Kwan, Analyst]

Okay.

[Christopher A. Govan, Chief Financial Officer]

Geoff, sorry, it's Chris. Just to throw in one other thing. I mentioned the $50 million transition in our investing capital as a result of putting discounts on our public company investments. It's probably just a good time to point out at June 30 that discount has grown to about $100 million.

[Geoffrey Kwan, Analyst]

Right. Okay, thanks. And then on OP IV, so this is 2 straight quarters that we've seen the IRR come up. Obviously, there's -- challenges were stabilized, but other investments are doing quite well. Do you feel as a whole that the IRRs are heading hopefully sustainably back in the right direction or is it still may be a little bit too early to kind of call that improvement?

[Robert M. Le Blanc, Senior Managing Director]

No, it is a little bit early, but we are seeing some improvement in several of the companies in that fund. We do have a couple of challenged companies as you know which Save-A-Lot and Survitec. But overall, we're pleased with the results so far year-to-date in OP IV in particular and we hope we can continue that, but it is early days.

[Geoffrey Kwan, Analyst]

Yes. And you mentioned the Survitec too, but on Parkdean, we saw an improvement, just any color around that. Again it's probably a bit early, but it seems like an encouraging that it was up quarter-over-quarter?

[Robert M. Le Blanc, Senior Managing Director]

Yes. The Parkdean's had a nice start to the year. As you know July and August and September are the 3 most important months for that business. Bookings looked really good and occupancy look good in July. August looks decent as well. [ I'm the new CEOs in the Chair, ] Steve Richard is doing a nice job. And I would expect you to see continued cash flow improvement as this year unfolds.

[Geoffrey Kwan, Analyst]

Okay. I know Bobby on the WestJet, you talked a little bit about the investment thesis. I think from -- like demand growth and also talked about some of the insights that you get from the other aerospace investments. Is there anything else you kind of able to share at this point in terms of the investment thesis around the WestJet investment?

[Robert M. Le Blanc, Senior Managing Director]

I'll let Tawfiq address that.

[Tawfiq Popatia, Managing Director]

Yeah, hi. I think there's only a couple of other additional things that we'd add beyond what we've talked about publicly. WestJet had a pretty tough 2018 and that was related primarily to the threat of a pilot strike. And then the announcement of a new joint venture with Delta Airlines that resulted in some disruption related to an existing courtier with American.I think part of our analysis was predicated on working through those factors and concluding that they were one-off. And so from the perspective of how the company was doing in the recent past relative to what its potential was, Bobby described, it is operational levers, strategic initiatives that we feel like we can experiment with, there is a lot going on at the company right now that just presents quite a few levers in terms of initiatives that we can use from here, I think, to create value in what is a pretty attractive marketplace in Canada. It's a very stable marketplace.Demand trends are good. Capacity additions in Canada are inflecting to be more in line with what's happened in the US. The hub dedication strategy around particular airport is also a little bit more nascent than it is in the US and so it just feels to us like a pretty exciting and interesting time to be investing in airline.

[Geoffrey Kwan, Analyst]

And if I can sneak in one last question. Just on the Gluskin transaction itself, just how a bigger picture on the thesis, I think you guys have a lot of -- if I remember correctly, a lot of tax losses that's able to help shield your taxable income that you earn at Gluskin. So you're kind of able from an IRR or multiple capital perspective able to get that benefit. Taking the pre-tax income out and call it your investment return. Is that correct?

[Christopher A. Govan, Chief Financial Officer]

Hey, Jeff, it's Chris. Yeah, that is correct. The losses -- the operating losses that we have at Onex Corp, which I think were about $1.2 billion last reported. We are able to access those to shield the income at Gluskin Sheff. The only thing I would maybe correct you on is, we just don't think of this investment as a multiple of capital or IRR investment. I think as Bobby mentioned, we think of this as a permanent part of Onex and something we are going to own forever and really have reflected in our share price through an ever-growing stream of asset and wealth management income.

[Operator]

[Operator Instructions] Our next question comes from Scott Chan with Canaccord Genuity.

[Scott Chan]

Just on the Gluskin, I think, going forward would you be providing disclosure on fund performance like they did in the past when they were public company or just kind of general asset growth and flows. Any color on what you think on that would be helpful.

[Robert M. Le Blanc, Senior Managing Director]

Sure. I think our current thinking is that going forward, we will not be disclosing individual fund performance, but rather just focusing on the bigger picture there.

[Scott Chan]

Okay. And so, it's all in that same vein on kind of talking about credit strategy is being offered to Gluskin clients. I'm assuming this is outside the CLOs or can CLOs be offered to Canadian clientele?

[Robert M. Le Blanc, Senior Managing Director]

In theory, I think anything can be offered to Canadian clientele. But at the moment, we're going to focus on the other senior debt strategies rather than CLO equity.

[Scott Chan]

All right. And just got to ask this on the 2 companies, the challenge companies Save-a-Lot, Survitec the metrics quarter-over-quarter were down significantly. Just wondering if you could provide us an update from last quarter.

[Robert M. Le Blanc, Senior Managing Director]

Jonathan, want to start with Survitec?

[Jonathan Mueller, Managing Director]

Yes. So on Survitec we continue to be engaged with the management team on addressing what exact word to describe as a continued disappointing financial performance. And so, it's an active engagement and one we're currently working through kind of the path forward at this point, but we don't have, I think very clear guidance we can give on the near or medium-term trajectory of this one.

[Matthew D. Ross, Managing Director]

Yes. And on Save-a-Lot, the company took meaningful steps in the first 6 months of the year to progress its transformation plan. That's obviously underperformed expectations with the major driver being the significant increase in competitive intensity over the last 2 years in the food retail market and it continues to ratchet up. So the goalposts have moved materially there and it's requiring more and taking longer than expected, but management continues to develop and launch new programs to reposition the company and we continue to support them in those efforts.

[Operator]

Thank you. That concludes our question-and-answer session. I will now turn the conference back to Bobby Le Blanc.

[Robert M. Le Blanc, Senior Managing Director]

Thanks everyone. We appreciate your support and as always, please feel free to reach out to Emilie, if you have any questions. We hope to see many of you at our Investor Day in October and look forward to speaking with you again next quarter. Enjoy the rest of your summer. Thanks.

[Operator]

Ladies and gentlemen, this concludes today's conference. Thank you for joining and have a wonderful day.