Onex Corp

TSX:ONEX

Earnings Call Transcript 2020-Q2

[Operator]

Welcome to the Onex Second Quarter 2020 Conference Call. [Operator Instructions]I will now turn the conference over to Ms. Claire Glossop Irani, Director, Client and Product Solutions at Onex. Please go ahead.

[Claire Glossop Irani, Director, Client & Product Solutions]

Thank you. Good morning, everyone and thanks for joining us. We're broadcasting this call on our website. With me today are Gerry Schwartz; Chris Govan; and a number of our Managing Directors. Earlier this morning, we issued our second quarter 2020 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. A 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 to discuss our recent activity.

[Gerald Wilfred Schwartz, Founder, Chairman, President & CEO]

Thanks, Claire. Good morning, everybody. It's been more than 4 months since our team began working from home. We've become accustomed to the rhythm of virtual interaction, but we're eager for a new normal. In spite of these challenges, we continue to make the most out of this really quite unusual situation. Overall, Onex investing capital is up 11% this quarter, with private equity capital up 16%. Chris will provide more detail about the upswing in our private equity portfolio. COVID-19 continues to affect many of our businesses, although fortunately, some in our portfolio have benefited in its wake. For example, in June, at Clarivate, we executed our third secondary shares sale. Onex Partners sold approximately $21 million shares at $22.50 per share. Onex portion of the net proceeds was $171 million, as both a limited partner in OP IV, and as a co-investor. And last week, Clarivate announced the transformational acquisition of CPA Global for a purchase price of $6.8 billion. CPA Global is our market leader in patent renewals, data, and analytics. The markets have reacted really favorably to this news, with Clarivate shares jumping from under $24 to almost $29. As a reminder Clarivate is our largest single private equity exposure.Since quarter-end, the value of our Clarivate shares has increased about 24%, and now represents 18% of our private equity portfolio. We're really pleased with how this investment has performed and our partnership with Jerre Stead, Clarivate's CEO, and believe in the opportunity for continued value creation. We're also delighted to announce, earlier this week, another secondary sale of our SIG Combibloc shares. Onex Partners sold approximately $32 million shares at CHF15.50 per share. Onex portion of the proceeds was $190 million, as both a limited partner in OP IV and a co-investor. Congratulations to Nigel Wright and all our team who worked on this. We continue to look at industries and names we know well for transactions that can generate PE like returns. This quarter, we made 2 preferred share investments in existing portfolio companies, Emerald Exposition and Ryan Specialty Group, and both those investments satisfied these criteria.At Emerald, the COVID-19 dislocation is actually what created an opportunity to invest in the business we know well with a solid collection of assets positioned to grow through acquisition. We believe this is an excellent investment for OP V, with the potential for attractive risk-adjusted returns. The transaction was executed at a compelling valuation, and has downside protection through a preferred share structure and only modest leverage. Onex invested $72 million through OP V as part of the fund's investment. An additional $35 million is expected to be invested from Onex in Q3 2020 as part of the fund's backstopping Emerald shareholder rights offering. The total Onex Partners V investment is expected to be approximately $390 million. At Ryan Specialty Group, one of our specialty insurance investments, we agreed to invest up to an additional $135 million in preferred shares, in connection with that company's add-on acquisition of All Risks, Ltd. As a reminder, this particular investment is held directly at Onex Corp. Like Emerald, we see the Ryan transaction as an attractive opportunity arising from this environment to help our businesses in their industry consolidation efforts.Our firm has also been growing throughout this period, in particular, at Onex Credit. We are making progress in building this platform into a well-rounded credit manager with additional strategies in areas like distressed and structured credit. We also issued 3 CLOs this quarter, 2 in the U.S., one in Europe. This was a real achievement in a very challenging market. In these issuances, we were able to both satisfy our desired return profile and to tidy up warehoused loans. I'd especially like to thank Paul Travers and his team for their efforts in making this happen. Last quarter, we announced the Jason New joined as Co-CEO of Onex Credit Since then, we've hired a number of high-impact professionals to enhance our existing strategies and to develop new ones. Senior team members who joined this quarter include Ronnie Jaber from Carlyle, who will be Head of Structured Credit, Tom Higbie and Chad Valerio as Portfolio Managers in opportunistic credit, and Clint Comeaux as Head of High-yield Credit, all well experienced in their fields. We warmly welcome these new additions and look forward to building our credit platform togetherThis quarter, Onex Credit completed the first close of its Onex Senior Loan Opportunity Fund, which invests primarily in North American and European first lien and senior secured loans. We also obtained launch strategies in structured credit, opportunistic credit, and high yield in the balance of this year.Let me turn now to our wealth management platform, Gluskin Sheff. It's been just over a year since Gluskin officially became a permanent part of the Onex family. As anticipated, Onex strategies have resonated with Gluskin clients. For example, in the last 6 months, Gluskin assets under management in Onex credit strategies increased 19%, largely due to inflows. We also continue to realize on our broader ambition to offer Gluskin clients holistic wealth management solutions. To lead strategic asset allocation and investment strategy, we hired Matt Lehmann as Managing Director, Head of Asset Allocation. Previously, Matt was it Credit Suisse in Zurich, where he was a member of their Global Investment Committee and responsible for leading the asset allocation process for the global bank's $70 billion pool of discretionary assets.So to wrap up, let me just say that it's been a memorable first half of the year. I remain optimistic about a return to a new normal and a remedy to COVID-19. But until then, and as always, I have enormous confidence in our team to navigate through these challenges. We've made meaningful strides in making Onex, our operating companies, and our credit portfolios more resilient, and we'll continue in these efforts. We remain fully committed to the alignment of management with shareholders, with a personal investment and everything we do. We're side by side with you in this journey. Thank you to all of our stakeholders, employees, and investors for your support.Now, let me turn this call over to Chris.

[Christopher Allan Govan, Senior MD & CFO]

Thanks, Gerry, and Good morning, everyone. Onex reported net earnings of $629 million or $6.43 per share in Q2, recovering a substantial portion of the loss reported in Q1. Q2 segment earnings were $689 million or $7.02 per share. Our segment results were driven by our investing segment, which contributed $657 million this quarter. As was the case in Q1, Onex's results this quarter are for the most part, a reflection of the significant and broad-based movements in underlying equity and credit markets. Happily, this quarter, those movements were upwards, with the S&P 500 up 21%, and the CS Leveraged Loan Index returning almost 10%. However, we are also pleased with progress we've made at Onex and the terrific job our investment teams and operating companies' executives have done at our private equity portfolio companies. So I'll try to highlight the Onex-specific factors that affected our results throughout my comments.Let's start by looking at Onex's PE portfolio. Q2 included a net mark-to-market gain from private equity investing of $435 million. As Gerry mentioned, this gain represents a gross quarterly return of 16%, reflecting value increases across much of the portfolio, as the equity markets rallied strongly from the lows reached in mid-March. As was the case with the public markets in Q2, the value increases in our portfolio were broadly based. As a reminder, Onex's PE portfolio is made up of 37 separate businesses with no cross collateralization. This slide details the allocation of the portfolio by industry segment at the end of Q2. Each of these 8 segments contributed positively to Onex's returns in the quarter. As our largest exposure, it's not surprising that business services was a big contributor, with over $120 million of value increases, mainly from Clarivate and PowerSchool. And Clarivate's performance post quarter end has given us a nice start to Q3. Although not a large exposure for Onex at the moment, industrials provided the biggest contribution in the quarter, thanks mainly to the significant rebounds in trading prices for both JELD-WEN and Celestica.Looking forward, there is little doubt that the equity value of many businesses will be driven by the extent to which business models and consumer behavior continue to be affected by the pandemic. Although industry sector is helpful in thinking about these issues, there are many different business models within a sector. So, as you recall from our Q1 call, we've bucketed our investments in the 3 categories of COVID exposure. As I said then, these buckets are far from scientific, but have been helpful in discussing our exposure internally and in conversations with our limited partners. Again, given the strong rebound in the equity and credit markets, value increases were seen are almost across the board in our PE portfolio. Even at the 7 most exposed companies, the efforts of our management teams to stabilize the businesses together with reduced risk premiums in the valuations resulted in a 7% value increase in Q2. However, the impact of the pandemic and the associated dislocations in the economy is better illustrated by looking at year-to-date changes in value across the portfolio. For me, there are 2 key takeaways from this chart. First, despite the very strong rebound we saw from the markets in Q2, our valuations continue to reflect a high level of uncertainty about the economy's path forward. Second, and perhaps more importantly, almost 60% of Onex's PE exposure is in businesses that have performed well, despite the pandemic. Although we all hope for a relatively quick return to a more normal economy, the $2.1 billion at work in these investments provide Onex a meaningful hedge against continuing COVID-related headwinds.Our credit investments also had a big bounce back, with $209 million of mark-to-market gains for the quarter. Given the structural leverage employed in the underlying strategies, the almost 10% return from the CS Leveraged Loan Index resulted in a 52% quarterly return from credit. As I mentioned last quarter, in addition to our focus on overall credit quality, we continue to watch our CLO's exposure to triple C-rated loans and the resulting impact on the interest diversion test. If the interest diversion test is not met, amounts that would otherwise be distributed to Onex on the CLO's equity are instead retained to purchase additional loans until the CLO is back on-site to test.The underlying metrics have improved nicely since the end of April and all our CLOs met their Q3 interest diversion test with only 1 left to be tested. Our 4 oldest CLOs are closest to the line. However, to put this exposure in context, these CLOs represented only about $4 million of our Q2 distributions.Although the mark to market improvements in our credit investments were good news, Gerry already mentioned what I think was the most important aspect of our Q2 credit investing -- the pricing of 3 new CLOs. At the end of Q1, Onex had a $144 million of capital invested in 3 separate warehouse facilities with aggregate exposure to a $450 million portfolio of underlying loans.The new CLO has provided a net distribution to Onex of $52 million and replaced short term warehouse financing with the long-term and durable financing structure, typical to our CLOs. These were great trades and meaningfully improved the risk adjusted return on almost $100 million of Onex capital going forward.Overall, the allocation of Onex's capital has remained fairly stable this year with cash and near cash now standing at nearly $2 billion or 32% of hard NAV. Although we haven't made any particularly large investments, our strong balance sheet has allowed us to commit to a handful of attractive PE investments post-COVID, and more importantly remain on the hunt for more.At Credit, we've been able to continue to build our CLO business and allocate $100 million of capital to opportunistically take advantage of dislocations in the market. And our balance sheet positions us to support Stuart and Jason as they build out the credit platform and what we expect to be a busy 12 months across several new strategies. Last but not least, our strong balance sheet has also allowed us to be active repurchasing off shares.Although, I believe there is meaningful value associated with our asset and wealth management platforms, given where our stock has been trading, I only need to look at Onex as investing capital or hard NAV to get comfortable with buying back our stock. At quarter end marks, Onex's investing capital per share was CAD84.63. However, I'd like to go one step further and adjust for the cash and publicly traded investments within our NAV.At quarter end, these assets alone represented over CAD43 per share. Assuming nobody will argue about the value of these assets, when we can buy back our stock at around CAD58, we're effectively buying in the rest of our investing assets about CAD42 per share of private PE investments and credit investments at an implied discount of about 60%.So as you can imagine, I'm pretty happy Onex has purchased almost 4.5 million shares through the end of July. At an average cost of CAD57.94 per share. These repurchases effectively created, about CAD120 million of NAV for our continuing shareholders.Before turning the call over to Q&A I'll spend a few minutes on the asset and wealth management segment. We generated net earnings of $32 million or $0.34 per share in Q2. The year-over-year increase in net earnings was driven by PE and in particular, an increase in carried interest on a mark-to-market basis to $23 million. This was partially offset by a reduction in PE management fees, which trended down as realizations reduced the fee base in our fully invested funds.The credit manager contributed a net loss of $1 million in Q2 reflecting upfront investments to build out the team and position the platform to meaningfully grow strategies outside of CLOs with senior loans. We're particularly focused on opportunistic and special situations, structured credit and high yield for near-term growth. As we raise fee-paying capital across these new strategies, we expect Onex credits profit margin to trend towards historical levels.On an LTM basis, year-over-year PE management fees were up $8 million with the inclusion of a full year from OP5, partially offset by decreases associated with realizations and fully invested funds. However, the most significant driver of LTM results was a $68 million net reversal of carried interest, which drove the PE managers net contribution to breakeven. However, with accrued carried interest of only $21 million at June 30, but over $9.5 billion of private equity AUM subject to carry, we expect carry interest to contribute meaningfully to improve results going forward.Looking at credit, the recent Q2 initiatives I discussed on the previous slide also contributed to a reduction in profitability on an LTM basis. And finally, Wealth Management's $43 million contribution reflects the first 12-month period following the Gluskin acquisition in June of last year. Looking forward, Onex's run rate, annual management fees are $296 million -- $184 million from private equity, $59 million from Gluskin's public equity and debt strategies, and $53 million from Onex Credit.We'd now be happy to take questions.

[Operator]

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

[Nikolaus Priebe, Research Analyst]

I'm wondering, when you look at across the existing private equity portfolio, have your views evolved to any degree on the amount of additional liquidity that some of the portfolio companies may require over the next 12 months. I think last quarter, you've indicated it wasn't too substantial; it may be something on the order of $100 million. But, I'm just wondering if there is any update on that?

[Robert M. Le Blanc, Senior Managing Director]

Nik, it's Bobby. The outlook for liquidity continues to be quite good across the PE portfolio. The one business for OP that we made an equity injection to as part of a covenant relief package is Parkdean, but that was a relatively minor injection and I don't see any liquidity issues in the portfolio for the next 12 months.

[Nikolaus Priebe, Research Analyst]

Okay. That's helpful. And then, maybe a question for Chris, just going back to the topic of buybacks, I have. I did pick up that you've been very active this year. I'm just wondering if you could speak to your remaining capacity on the NCIB and how much capital you might be comfortable committing to buybacks, just given that you have 30% that goes investing capital allocated to cash.

[Robert M. Le Blanc, Senior Managing Director]

Yes. We don't have any definitive limit other than obviously the actual limit under the normal course issuer bid, Nik, in mind. We're going to continue to look at our liquidity at Onex Corp, which remains very strong and compare the opportunity under the normal course issuer bid to the opportunities we see coming down the pipe to put money to work in private equity and credit and elsewhere. So I think we're going to stay open-minded and opportunistic and don't have any sort of set targets or limits.

[Nikolaus Priebe, Research Analyst]

Okay, fair enough. And then, on one of the pages of the presentation where you categorized the private equity investments into the 3 buckets based on relative exposure to COVID-19 and you also have the year-to-date changes in values. For that bucket with low to positive exposure, I think the investment has actually been marked up 21% on a year-to-date basis, even though, when I look at public equity valuations, they're roughly flat on the same time frame. So what are the standouts in that group that are really driving growth in the market? I imagine clarity is included there, but are there any other new color?

[Gerald Wilfred Schwartz, Founder, Chairman, President & CEO]

Clarivate is included there and it's obviously a standout including as Gerry mentioned some significant uptick since June 30. The other 2 that I'd probably point to are kind of comparable exposures: one being RSG and the other been Convex in the specialty insurance market where, again, I think both businesses are well positioned to capitalize on some real positive trends within that industry. And then last, I probably point to PowerSchool whose business model, including the add-on acquisition of [ Squalor G ] last year, it's positioning it to take advantage of some aspects of the pandemic, as it relates to particular-in-class capabilities and services that school boards require. I don't know, Bobby, whether you'd have anything to add to any of those?

[Robert M. Le Blanc, Senior Managing Director]

No, I think those are the 4 that are really well-positioned at the moment--

[Gerald Wilfred Schwartz, Founder, Chairman, President & CEO]

--add a little bit to SIG Combibloc has moved up nicely, a big position.

[Robert M. Le Blanc, Senior Managing Director]

Yes, the industrials rally pretty well this quarter with JELD-WEN and SIG.

[Operator]

Our next question comes from the line of Geoff Kwan of RBC Capital Markets.

[Geoffrey Kwan, Analyst]

My first question got a couple of parts, so just kind of adding into next comment on a question on the buybacks. But given Onex shares are still trading at a big discount to NAV, you talked about how you're buying back stock, but just wondering on what you've done so far, have you been generally kind of maxing out on the daily limits that that you're allowed to do? And also in general, how you're thinking about returns of putting capital to work or cash to work, versus the share buybacks? And then, does a substantial issuer bid make any sense and also how that impacts share liquidity?

[Christopher Allan Govan, Senior MD & CFO]

So I think, and I'll probably get some help from others when I'm done here, but in terms of the stock buyback itself, we have and are capable generally of capping out on our daily limit, when we're in the market and want to be in the market. As you know, in the first, I'm going to say-- I'm trying remember whether it carried on through May, but during part of the first half of the year, the daily limit was actually twice its regular daily limit, as a result of some relief provided by regulators, but that's backed down to its normal limit. So that's the extent, we want to be buying stock and are in the market, it's typically quite straightforward to get to the daily limit. We have had a few blocks that have moved, but not all that many that have allowed us to exceed our daily limit from time to time, and we're always on the lookout for those and we'll evaluate those opportunistically as they arise. I think substantial issuer bid, we've obviously thought about that from time to time as a management team. I think that, and we've generally been of the view that in our business, where there are opportunities to invest that arise, sometimes on relatively short notice, that taking ourselves out of the market for a long period of time, while the substantial issuer bid is out there and tying up capital, if you will, for a bid that may not actually be filled, which could give rise to missing other opportunities, hasn't felt like the right thing to do up until now. We felt that being nimble in the market through the normal course issuer bid, has been the right path forward. But as I said, we do think about that from time to time. It's an obvious question. But that's sort of where things have shaken out here before.

[Geoffrey Kwan, Analyst]

Okay, and then relative to the comments from last quarter, anything kind of changed from the deal pipeline, any color around that? And then also, if there is anything that you see in the portfolio that might make sense as the monetization candidate?

[Gerald Wilfred Schwartz, Founder, Chairman, President & CEO]

So in terms of new business activity, it was slow for the last couple of months, but in the last few weeks, the banks have been telling me to expect processes in Q4. I don't know how much of that's being driven by uncertainty around the US elections and related issues that might come from that. But we see it beginning to percolate again. Again, nothing near normal, but better. In terms of monetization, we really don't like to talk about the things that we're contemplating selling, but again, we constantly look at hold versus sell across our portfolio and we'll continue to do that consistently.

[Geoffrey Kwan, Analyst]

Okay. And just my last question. Chris, page 25 of the supplement, it kind of shows the asset wealth management earnings. And I believe that is the one that shows including this theoretical fees that would be charged to Onex, or the fees that would be allocated from an accounting perspective. And is it page 27 of the supplement-- again, would be kind of the apples-to-apples, showing what the earnings would look like without those fees that are allocated at Onex's capital?

[Christopher Allan Govan, Senior MD & CFO]

Yes, that's right, Jeff. So, both on a quarterly basis and a year-to-date basis is a little later in the deck. We've provided supplementary schedules just to bridge segment earnings to what segment earnings would be if we did not include fees on Onex's private equity capital. That's correct.

[Operator]

Operator instruction] Our next question comes from the line of Scott Chan of Canaccord Genuity.

[Scott Chan]

Gerry, in your opening remarks, you kind of talked about 2 preferred share investments. These investments are obviously opportunistic in this marketplace, but do they have the same potential total return profile, as say a typical private investment that you would look at?

[Gerald Wilfred Schwartz, Founder, Chairman, President & CEO]

We always look at the risk as compared to the rate of return opportunity and I would say that both of those with significant structural preference to our new investment. I think the risk return profile in them is actually even better than the normal PE type of returns that we're looking for. I feel pretty confident that risk return ratio is really, really, very favorable. Absolute return basis, if we see any kind of a return to normalcy within the next 2 years on Emerald, then I think it has the potential to be even better on an absolute return. Our RSG, Ryan Specialty, is already so highly successful for us that we're chasing a higher standard.

[Scott Chan]

Okay. And in terms of the groups that you talked about doing well. I'm just interested in an update in Convex. I don't think we've kind of discussed it since you made that as your first investment in OP V.

[Gerald Wilfred Schwartz, Founder, Chairman, President & CEO]

Convex is doing quite well. We've attracted all the human capital that we were seeking to higher within the first year. The original investment thesis was we talked a property casualty industry generally have been under pricing risk for years and then, there would be adverse reserve development and we began to see that on a quite well pre-COVID, and COVID has just accelerated that thesis through price increases almost across the board in the P&C industries. I would say Convex is even better positioned than when we made the investment, we're going to probably accelerate our growth plan, just given how good the pricing is relative to risk, and the fact that Stephen and Paul have no legacy liabilities to deal with like the rest of the industries and state of the art systems, I think from an operational efficiency point of view, they're going to have an advantage, as well. As long as we execute, we undue really well there, even better than our original investment thesis. And I'd just add to that Bobby's, while we mentioned it, but it deserves a bit of emphasis that we've gone from a standing start of 3 or 4 employees when we first established Convex, to now a full team of what, Bobby? 120 or 140 people--

[Robert M. Le Blanc, Senior Managing Director]

Yes, underwriters, across all disciplines, we're really excited about.

[Scott Chan]

Okay. And we don't talk about ONCAP for too much, but I noticed the net return is modest. Is there anything in that portfolio that kind of sticks out that has been impacting the performance of that mid cap private equity fund?

[Robert M. Le Blanc, Senior Managing Director]

No. And again, they have 2 companies that sort of were consumer-facing, Pure Canadian Gaming and auto source like Parkdean, they had to work with their lenders to make sure they were okay on some covenant issues, nothing major there. But those would be the 2 I would highlight in terms of being sort of in the direct line of C-19 like an ASM or [ whenever it was ].

[Scott Chan]

Okay and just last question. Lots of senior hires in the last several months, do you anticipate any more? Are there any kind of holes in your segments that you look to operate or expand?

[Robert M. Le Blanc, Senior Managing Director]

I'm sorry, I missed the question. Can you repeat at the beginning of the question?

[Scott Chan]

Yes, Bobby, I was just noticing that you've hired several senior key people, like within -- I guess specifically, credit and [ Gluskin ]. I'm just wondering if you guys anticipate any additional hires to expand any of the other segment at all.

[Robert M. Le Blanc, Senior Managing Director]

Seth, do you want to speak to credit and questions?

[Seth Mitchell Mersky, Senior Managing Director]

Sure. I think we're probably most of the way through the most senior hires, we probably still have a little bit of growth-related hiring at Gluskin and we will probably also add a little more feet on the street to our Distribution Group. But in terms of senior portfolio management leadership, I think we're pretty close to done for now.

[Robert M. Le Blanc, Senior Managing Director]

And the PE side, we will continue to recruit the younger talent into the organization to a little bit toughen in this environment down to do those interviews, but we'll do them remotely and we're always on the look for senior talent at both on cap, but nothing that's planned.

[Operator]

At this time, I'd like to turn the call back over to Gerry Schwartz for closing remarks, sir.

[Gerald Wilfred Schwartz, Founder, Chairman, President & CEO]

Thank you. Thanks everybody for participating today. It's always nice that to see some glimmers of hope coming back and that COVID isn't totally controlling all up our thinking and all of our worst nightmares, so thank you for your patience and thank you for your continued support. Thank you.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.