Onex Corp

TSX:ONEX

Earnings Call Transcript 2018-Q3

[Operator]

Welcome to Onex Third Quarter 2018 Conference call. My name is Kevin, 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, Kevin. 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 third quarter press release, MD&A and consolidated financial statements, which are available on the Shareholder 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 relating 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. With that, I'll now turn the call over to Bobby.

[Robert M. Le Blanc, Senior Managing Director]

Thanks, Emilie. Good morning, everyone. I'll start as usual with an update on what we're seeing in the markets, followed by commentary on our recent activity. Year-to-date, global private equity capital deployment has increased, with volume and transaction value of 8% and 16%, respectively. The average EBITDA purchase multiple in the quarter also increased to 11x, which was 0.5 turn higher than the average multiple over the past year. North American-focused private equity funds raised $82 billion in Q3, up more than 50% over the prior quarter. While overall dollars raised increased significantly, the number of funds closed declined, illustrating an ongoing trend towards greater concentration of capital among larger managers.Outstanding leverage loans in the U.S. now total $1.27 trillion, which is more than the amount of high-yield bonds outstanding. The heavy demand for floating rate debt as rates increased has made for a very good borrowing environment despite a rising LIBOR rate. With this as a backdrop, I will now move on to our recent activity. On the capital deployment front, we've invested or committed to invest $2.3 billion in 9 operating companies this year. Let's take a look at 2 of our recent investments, Walter Surface Technologies and Ryan LLC.In September, ONCAP acquired Walter and they were looking to reduce their ownership to focus on other opportunities. We acquired a 94% interest, and the balance remains with the family and company management. Our thesis is to leverage Walter's platform to grow both organically and through acquisitions. In October, Onex Partners invested in Ryan, which is a global tech services and software provider. We have known the founder, Brint Ryan, for several years. When he approached us looking for an equity partner to help support the company's acquisition plans, we were excited by the opportunity to back an accomplished entrepreneur and invest in a market-leading business. Brint was attracted to our culture of strong alignment, our reputation for doing what we say we'll do and our successful M&A track record.Given our investment in Ryan and our pending acquisition of KidsFoundation, we'll now be investing from Onex Partners V, the $7.15 billion fund we raised last year. We expect to start accruing fees in this fund later this quarter. I'll leave it for Christopher to provide more detail, but this new fee stream will provide meaningful incremental operating leverage for our asset manager. On the realization front, we returned more than $1.8 billion to Onex and our limited partners. This includes the pending sale of Tecta America, which is anticipated to close later this year. This realization will result in a multiple of capital of more than 3x over the 2.5 years we've owned the business. Last month, we took SIG public on the Swiss Stock Exchange. This was the largest IPO in Onex' history and the third largest in Europe this year. We sold approximately 46 million shares for net proceeds of $511 million and remain a majority shareholder with a 51% interest. Based on recent trading, our multiple on invested capital including realizations is 1.8x. We're pleased with these outcomes and owe a big thank you to the terrific management teams who run both companies.Looking at our private equity portfolio, our performance continues to be mixed and below where we'd like it to be. Although many of our businesses have seen their value grow this year, others have faced headwinds. When performance lags, we can and must drive change when necessary. Recently, we initiated the replacement of senior leadership at a few of our businesses, including Survitec and Emerald. And we worked closely with some of our management teams to implement and/or expand cost savings plans to offset certain negative economic or industry factors as is the case with Parkdean and Schumacher. It will take time to see the benefit of this activity, but we think we're on the right track.I would highlight that about 45% of our private equity portfolio was invested in the last 2 years, so we're in the early days of our investment thesis for many of our companies. Overall, we remain optimistic that our diversified portfolio of 30-plus businesses will ultimately generate attractive returns.Turning to credit. Our pace of new CLO formation has been quieter this year. As a reminder, we're selective. And over the second half of the year, we found fewer new loan transactions where pricing and risk seem right to us. This is also combined with unattractive prices in the secondary market and recent widening of spreads on CLO liabilities. As with everything we do, our level of activity will vary year-to-year depending on market conditions.While our private debt fund continues to find attractive opportunities, our activity slowed in the quarter having deployed a net $75 million. Overall, we're pleased with the quality of the portfolio and our pace of investment to date, which is important for a first time fund building a track record. We've now invested about $800 million of the more than $1 billion of available capital. Finally, one of our key tenets of our story is our team's meaningful personal investment in everything we do. In total, we have $2 billion invested in our shares, operating companies and credit platform, including $120 million invested so far this year. This financial alignment is critical to our culture and overall success. We all share in the risk and rewards of everything we own. I'll now turn the call over to Chris.

[Christopher A. Govan, Chief Financial Officer]

Thanks, Bobby, and good morning, everyone. I'll review Onex' Q3 performance relative to our shareholder value model. And to remind you, we target being about 75% invested, earning blended returns from private equity and credit in the high teens and generating positive operating leverage of our asset management platforms. So let's start with asset mix. Changes in Onex' asset mix are driven by the net investment activity at both private equity and credit. A strong year of deploying capital through our PE platforms continued in Q3, with almost $400 million of Onex capital invested in PowerSchool, Walter and Precision. Net of some smaller realizations and combined with about $20 million invested through Onex Credit, we ended the quarter 82% invested, ahead of our 75% target. The results were quite a bit of investment activity that closed or was announced after quarter-end. We closed on our investment in Ryan LLC and expect our acquisition of KidsFoundation to be completed later this month. These 2 investments were balanced with 2 realizations: the IPO of SIG in early October and the recently announced sale of Tecta. If you adjust our asset mix for the almost $200 million of net proceeds from these 4 transactions, Onex moves to 79% invested on a pro forma basis. On to the next component of our shareholder value model, investment returns. I like reviewing our returns by looking at the quarter-over-quarter changes in the How We Are Invested schedule. Looking at this schedule, you'll see Onex' investment in private equity was roughly $500 million greater than at the end of Q2. This was largely due to the investment activity of both Onex Partners and ONCAP discussed earlier. Also contributing to this increase, albeit less so, were our PE returns of 3% in the quarter. On an LTM basis, Onex' PE investments have returned 9%, which contributes to our 5-year compound returns of 16%. Looking at the schedule as a whole, Onex' Q3 hard NAV per share was $65.61, up 2% since Q2 and 3% in the last 12 months, both of which reflect the recent below-target returns from our PE investments. I'll shift now to discuss the last driver of the shareholder value model, the operating leverage we achieve from managing fund investor capital. Turning to the schedule of fees and expenses, I'd note that the overall contribution in the September LTM period has improved by $9 million over the Q2 LTM amount. However, the real story here remains the same as last quarter. Onex' operations are running about breakeven despite private equity management fees at a trough and carried interest meaningfully below the 5-year average. As Bobby mentioned, our new flagship fund, Onex Partners V, will begin accruing fees when we close on KidsFoundation later this month. Although the impact will be rather modest in Q4, these new fees will move annual run rate fees across our 3 asset management platforms to over $200 million, a $55 million improvement. Now the annual contribution from carried interest is less predictable, but this step function increase in our management fees positions our asset manager to meaningfully contribute to our NAV growth in the coming years. I always like this last slide. I think it's a good snapshot of our progress and our stock's performance. I must admit, I'm disappointed to see our stock's CAGR at 6%, actually slightly below our NAV growth, given that our fee-generating AUM grew at an 18% clip over the same period. However, we'll stay focused on growing both our NAV and AUM, confident that our stock will reflect our results in the long run. That completes my comments. We'd now be happy to take any questions.

[Operator]

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

[Nikolaus Priebe, Analyst]

Just wanted to start with a point of clarification on the marks for the private operating companies. I understand the marks are, to some extent, based on public comparables as of September 30. Is that correct? Or I guess what I'm trying to get at is whether the volatility that we've seen in public market multiples subsequent to quarter-end would be reflected in the marks presented on the How We Are Invested schedule?

[Christopher A. Govan, Chief Financial Officer]

Yes. So Nik, the short answer is no, they would not be reflected at September 30. September 30 is based upon September 30. And obviously, our public holdings, there's a direct drive in terms of their valuations today relative to September 30. And you're right, if the equity markets remain down, that would be a headwind in terms of marks in the private portfolio as well, to some extent, at year-end.

[Nikolaus Priebe, Analyst]

Okay. That's helpful. And then I was also wondering, could you give us just a bit of color around the decision to take SIG public? The length of ownership looked a bit shorter than I think your typical holding period is. Is it just a case that you would realize on your value creation strategy with that investment and elected to pursue an exit? Or was it the consequence of favorable market conditions? Any color on that decision would be appreciated.

[Robert M. Le Blanc, Senior Managing Director]

Nigel?

[Nigel S. Wright, Managing Director]

Yes, a lot of things went into the decision to take SIG public. But a key one was an opportunity to delever its own balance sheet to support growth, which both we and management believe that SIG has ahead of it, which could include plant expansions and growth into the new geographic markets. You may have seen that they've entered Japan, India and several South American countries recently. So it was a good opportunity to use a public offering to delever their balance sheet and finance their growth plans.

[Nikolaus Priebe, Analyst]

Okay. That's helpful color. One last one from me before I pass the line. I also want to ask one about credit business. And I think, Bobby, you'd alluded to slower pace of CLO issuance in your prepared remarks. But it looks like some of the central banks like in U.K. and Australia have expressed some concern in the growth of leverage loan to market. Just wondering if you can kind of expand on how your thoughts might have evolved regarding the CLO business as it kind of relates to balancing the growth of that platform and the associated risk considering where we might be in the cycle. Like do you see CLO issuance continuing to slow on kind of a go-forward basis relative to the past few years?

[Robert M. Le Blanc, Senior Managing Director]

I'll let Michael answer that question first.

[Michael Jay Gelblat]

Sure. So well, I think that, as Bobby alluded to, our slowing pace was driven in part by our seeing less attractive opportunities. The pace at which we issue CLOs is really, as Bobby said, market dependent. It's -- when we issue see CLOs, where we source assets from is a combination of new issuance secondary market, so it depends on the prices we're seeing. Does that answer your question?

[Nikolaus Priebe, Analyst]

Yes. That's helpful.

[Operator]

[Operator Instructions] Our next question comes from Geoff Kwan, RBC Capital Markets.

[Geoffrey Kwan, Analyst]

You mentioned, I guess, changing some of the management at Survitec and Emerald. Can you remind me, when you did those acquisitions, did you keep the management teams that were in place? Or were those -- either one of them ones where you had brought in new management at the time of the investment?

[Robert M. Le Blanc, Senior Managing Director]

No, in both cases, the management team was there.

[Geoffrey Kwan, Analyst]

Okay. And then in terms of the companies that you view as not generating the returns that you'd be expecting at that point of the various investments, how -- like, do you think you're at a point or for each of the investments where you're already making some of these changes and the financial results have maybe bottomed or close to the bottomed and we should see the numbers improve from here? Or are there certain businesses where you think there may be some additional downside as you try and work these investments out?

[Robert M. Le Blanc, Senior Managing Director]

There's no sort of rule of thumb, if you will. We're focused on all of our portfolio companies, the ones that are doing well and the ones that need some work. There are some that are longer-term projects, like Save-A-Lot where we knew going in it was going to take longer than normal to get the earnings going the way we want it to because there's a lot of investing to make. But for the most part, we just -- yes, that's it. We're just working them all, good and bad.

[Geoffrey Kwan, Analyst]

Okay. On, I guess the old ResCare now, BrightSpring had a question there and I know -- I'm not going to ask you about the -- some of the media articles about potentially monetizing that. But I noticed the LTM EBITDA went up quarter-over-quarter, also the net debt. Was that the case of doing an acquisition and that was the pro forma?

[Robert M. Le Blanc, Senior Managing Director]

Yes.

[Geoffrey Kwan, Analyst]

Okay. And just the last question I had is obviously where the share price is at and how you guys are looking at potential opportunities. Any sort of comments? And I think I've seen a little bit of a share buybacks in the past -- finally, from the past week or 2. Just thoughts on the stock and how active you may want to be in it in the near term.

[Christopher A. Govan, Chief Financial Officer]

Yes. It's Chris. I think as we've probably discussed before, our stock buyback is not formulaic and focused on the stock price relative to any particular NAV. A very big driver of our stock buyback activity is really our liquidity and we see it as an opportunity to invest in our existing portfolio, and balancing that with our pipeline and our commitments to our existing funds. So there's no doubt, when the stock trades off, it's more attractive for a stock buyback, but it's not the only factor and so it's not going to drive a huge change in behavior.

[Geoffrey Kwan, Analyst]

And if I can maybe sneak in one last question in terms of your comment around liquidity, and obviously I'm not going to be privy to what's your outlook you think in terms of capital deployment. But is that kind of 25% of NAV as cash kind of where you'd like it to be? So being at 21% pro forma, you're a little bit directionally lower on cash than where you kind of would prefer to be?

[Christopher A. Govan, Chief Financial Officer]

No, I wouldn't put it that way. I think of the 25% target as sort of a through-cycle target. And in fact, we have to be below 25% for decent lengths of time to hit that through a cycle. So at pro forma 21%, nobody around the table is thinking we want to raise some money to get to 25%. We're very comfortable where we're at.

[Operator]

[Operator Instructions] Our next question comes from Paul Holden with CIBC.

[Paul David Holden]

So just want to go back to the discussion on CLOs and levered loans because it's become a big topic of conversation in the marketplace, not necessarily just particular to Onex, but just generally speaking. So I think what people might be concerned about when it comes to Onex is the current exposure on the balance sheet, let's call it. So maybe you can talk to that. I'm not talking about so much about how default rates are trending today, because we know they're trending fine, but what your view is relative to how the central banks are thinking about it. And generally, how you think about your exposure on the balance sheet today.

[Christopher A. Govan, Chief Financial Officer]

Sure. Paul, it's Chris. Maybe I'll start with just a little bit of comment from the Onex balance sheet perspective. I think, the way I think about it and we think about it, and to remind you, is that these are long-term investments for us. These are cash flow CLOs with really, effectively no mark-to-market risk. And long term, the performance is going to depend upon the default in recovery rates, if you actually held the loan through a default, across a very diversified portfolio over a fairly long period of time. Now I would say, and I'm sure shareholders appreciate this, that in terms of the mark-to-market exposure in our NAV, that's significant. And if there was a meaningful correction in the senior loan market, there's no doubt that the value of our CLOs at a point in time that we include in our How We Are Invested schedule in our NAV could meaningfully go down at that point in time. But again, we, generally speaking, are in control positions in all of our CLOs. And on top of that, as I said, there's no mark-to-market test that cause you to unwind and sell assets. So I think in terms of personally, as a stockholder, I'm very comfortable with our exposure, recognizing that, again, there could be a short-term blip that causes a dip in NAV.

[Paul David Holden]

Okay. And can you kind of remind us what proportion of the CLO the equity tranche generally represents?

[Christopher A. Govan, Chief Financial Officer]

Yes, Michael, correct me, I think it's typically a little less than 10%.

[Michael Jay Gelblat]

Yes, that's correct, Chris.

[Operator]

[Operator Instructions] This concludes our question-and-answer session. I will now turn the call 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 contact Emilie if you have any questions. We look forward to speaking to you again next quarter. Have a good weekend.

[Operator]

Ladies and gentlemen, thank you for your participation. This does conclude today's presentation. You may now disconnect, and have a wonderful day.