Onex Corp

TSX:ONEX

Earnings Call Transcript 2021-Q3

[Operator]

Welcome to Onex Third Quarter 2021 Conference Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Jill Homenuk, Managing Director, Shareholder Relations and Communications at Onex. Please go ahead.

[Jill Homenuk]

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; Bobby Le Blanc, Onex' President and Head of Onex Partners; and Chris Govan, our Chief Financial Officer. Earlier this morning, we issued our third quarter 2021 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.

[Gerald Wilfred Schwartz, Founder, Chairman & CEO]

Thanks, Jill. Good morning, everyone, and thanks for joining us today. Q3 -- I am very happy to report Q3 was a strong quarter for Onex, with continued performance across all our businesses. In our very important investing segment, net asset value per share ended the quarter at USD $86.95. It grew 8% in the quarter. If you exclude recent quarters impacted by the pandemic, this was actually our highest rate of growth since 2013. Across our platforms, we're executing on opportunities with accelerated pace, and we still see lots of potential ahead. The strategy we presented at our recent Investor Day resonated with shareholders, and we feel confident in our plans and ability to deliver. As Bobby said, we have the right people, strategy and culture to be successful. As I reflect on the year that's almost over, I'm proud of what our team has achieved. The level of activity across the organization has been impressive as is the energy and enthusiasm for evolving and growing our business. We have made significant progress over the past year, strengthening our team and expanding our platform. I'm excited about what lies ahead. We're committed to delivering strong performance across all of our key metrics, including the new financial measures that we introduced at our Investor Day. Results like we reported today are an endorsement of our ability to drive long-term shareholder value, just as we have always wanted to do. We look forward to more opportunities to engage with you. In the meantime, we thank you again for your continued support. And with that, I'll now turn it over to Bobby for more on the quarter.

[Robert M. Le Blanc, President]

Thanks, Gerry. Earlier today, we reported segment net earnings per share for Q3 of $6.59 and net earnings per share of $6.76. It's been a very active period, with good progress across all of our businesses. As Gerry mentioned, it was a strong quarter with investing capital per share growing 8%. It's up 18% year-to-date and 30% over the last 12 months. Gross private equity return for Onex were 11% in the quarter, 25% year-to-date and 42% for the last 12 months. Year-to-date, Onex Partners IV and V returned 35% and 18%, respectively, and our ONCAP Funds returned a collective 19%. We generated $76 million of carried interest in the quarter, with continued strong contributions from OP IV and OP V. We ended Q3 with $271 million of under-realized carried interest. Through our private equity platform, we've deployed a total of $3 billion of Onex and third-party capital year-to-date, which is already a record for the most capital deployed in any year in our history. This number includes OP V's recently announced investment in Fidelity Building Services Group. We also recently completed an investment in Wealth Enhancement Group, an independent U.S. wealth management firm and a sector we've studied for several years. With these 2 investments, Onex Partners V will be 73% invested. As we mentioned at Investor Day, we expect to begin fundraising for OP VI in the first half of next year. Realizations have also been strong and are well ahead of pace relative to 2020. In total, we've realized $3 billion year-to-date, with proceeds to Onex of $1.2 billion. Our most recent realization was ONCAP sale of Bradshaw Home. It was an impressive investment generating a gross MOIC of 6.6x and a gross IRR of 26%. We also sold our remaining stake in JELD-WEN, resulting in a gross MOIC of 2.9x and a gross IRR of 20% for our 10-year investment. We're seeing good opportunities for deployments and realizations across the platform and expect activity to continue throughout the remainder of the year. Within Onex Credit, we recently priced the reset of CLO-10, originally issued in 2015. It was a successful deal, attracting a broad group of investors. Importantly, it was the first CLO issued with a portion of its debt tied to the new base rate, SOFR. This is in advance of LIBOR being phased out for all new loans and CLOs starting in 2022. It was a critical milestone for the industry and strong evidence of our leadership in the CLO space. Last month, we also priced U.S. CLO-22, raising $550 million of fee-generating AUM. Onex retained just 11% of the equity, with the remainder going to 5 other equity investors. Four of these were first-time buyers of Onex new issue equity. We now hold less than 70% of total CLO equity, with plans to further decrease holdings over time. Fundraising for other strategies in private credit is also progressing. You heard about the initial success of Onex Falcon Direct Lending at Investor Day. The strategy has been well supported by Gluskin Sheff clients, with close to $200 million allocated to date. Fundraising for Onex structured credit opportunity strategy, or OSCO, is also going very well, and we are very near our short-term fundraising goal. Early returns for OSCO have been good, with a gross MOIC of 1.1x and a gross IRR of 37% at quarter end. The IRR is driven by some early crystallized gains, and we expect it to normalize over time. However, this will give you an idea of the strategy's strong start. Onex Credit is showing good momentum, and we feel confident about the team's ability to continue to execute on the strategy we presented at Investor Day. Recently, we were informed by Jason New that, for family reasons that require significant attention, he's made the difficult decision to leave Onex Credit. Jason will be with us into the new year to help ensure a smooth transition. We will take the appropriate time to identify a new leader of Onex Credit, one who aligns well with our culture and on Onex' commitment. Onex Credit has been strategically expanding its team and platforms and has the people and strategy in place to continue to deliver strong performance and growth. We wish Jason well and offer him our full support. Turning now to ESG. As you heard from Judy Cotte at Investor Day, we are making good progress. We're now officially a signatory of the Principles for Responsible Investment, or PRI. In addition, we are preparing to publish our new responsible investing policy, a firm-wide commitment outlining our approach to ESG across all investment platforms. We're also undertaking to measure Onex' carbon emissions, an important step in the development of our climate strategy. These are all significant enhancements to our ESG program, driving real value for us and our stakeholders. Now I'll turn things over to Chris shortly. In addition to his usual update, he'll also touch on fee-related earnings and distributable earnings. We included reporting for both in our supplemental information package and are planning to transition our financial reporting fully in Q1 of 2022. Thanks again to all of you who joined us from our recent Investor Day. We feel confident in the strategy we presented, and we'll continue to update you on our progress. Chris, over to you.

[Christopher Allan Govan, Senior MD & CFO]

Thanks, Bobby, and good morning, everyone. Q3 was another strong quarter for Onex on many fronts. First, as Bobby mentioned, segment earnings of $6.59 per share driven by our investment activities, which contributed $5.36, with our asset management activities contributing another $1.23 per share. These results were driven by the performance of our private equity investments. Our PE portfolio was up 11% in the quarter. Year-to-date, Onex' PE assets have returned to 25%, outpacing the S&P 500 which returned 16% in the same period. Onex's PE returns were led by the post-IPO appreciation for PowerSchool and RSG. At quarter end, both were up about 40% from their IPO prices. We're happy but not surprised with the market's reception for both these businesses, they're leaders in their industries and poised for continued success. Although PowerSchool and RSG were strong contributors in the quarter, they were far from the whole story. All 5 industry verticals contributed meaningful positive returns in the quarter, and we've seen double-digit returns from all verticals year-to-date. Importantly, the entire $330 million of Q3 markups at Onex Partners private companies are attributable to business performance, value increases tied to improved earnings or cash flows, not higher multiples or lower discount rates. As you heard from Tawfiq at Investor Day, increases in valuation multiples for our PE investments have been at a discount to the public markets, meaning more of our returns are driven by tangible performance across our portfolio. Our credit investing also contributed to segment earnings. Onex' credit investments returned 4% in Q3 and are now up 16% over the first 9 months of the year. Most of the value increase in the quarter came from our CLO investments. Strong performance is also helping us develop the new CLO investor relationships Bobby alluded to, which in turn are allowing us to reduce the capital intensity of the CLO business, an objective we signaled a year ago. As discussed at Investor Day, we want to reduce the capital intensity and increase the return on capital for all our asset management platforms. For private equity, where funds have a 10-plus year life and successor funds get raised every 4 or so years, progress will be made over the long term and in step functions. However, our CLO platform is one where we're raising capital almost perpetually, and therefore, a business where we've already made good progress. You can see from this chart that Onex' average equity position in the CLOs has trended down nicely over the last year from almost 90% to about 68%. We've been reducing our capital intensity in 2 ways, by syndicating a higher percentage of the equity in new deals, as with the case for the recently priced CLO-22, in which Onex holds only 11% of the equity; and by opportunistically selling down equity in existing deals, including 3 sales we've already executed in Q4. Another way to look at our progress on this front is to compare the ratio of fee-generating AUM to Onex Corporation capital in our CLO platform. For those of you that tuned in to Investor Day, you know that this ratio was something we want to increase Onex-wide in the coming years, as it is one of the factors that will drive our capacity to generate fee-related earnings. Again, you can see in this chart that our CLO team is already making good progress on this front. Stepping back and looking at the investing segment as a whole, Onex generated earnings of $493 million in Q3 and over $1 billion year-to-date, driving Onex' investing capital per share up 8% in the quarter and 18% year-to-date. At September 30, investing capital per share stood at $86.95 or a little over CAD 110. In addition to growing the value of the existing portfolio, our private equity team put $750 million of Onex Corporation capital to work in new opportunities so far this year. And given the strength of the financial markets, the team has also been busy realizing on investments, generating just over $1 billion of proceeds for Onex Corporation so far in 2021. Taken together, all of this activity leaves us with 83% of our hard NAV at work, up from 80% at the start of the year. All in all, Q3 was a terrific quarter for our investing segment. We outperformed the broader markets, surfaced additional value through well-executed realizations and IPOs, and found opportunities to deploy capital in our core verticals to seed NAV growth going forward. These strong investment results also benefit our asset management segment. In the long run, strong investment results position us to attract ever-larger amounts of fee-generating AUM and grow our asset management platforms. However, the more immediate impact of our results is seen through the accrual of carried interest from our PE funds. We started to accrue carried interest in OP IV in late 2020, and as a result of a 35% gross return so far this year, we're pleased that OP IV is now in a full carry position. Together with OP V and the ONCAP Funds, Onex accrued $112 million of carried interest in Q3 and $300 million year-to-date. Looking only at carry from third-party capital, Onex benefited from $76 million in the quarter and just over $200 million through the end of September. OP V is off to a strong start and we expect it will contribute meaningful shareholder value through carried interest going forward. The team has deployed $1.3 billion of third-party carry-eligible capital through OP V already this year. Turning to Onex Credit, which as we shared at Investor Day now includes the legacy Gluskin Sheff asset management platform, the focus continues to be on raising capital for new strategies. To that end and as Bobby detailed, we've made good progress raising about $1.9 billion of fee-generating AUM so far this year. With the decision to defer a key fund raise to 2022, we won't meet the 2021 growth target we set a year ago. However, we do expect to meet the original goal of about 50% growth in Onex Credit's fee-generating AUM over the course of 2021 and 2022, all consistent with the 5-year plan we introduced at Investor Day. Before I wrap up, I want to pivot to fee-related earnings and distributable earnings, 2 KPIs we introduced at Investor Day. As a reminder, there are a few important differences between FRE and our asset management segment earnings. In particular, FRE includes revenues only from third-party AUM. FRE excludes carried interest. And FRE is presented with a more complete allocation of shared service costs to the asset management platforms to reflect fully burdened contributions. Onex' year-to-date FRE loss of $23 million stems mainly from the high proportion of nonfee-paying Onex Corporation capital in our PE platform and the significant investments we've made in the credit team to support the launch of new fee-generating strategies. Looking forward, we expect growth in Onex' FRE to come gradually and consistently from Onex Credit as we raise fee-generating AUM around our expanded team, whereas improvements in private equity contribution will follow a step function connected to the fundraising cycles and possibly new product launches. To get to distributable earnings, the second new KPI, you'll see at the bottom of the schedule, we add the realization-driven carried interest as well as gains realized on Onex Corporation's capital. As a reminder, both carry and investment gains are included in DE on a realized or cash basis, and therefore, will often reflect value generated over multiple years, that's already been included in our hard NAV on a mark-to-market basis. However, distributable earnings are important. They demonstrate Onex' significant capacity to deploy capital in support of its plans to grow. Our financial results all point to a very strong Q3 and so far a solid 2021. However, I'm also very pleased with the foundation we're continuing to lay for future financial performance, putting a record amount of capital to work through our PE platform, but balanced with an even larger amount of realizations, all while raising almost $2 billion of fee-generating AUM at Onex Credit. With that, we'll be happy to take any questions.

[Operator]

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

[Nikolaus Priebe, Research Analyst]

Okay. So PE returns to NAV growth were both a bit better than I had anticipated in Q3. And I think in your commentary, you alluded to the fact that growth in the private markets in the quarter was driven more by earnings and cash flow growth as opposed to multiple reratings. And I understand that for a variety of reasons, you're often reluctant to divulge too much on individual portfolio companies. But just aside from the post-IPO performance of Ryan Specialty and PowerSchool, are there any investments in particular that you would call out that have been maybe experiencing a good earnings tailwind and generating an outsized contribution to NAV growth?

[Robert M. Le Blanc, President]

It's Bobby. Yes, look, I would highlight Parkdean. I would highlight WireCo, which is having a very good year. And a lot of the more recent investments that we've done, they're all tracking very well relative to what we underwrote the things we bought in the last 18 months. So it's a bunch of different contributors, but those would be some of the bigger ones.

[Gerald Wilfred Schwartz, Founder, Chairman & CEO]

Parkdean is a pretty good example, Bobby. The quarter just standard at Parkdean is probably the best they've ever had, and that's coming out of COVID and all the problems associated with it. So there's -- you're right, there's some real tangible evidence.

[Nikolaus Priebe, Research Analyst]

Understood. Okay. That's helpful. And wondering if you could tell us a little bit more about the Wealth Enhancement Group and the thesis on that investment. It sounds like it's an RIA roll-up strategy. Just wondering if you could tell us a bit more about what appeals to you and your plan to create value there as a [ control ] investor on a platform like that?

[Gerald Wilfred Schwartz, Founder, Chairman & CEO]

Yes. It's a wonderful roll-up opportunity with a wonderful management team. Todd and the team have been studying that space for the better part of 3 years. And we're patient to find the right one. And we think we have the right one. They have a tremendous track record of both organic growth and inorganic growth. And early days, but we don't see any signs of that slowing down. So we're quite pleased with that. Just another example of when our go-to-market strategy change and being very thematic within the verticals that we're participating in, that was a great example, right? That has been 1 of the 3 themes that the WEG team has been trying to figure out a way to deploy capital. They serve sort of the lower end of the wealth management market, sort of the $1 million to $5 million sort of average ticket size, which, as I'm sure you know, is a -- there's plenty of people in that category and plenty of businesses to roll up.

[Nikolaus Priebe, Research Analyst]

Okay. And then just one of the broader macro themes that's been unfolding this year has been labor shortages and certain supply chain issues. Are there any companies within your portfolio that might be kind of uniquely exposed to some of those challenges?

[Robert M. Le Blanc, President]

Yes. Where we're seeing the most challenges is businesses that sort of have a labor pool that are making in the $15 to $25 an hour range. It's been hard to get people to stay employed at those jobs. It's hard to recruit into those jobs. And we need to manage through it. But that's really where we're seeing the brunt of labor inflation within our own portfolio.

[Operator]

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

[Scott Chan]

Just going back to the Wealth Investment Group. Bobby, you talked about your group studying the sector for a while. Is this something that you could potentially buy with your own capital, similar to like a Gluskin and the [ management ] in the U.S. marketplace?

[Robert M. Le Blanc, President]

No. This was done in the fund. So this was not a balance sheet deal. Could we look at that like a Gluskin sometime in the future? We could. But right now, we're not looking at other inorganic opportunities within the wealth space head corp.

[Scott Chan]

And within WEG, when you participated in the deal, is there a significant opportunity for margin expansion as you grow organically and inorganically at this point?

[Robert M. Le Blanc, President]

Yes. I think in the beginning, it'll look a lot like USI. Look, I think we'll reinvest margin expansion back into the business to fuel growth and to fuel M&A. But certainly, you can manage it for margin expansion. In the near term, no, I would expect the margins to stay relatively flat as we continue to invest the profits back into the business.

[Scott Chan]

Okay. And just lastly, I guess with Jason New, does that impact anything near term in terms of current fundraising activities on your credit strategies?

[Robert M. Le Blanc, President]

No. Well, maybe with one exception. We've built a really good team at Credit, and we have the talent at each one of the products to sort of not miss a beat. The fund that Jason was going to run himself or co-run himself, we may see a goal of a little bit lower goal in terms of AUM for the first-time fund. But we're going to keep the strategy, keep the team around Jason. That's the only short-term impact I see. But long term, I think we built a team to succeed. And we -- again, we totally support Jason and wish him well.

[Scott Chan]

Can you remind me what strategy that was, Bobby?

[Robert M. Le Blanc, President]

OCS, Onex Credit Solutions. That's the opportunistic fund.

[Operator]

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to management for any further remarks.

[Robert M. Le Blanc, President]

Thanks, everybody, and thanks to not only our shareholders and analysts but also to the team. The team really performed well, and our thanks go out to them. We appreciate everybody's support, and thank you always for that. The holidays look like they're right around the corner. I hope that everybody and their families enjoy those holidays, and above all, stay safe. Thanks very much.

[Operator]

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.