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Onex Corp
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Welcome to Onex' Fourth Quarter and Full Year 2018 Conference Call. My name is Sonya, and I'll be your operator today. [Operator Instructions] As a reminder, this conference is being recorded. I will now like to turn the conference over to Ms. Emilie Blouin, Director Investor Relations at Onex. Please go ahead.
Thank you, Sonya. Good morning, everyone, and thanks for joining us. We're broadcasting this call live on our website. With me today are Gerry Schwartz, Chris Govan and a number of our managing directors. Earlier this morning we issued our fourth quarter and full year 2018 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 season expenses and additional information 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.Before I pass the call over to Gerry, I wanted to let everyone know that this year's Investor Day will take place in Toronto on June 13. Should you wish to attend, please contact me for details. With that, I'll now turn it over to Gerry.
Thanks, Emilie. Good morning, everyone. I'm going to start by taking a look at what we're seeing in the markets. As pretty much everybody on this call probably knows, the fourth quarter was a pretty wild ride. Both credit and equity markets suffered huge volatility. In the case of the credit markets, new issue activity ground to a near halt. Most of the damage was caused by loan mutual funds needing to sell loans to raise liquidity. This sell-off caused private equity activity to take an early holiday, as everyone realized assumptions around financing cost and availability of financing had changed meaningfully. Today, the credit markets are open again, but the cost to borrow has increased by about 150 basis points relevant to most of 2018. If this persists, it should eventually lead to lower leverage buyout pricing, but it's early to make that prediction, given how quickly the markets have already recovered.Let's now review our activity in 2018 and some updates since year-end. We had a busy 2018, investing nearly $2.3 billion in 9 operating companies. A couple of the highlights of the year are PowerSchool, our first significant investment in the software sector, an area we started actively covering about 2 years ago; and KidsFoundation, our first investment in a Dutch headquarter business, driven by our expanding presence in Europe. With the acquisition of KidsFoundation in the fourth quarter, we've now started accruing fees on Onex Partners V, the $7 billion fund we raised in 2017. I'll leave it for Chris to provide more detail, but this new stream of fees provides incremental operating leverage for our asset manager.I'll move on, again, this time to realizations. We returned nearly $2 billion to Onex and our partners the last year. This included the sales of Mavis Discount Tire and Tecta America and the initial public offerings of SIG Combibloc, a quite large IPO in Switzerland, and Pinnacle Renewable Energy. We also expect to distribute an additional $780 million from the sale of BrightSpring Health Services, when that transaction closes later this month. As a reminder, we first invested in this business, at that time named ResCare, in 2004, when we bought a minority interest in the then public company through our first fund, Onex Partners I. In 2010, 6 years later, we acquired the remainder through Fund III and took the company private. It's really a great example of our desire and willingness to continuously invest in good businesses that we know well.Over the course of our ownership, we increased the breadth and depth of BrightSpring Services through a combination of organic growth, add-on acquisitions and improvements in the service delivery model. On a blended basis, we will achieve a return of 5.7x our money and a 17% IRR compounded over more than 14 years. What a terrific outcome and exactly what we think we can do well, compounding our capital over a long period of time.Let me take this opportunity to thank John Russo and the entire BrightSpring for being great partners. We're proud of the company's mission, and we wish the team continued success in the future. Since year-end, we've also announced large, strategic transactions at 2 of our operating companies, both big investments. We agreed to publicly list Clarivate Analytics through a transaction with Churchill Capital Corp and will merge SMG with AEG Facilities, creating a larger, more diverse and faster-growing venue management platform. We look forward to working with our partners to grow these businesses and I might add, we're very excited about both of these transactions and what they mean for the future of our businesses.Looking at our private equity portfolio as a whole, we were, without question, disappointed with the performance of several of our operating businesses in 2018. This isn't the first time we've experienced an underperformance. As anyone on our team will tell you, we're focused on improving the performance of all our businesses. As investors with controlling interests, this is exactly what we can and must do. It will take time to see the benefit of this activity, but we know we're on the right track. In support of our optimism, we continue to be active with our share buyback program, repurchasing nearly 1.2 million shares in 2018 and an additional 620,000 so far this year.Turning to our credit platform, we increased our assets under management by 7% in 2018. This was driven by the issuance of CLO 15 and capital raised for our first private debt fund. To date, this fund has invested more than 70% of its $1.1 billion of available capital, and we've been really quite pleased with the quality of the portfolio. The fair value of our CLO investments decreased in the year. However, the volatility of our equity marks was not driven by a deterioration in the underlying portfolio. It was largely due to spreads widening, which caused asset prices to decline, but doesn't have any permanent effect on our equity investments.Remember, the assets in our CLOs are mostly senior secured first lien loans. We do bottom-up analysis and are constantly reviewing and managing the portfolios. Each CLO is diversified both by industry and individual company exposure. Let me size that for you a bit. In our most recent CLOs, there are close to 200 names in each of those CLOs. So our exposure to any one company is actually quite low. And our funding structures are extremely resilient and don't depend on marks to preserve funding. Therefore, our CLOs should continue to perform very well. Already this year we've priced CLO-16 for more than $500 million and have seen a recovery in CLO equity values.Finally, one of the key cultural facets of Onex is our team's alignment and personal investment in everything we do. Last year our team invested $135 million across our private equity platform, credit funds and Onex shares, bringing our total investment to approximately $1.7 billion. We all share in the risks and rewards of everything we own.I'll now turn the call over to our CFO, Chris Govan. Chris?
Thanks, Gerry, and good morning, everyone. I'll review Onex' Q4 performance relative to our shareholder value model. As usual, I'll start with our asset mix. Changes in Onex' asset mix are driven by the net investment activity in both private equity and credit. A strong year of deploying capital through our PE platforms continued in Q4, with a little over $140 million of Onex capital invested in Ryan, KidsFoundation and Wyse. We also had a couple of successful PE realizations with ONCAP sale of Tecta and the IPO of SIG generating over $300 million of proceeds for Onex. Including credit, Onex' investment activity generated about $155 million of cash in the quarter, which, combined with an overall decrease in Onex capital due to mark-to-market losses that I'll discuss next, left Onex 77% invested at quarter-end. As Gerry mentioned, our invested capital underperformed in 2018, particularly in Q4. I'll break that down by looking at the quarter-over-quarter changes in the How We Are Invested schedule.Turning to that schedule, you'll see Onex' investment in private equity was roughly $600 million less than at the end of Q3, and that's due to both our net realization activity that I mentioned and the underperformance of the portfolio. A significant portion of this decline won't come as a surprise to any of you based upon the year-end trading prices of our publicly traded businesses. These investments accounted for about 70% of the mark-to-market PE losses and a $2.75 decline in our hard NAV per share.Similarly, the mark-to-market performance of our credit investments largely followed the broader market. The CS leverage loan index, a rough proxy for the underlying investments in our CLOs and the OCLP private debt fund was off 3.1% in the quarter. Given the structural leverage employed in CLOs, and to a lesser extent at OCLP, the decline in the underlying market was magnified. Credit generated $79 million of mark-to-market losses in the quarter, which represents a little over 15% of the Q4 decline in total hard NAV per share.On the bright side, we've already seen a recovery in some of these market-driven losses. At credit, we recovered about half of the Q4 losses by the end of January, and the leverage loan market continued to move higher in February.In PE, 1/3 or about $1 per Onex share of the Q4 decline in our publicly traded investments has reversed based on recent trading prices. Although we invest for the long term, there's no escaping the short-term impact that a significant decline in the equity or credit markets will have on our hard NAV per share.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, you'll see that the overall contribution for calendar 2018 was $14 million, up from negative $1 million in the Q3 LTM period. This improvement was driven by the PE platform, and there are two aspects of that to discuss. First, PE management fees were up $7 million to $103 million for the calendar year, as we began to accrue fees from Onex Partners V late in the quarter. This increase represents the first step up as we move towards our run rate PE fees of $142 million over the course of 2019.The other aspect to discuss is variable compensation in our PE platform, which was down almost $30 million when compared to the Q3 LTM period and was down $42 million year-over-year. As Gerry discussed, we were disappointed with the returns from our Onex Partners' portfolio in 2018. The decline in incentive compensation for the senior management of Onex Corporation and the most senior investment professionals at Onex Partners reflected this disappointment. Now as discussed last quarter, with total run rate fees of almost $200 million from PE in credit and over $11 billion of PE capital subject to carry, we believe our asset manager is positioned to meaningfully contribute to value creation in the coming years.After several years of consistently trading at a premium to our hard NAV, the Onex stock has been trading at a discount of late. I suspect that reflects the market's disappointment with our recent NAV growth. We bought back almost 1.2 million shares last year, and we've capitalized on the recent weakness in our stock allocating over $34 million to buybacks already in 2019. More importantly, as Gerry discussed, the team is hard at work, driving change at businesses that have underperformed and making sure our most recent investments get off to a good start. If those efforts are successful and we continue to grow our AUM, I'm confident our stock price will respond. That completes my comments. We'd now be happy to take questions.
[Operator Instructions] Our first question comes from Geoff Kwan of RBC Capital Markets.
Just, Chris, going back to your comment on the CLO, so I think the math was roughly -- the hit in Q4 was about USD 0.70 per share to the NAV on the mark-to-market. And I think your comment -- you were saying is, about half of those losses were recovered in January, but the leverage loan pricing has kind of almost come back to where it was at the end of September. Like, do you have an updated number, kind of quarter to date, like, would the recovery be mostly done by now? Or do you have an updated number?
Yes. I don't, Geoff. And you're right. Your observations about the leverage loan index are correct. I think the issue with CLOs, and we've talked about this in sort of other contexts, is the valuations there and the markets there aren't sort of the same as you might see for a publicly traded stock. So we really don't have good visibility yet on where those marks would have been at the end of the month yesterday. But directionally, I think you're correct. Expectations would be that those marks would follow that broader index, but I don't have a better update for you.
Okay. And then I just wanted to clarify, in the NAV, with the Clarivate transaction, because that was announced in January, I think from what I see, it was not -- sorry, and if any sort of valuation left was not reflected in your reported Q4 NAV. And if that is the case, I'm not asking, I guess, what the value you have on it, but are you able to talk about even ballpark if there was a NAV lift, like, what the delta would be versus what was on the books at Q4?
No. We're not in a position to talk about specific marks. But I would tell you that, that transaction was not factored into our year-end mark. And obviously, we don't generally undertake those kind of transactions unless we think they're positive.
Okay. And then I guess would the SMG, AEG transaction, because that was more a little bit closer kind of merger, to your comment there, would that also be something where you wouldn't necessarily pursue it unless it kind of increased the value as opposed to just kind of keeping it steady, but now you've got a bigger platform?
I think that one is a little bit tougher to comment on. It's obviously a private transaction and something, as you said, closer to a merger. I view that one, Geoff, as one where we view it as a really important event strategically for the business. But given that it's in the private markets, there's probably less of a view about what that would mean from a valuation perspective in the short term.
Okay. And if I can just ask one more question. Some of the kind of investments that have been underperforming, say, Save-A-Lot, Survitec and Parkdean, the EBITDA didn't improve in the quarter, which I don't think is overly surprising. But just wondering if there's other data points, if you can talk about those investments or even if there's other ones that you want to talk about where you may be seeing some early signs of green shoots or other things to kind of give indications that the changes that you're making are moving things in the right direction?
I wish I had a single answer for you, but I do not. We first examine what ails a business, the commerciality of the enterprise and obviously the management team and have started to make those changes, certainly at Parkdean and Survitec. And in the case of Save-A-Lot, the team is working, as we speak, aggressively with the management team to address their issues. These things take time, though, and they're not a straight line, and we'll be updating you every -- each and every quarter. And we hope to see some gradual improvement through the year, particularly in Parkdean and Survitec. But it is -- it's a time-consuming and difficult process to right a company that's gone astray a bit.
I just add to that -- to a little bit, Geoff. Turnarounds are difficult and take time at -- and -- sorry, just added to my mic, then it's repeat myself. Turnarounds are difficult and take time to achieve. And I don't think it's an effective thing to try to measure that and look at it quarter-by-quarter. At best, you can look at it year-by-year.
And our next question comes from Paul Holden of CIBC.
So maybe one follow-up question, I'll start with the underperforming investments because you talked about you've been in this position in the past. So maybe you can remind us on different situations in the past where you have successfully turned around businesses that got off to a challenging start?
I'll give you an example. When we -- and Gerry spoke of BrightSpring and our realization this morning. When we had put the minority investment in, in 2004, coming out of the financial crisis of state budgets really caused huge earnings pressure on that business. We took it private in the face of that pressure and needed to take years, quite frankly, to change the way we operated that business and to add complementary services to which we weren't so dependent on one form of service to the government, for the people that we serve. And that was a multiyear journey. And if you get it right and you stick to it, the results can turn around, and we hope that we're in the same situation in several of the businesses that we own today.
You -- that was a great question. It caused us to search our brains for a minute.
I can give you one. I can add one. I'd offer JELD-WEN as an example where we got off to a rough start. We actually bought the business off of $145 million of EBITDA. In our first year, we saw positive uplift to $180 million, but then took a meaningful step backwards almost right to where we started in year 2 before or getting traction with all the turnaround efforts that we were making there. And I think as people know today that company reported $465 million of EBITDA for the year-end 2018. And so there we got up to a good and then bad start and took us several years to ultimately deliver on the investment thesis.
And then I would add to that Allison, Husky, both of which we brought before the financial crisis, and I'd add TMS to that. It's a great question because it's really got me thinking how many times we buy something and have to steer it through very, very rough waters. And that's the beauty of control investing. We stick it out, we make changes where changes are needed or just provide some coaching and a set of ears when the markets -- when the end markets don't do us any favors. And that's what our business is all about.
And I would add to that, that the right touch points or KPIs to look for aren't necessarily financial. For instance, at both Survitec and Parkdean, we have already changed the Chief Executive in both cases. In Survitec, we've been at it with new Chief Executive for a few months and made significant changes in his management team. So there are nonfinancial things to -- that are better touchstones to see what's happening.
Great. That's a great answer. Next question would be related to CLOs. And I guess, specifically CLO -- the closing of CLO-16. So I think Michael talked in 2018 about more covenant-light loans and maybe credit quality degrading a bit for the market. So just wondering how you've tried to differentiate CLO-16 in the face of some of those credit trends?
Mike, you're on the line, aren't you? You're quite close to...
Yes, I'm here. So Paul, on CLO-16, as we haven't closed yet, we just priced at the private offering, we're sort of limited to what we can say. But CLO-16 would have benefited from being able to take advantage of some of that market weakness that both Gerry and Chris mentioned.
That makes sense. That's good. So you're able to do some stuff, in not just the primary market but also in the secondary market is what you're suggesting?
Yes. I think as I've mentioned prior, the ramping of warehouses for CLOs differs in different market conditions. And your observation that a decrease in loan prices would make the secondary market more attractive would be accurate.
I'd add a general observation on what happened in the fourth quarter to give you a little color, and Michael, certainly correct me if I get it wrong, he always does, in the fourth quarter, most of the downdraft was caused by loan mutual funds faced with redemptions and having to raise liquidity and therefore selling loans. In contrast, CLOs, Gerry I think mentioned the durable structure they have, they aren't -- they don't become for sellers because there's no threat of redemption. And it actually gives Mike and his team an opportunity to trade up, if you will, to improve the portfolio with some of the high-quality loans that are coming into the market at low prices. So it's kind of interesting contrast in how patient capital, long-term capital gives you an opportunity in a market downdraft like we had in the fourth quarter.
There's only one thing I would add is, it also provides us the opportunity to have more assets available to diversify our holdings. So as Gerry mentioned, we hold, in the U.S., CLOs over 200 names in a CLO, which have the longer-term impact of potentially dampening volatility as exposure to an individual name is lower.
Got it, that's helpful. Another question on credit, I guess, related to the recent direct lending platform you closed, I believe the final close was a little bit below target and often, at least, with the private equity funds, we see Onex close funds above target. So is there something that changed or was different from your view on demand for that product? Has demand for direct lending platforms slowed or is this just more of a matter of people need you to build a track record in direct lending before committing more capital?
We -- broadly speaking, we had 2 areas of pushback from investors. First-time funds, not much you can do about that other than get through your first fund. And a relative lack of origination or less origination in some of our -- less origination capability than some of our competitors. So this year's mission in the team will be to build out some of that origination capability and then, obviously, having begun almost about 70% invested now in Fund I with a good track record thus far, we hope to be able to address both issues going forward.
Yes. And just adding to that. The track record in Fund I is actually, in terms of both credit quality and yield, has done meaningfully better than our own projections when we took that out to potential investors. So I think that gives us a lift in -- when we're ready to do Fund II.
Okay. Final question. So a couple pending mergers taking place. Is that -- so correct me if I'm wrong, but I don't recall seeing that as a typical path to monetization in the past. Are these sort of maybe distinct opportunities? Or maybe you've kind of found a new way to help service value and we could see more of these types of mergers in the future?
I'll make a quick initial comment, some others may want to jump in on this. These are opportunities to do 2 things. One is to build businesses. The SMG, AEG merger is a perfect example where it makes it a much stronger platform to take out to customers, where our company, SMG, had huge strength with municipal venues and AEG had enormous strength with privately owned, generally entrepreneurial venues. So this brings the strength of 2 companies together and we're in very nice position and a position in which they really weren't competing with each other before, but when you put the 2 together, it's a very strong offering. Anybody else want to jump in on that? Let me just add one other quick thing. Thanks, Kosty. And that is that in both cases you'll see a very substantial lowering of the -- not just the -- but the debt as a percentage of total lending in the capital structure. So we think we've also meaningfully reduced financial risk by bringing a much lower percentage of debt to the capital structure. Kosty?
I think it's totally natural to look at the fact that the 2 announcements came out within a week or 2 of each other and to try to see if there's a pattern in how we're looking at things and there really isn't. The 2 situations are completely distinct and they're reflective of unique opportunities that each business saw and each business independently pursued and obviously with our stewardship. And that's the way that we look at every single one of our investments. There really is no sort of thematic pattern around what we want to do. There was just 2 separate opportunities that happened to take place at the same time.
I'll add another thing. These transactions, you mentioned steps towards liquidity or steps towards realization. I wouldn't view either of these mergers as steps towards realization. I'd simply view them as company building, business building.
And our next question comes from Scott Chan of Canaccord Genuity.
Chris, you gave some good color on the credit portfolio to date, and I missed your commentary on the private equity side. I guess, in particular, until, like, what the Q4 public stock contribution was? And kind of what the year-to-date makeup was? I don't know if you can kind of repeat that, please?
Sure, yes. If you look at the total decline at private equity in Q4, about 70% of that was day-open declines in our publicly traded operating companies. And I think the stocks have jumped around this week, but earlier this week, with about a 1/3 of that decline had been recovered when you looked across all the publicly traded companies in our portfolio.
So the private companies, like, which is the vast percentage within that private equity portfolio, it really didn't have much of an impact, I guess, because of the -- is that kind of fair to say?
A much smaller impact. I think -- we've talked about some of this before. They were down overall, but it's a large portfolio with lots of different things going on. And in particular I'd kind of call out 2 things. One, because of the way we invest, because we're control investors and we have active theses going in, you can find situations, and we have a couple of them in Q4, where, for example, the multiple we value something that might go up even when markets are down because of something significant occurring within the business that gives us the confidence that we've moved sort of along the value chain and deserve to shrink the gap between our publicly held multiple and the public market. So that happens from time to time. The other thing I'd point to is that there are a handful of our investments that use DCF as a primary methodology and some use it as a secondary methodology and that has the impact both in up markets and down markets. It's sort of dampening the effect of changes in trading prices, and so that was certainly a factor as well in Q4.
Got it. And just for OP V, maybe you can just kind of refresh. I guess you made a first investment, a co-investment in that fund already? Just one investment?
Yes. Yes, we made part of our investment in KidsFoundation through Onex Partners V. I think that closed right near the end of November. And so as Gerry mentioned, Onex Partners V went live that date, and we began accruing fees in December.
Got it. And what is the private equity pipeline right now amidst all the market volatility we're seeing in the last 5, 6 months?
The pipeline -- given the volatility in Q4 in the credit markets that Gerry talked about really caused the bid-ask spread between buyers and sellers to gap out of it. That's leaked into the first part of this year. So I would characterize our pipeline as being, on a relative basis, not as strong as normal at the moment. We are working on things, and we've got good projects going on, but just the sheer number of things that are quality in the pipeline is a little below of what we'd like to see.
It's interesting. In this kind of an environment, the -- all of the logic would tell you that pricing ought to be coming down, and all of that logic applies to all the buyers, but it doesn't seem to apply to all of the sellers. We have to see where it comes out.
[Operator Instructions] We do have a follow-up question from Geoff Kwan of RBC Capital Markets.
Just following up on Scott's question, because I didn't get a chance to run the math, but -- so the portfolio decline in Q4 was down 10%, you were saying, I think, 70% of that was the publicly traded, but do you have the number, like, what the privately held investments on an apples-to-apples basis of what was owed at September -- 31st of December, like, how much that mark was down in the quarter?
I don't think I have it cut that way, sorry. But I think -- if you go -- I think you can -- I can do the math, but I don't have the time or the calculator in front of me. But if you just -- 70% of the -- about 70% of the decline was public, I think you can back into it based upon the other numbers we disclosed.
So if you had the private equity at 4 point, call it, $5 billion at Q3, then you're taking that 10% decline off of that value. Is that right?
No. If you look in our supplementary deck, there's a bridge, because you also have to factor in investments and distributions. So you have to take out that net investment first and then do the math you're talking about.
And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to Gerry Schwartz for any closing remarks.
Thanks, everyone, for participating in the call. We appreciate your support. And as always, feel free to contact Emilie if you have any questions. We look forward to speaking with you again next quarter. Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.