Onex Corp

TSX:ONEX

Earnings Call Transcript 2019-Q4

[Operator]

Welcome to Onex' Fourth Quarter and Full Year 2019 Conference Call. My name is Liz, 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, Liz. 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 other members of our leadership team. As you may recall, as of January 1, 2019, we determined Onex met the definition of an investment entity as defined by IFRS 10. This change in status has fundamentally changed how we prepare, present and discuss our financial results. It's important to note that periods ending on or before December 31, 2018, have not been restated to reflect this change. Accordingly, readers of our fourth quarter and full year materials should exercise significant caution in reviewing, considering and drawing conclusions from period-to-period comparisons and changes as the comparisons across periods can be inappropriate or not meaningful if not carefully considered in this context. As a reminder, all references to dollar amounts on this call are in U.S. unless otherwise stated. I must also point everyone to our webcast presentation for our usual disclaimer and cautionary factors relating to any forward-looking statements contained in today's presentation and remarks. Earlier this morning, we issued our fourth quarter and full year 2019 press release, MD&A and consolidated financial statements, which are available on the Shareholders section of our website and have also been filed on SEDAR. Our supplemental information package is also available on our website. Before I pass it over to Bobby, I'd like to highlight a few of our full year results. We reported segment net earnings of $836 million, which on a fully diluted per share basis was $8.09. Onex shareholder capital increased to $7.2 billion or $69.47 per fully diluted share. Our investing capital per share increased by 11% on an adjusted basis, and our fee-generating assets under management increased by 33% to $27.5 billion. With that, I'll now turn the call over to Bobby.

[Robert M. Le Blanc, Senior Managing Director]

Thanks, Emilie. Good morning, everyone. I'm going to start by taking a look at what we're seeing in the markets and then review our activity in 2019. Debt remains readily available, and there's lots of liquidity on the sidelines. However, M&A activity is down so far this year. And as such, our private equity pipeline is relatively quiet in both North America and Europe. With that said, Onex Partners is currently evaluating a few opportunities that could prove to be very interesting. As we discussed at Investor Day, at Onex Partners, we're focused on deepening our expertise across 4 core verticals, concentrating on thematic investing and prioritizing proprietary transactions over auction processes. Finally, over the past few days, we've seen significant volatility in the equity markets driven by economic uncertainty and the potential impact of the coronavirus. As you would expect, we're monitoring the situation in real time. Right now, there's no material concern for our private equity business, but we'll continue to keep a close eye for signs of negative developments. Let's now turn to our activity by business unit. Our private equity platform had an active year. In total, the Onex Group invested $2.7 billion and about half of that was deployed in the fourth quarter. This was mainly through 4 new platform investments, WestJet, Convex, Enertech and ILAC, 3 of which were proprietary. Of that amount, about $470 million came from Onex, and the vast majority of the remaining $2.2 million came from our limited partners. What's important to note is of the LP capital, nearly $1.2 billion was above and beyond their fund commitments. This unusually high amount of co-investment was largely driven by the Convex opportunity and highlights the strong partnerships we built and our investors' desire to commit further capital alongside us. With the acquisition of WestJet, Onex Partners V now has 3 companies in it. Although it's early days, we're pleased to see good progress within each of these businesses to date. ONCAP IV, our mid-cap fund, is now 65% invested. As a reminder, a fund needs to be 75% invested before we're able to start raising a successor. Depending on the pace of our acquisition activity, we could be fundraising for our next mid-market vehicle within a year or so. Moving on to private equity realizations. In 2019, we returned the second-largest amount of capital in our history. The Onex Group realized $3.7 billion, of which Onex' share was more than $1.2 billion. This was driven by sales of publicly traded shares and the outright sale of businesses. It's worthwhile to remind you that these monetizations stem from years of work executing on our investment thesis. A majority of the realization activity was driven by investments within Onex Partners IV, which helped to improve the fund's performance. At year-end, OP IV had a net IRR of 5%, which is a nice improvement from the negative 2% a year ago. Our realization activity, together with the increase in value of our unrealized portfolio, resulted in Onex' private equity investments increasing by 21% gross in the year. Lastly, our Onex Partners platform continues to focus on building its operations team. As a reminder, this team is focused on creating value within our operating businesses and enhancing our diligence processes. We now have experts on our team focused on health and benefits, supply chain and procurement. We expect to continue to add new talent as we seek to grow our operations capabilities. I'll now move on to Onex Credit. We had a pretty strong year in 2019. Fee-generating AUM grew by 16% to $10.5 billion driven by both new CLO issuance and the introduction of Onex Credit products to Gluskin Sheff clients. Our CLO distributions grew by 44% to $85 million, benefiting from the refinancing activity we did in 2018. Our net equity investment in CLOs remain pretty flat at about $450 million. Later this year, we expect to be raising our next direct lending fund. In anticipation of this, we're focused on continuing to grow our origination capabilities. We now have a team of 6 people dedicated to origination and have 2 more expected to join shortly. We intend to continue to add to this team throughout the year. I'll now turn to our wealth management platform, Gluskin Sheff. We ended the year with CAD 8.3 billion of client capital, up nearly 2% since our acquisition in June. In the fourth quarter, we saw an increase in client additions and good investment performance, which offset stable capital outflows. Our goal is to build a comprehensive wealth manager with institutional-caliber public and private market strategies and best-in-class financial planning offerings tailored to sophisticated, high net-worth clients. On the wealth planning side, we've grown the team from 2 to 6 people and now have top talent in both tax and estate planning. We're now turning our focus on hiring more mid-level and junior resources to further strengthen the value-add for clients. Part of our investment thesis with Gluskin Sheff was to simplify its fee structure and make it more competitive within the wealth management space. We implemented initial changes earlier this year, which we believe will better position the business for growth. The activity within our private equity, private credit and wealth management platforms led to our fee-generating AUM increasing by more than 30% last year. Gluskin Sheff was the largest contributor to this growth. Another topic I'd like to touch on is our progress to further integrate ESG considerations across the organization. Since our founding, we've always taken the approach that we're not simply buying share certificates but rather investing in living, breathing companies. We believe that responsible investing is part of being a good investor. However, as Onex has grown, so, too, must our approach to ESG. In 2019, we established an ESG Committee comprised of representatives from all of our platforms and corporate office. This committee is focused on enhancing the firm's holistic approach to ESG. We also became an Alliance Member of the Sustainability Accounting Standards Board. These steps do not mark a change in how we do business or our view as to the importance of responsible investing but rather are a formal acknowledgment of the standards we've always believed are fundamental to successful investing. To wrap up, 2019 was a good year for Onex. We're pleased with the progress made with each of our platforms, and we continue to invest in our people to support growth and build value for all investors. Today, we have a strong balance sheet with approximately $1.8 billion of cash and more than $4 billion of committed, uncalled third-party capital available to deploy in new private equity investments. Finally, as we always like to remind you, alignment with our investors is core to our culture and critical to our success. This is evidenced by Onex management's personal investment of $1.9 billion across our various funds and Onex shares. With that, I'll now turn the call over to Chris.

[Christopher Allan Govan, Senior MD & CFO]

Thanks, Bobby, and good morning, everyone. Onex reported net earnings of $187 million or $1.86 per share in Q4. As I've noted in prior quarters, my focus during these calls will be on segment earnings, which we believe best reflect Onex' performance. Onex' segment earnings are computed before deducting stock-based compensation and the amortization of intangibles and most of our PP&E. We've defined Onex' segment earnings this way to be comparable to the basis on which many of our publicly traded peers report and to be consistent with how we manage our business. Q4 segment earnings were $211 million or $2.04 per share. Quarterly segment earnings were again driven by the investing segment, which contributed $1.55 per share. However, the asset and wealth management segment had a particularly strong quarter, contributing $51 million or $0.49 per share. All told, Onex generated $836 million of segment earnings for 2019 or $8.09 per share. About 90% of these earnings came from the investing segment, so I'm going to drill down there first. Onex continues to have a substantial majority of its investing capital at work in private equity, so investing segment earnings depend on the performance of our private equity funds. A 6% gross return from Onex' private equity portfolio in Q4 resulted in $145 million of net investment income. Q4 capped off a consistent year of value creation in the PE platform, a 21% gross return and net investment income of $683 million. These returns were primarily attributable to Onex Partners IV, which generated $793 million of gross value increase for Onex Corp in 2019. I'll circle back to the importance of OP IV's performance when I discuss our asset and wealth management segment. I should also mention that the Q4 PE results are net of a $66 million charge stemming from changes to the compensation and investment programs for the Onex Partners team. As discussed in the MD&A, the changes were designed to have no net cost to Onex Corporation overall. The upfront $66 million accounting charge will be balanced with lower compensation expense going forward. Additional details will be provided in Onex' upcoming information circular. Turning to our credit platform. The investing activities there contributed $12 million in the quarter and $64 million for the year on a mark-to-market basis. These results generally line up with the performance of the Crédit Suisse Leveraged Loan Index. However, as you know, we're focused on the cash returns from our CLO equity investments, and 2019 was a strong year in this regard. These investments yielded 12% in a year, and once you include the fee stream we capture as the manager, the gross CLO platform yield was 18% for the year. This next schedule details Onex' shareholder capital at quarter end and provides Q3 and prior year amounts for comparison. As you can see, there haven't been any fundamental shifts in Onex' capital allocation. However, despite a busy and successful quarter realizing value in our PE funds, Onex' overall exposure to private equity increased slightly. OP V's acquisition of WestJet and net value increases across the funds more than offset the distributions from the SIG and Clarivate secondary sales. Although investment segment earnings do a good job of capturing Onex' investment performance, I think it continues to be useful to also think of those earnings as a return on investing capital. As you can see from this slide, 2019 was a solid year from this perspective, with shareholders enjoying a 13% return on their investing capital before an $80 million contribution from the asset manager. With that, I'll move on to the asset and wealth management segment, which generated net earnings of $51 million or $0.49 per share in the quarter and $80 million or $0.76 per share for the year. The private equity asset manager contributed $33 million in Q4, up from a net loss of $1 million in the prior quarter. This increase was the result of a $27 million mark-to-market improvement in carried interest primarily from Onex Partners III. Given the cumulative performance of OP IV to date, we're not yet accruing carry on that fund. However, 2019 was a strong year with gross value increases of $1.3 billion for the fund as a whole. As Bobby mentioned, this performance has driven OP IV's net IRR from negative 2% to 5%. Should OP IV cross the 8% net IRR threshold, carry would begin accruing. As is typical in the industry, OP IV includes an 80-20 catch-up such that 80% of the gains above 8% go to the carry pool until aggregate carry equals 20% of the cumulative gains. So if OP IV's recent performance continues going forward, carried interest will become a significant contributor to segment earnings. A strong quarter from Gluskin Sheff resulted in wealth management contributing $21 million. The quarter-over-quarter improvement was driven by $23 million of gross performance fees. These fees are earned based on the calendar year performance of the underlying Gluskin Sheff funds and, therefore, only accounted for at year-end. Looking at the full year results. Private equity contributed $69 million compared to $6 million in 2018. The increase was driven by management fees from OP V, which began to accrue in November of 2018, and a net $41 million improvement in carried interest. These increases were partially offset by higher variable compensation compared to 2018 when Onex Partners' performance led to lower compensation across the team and, in particular, the 5 members of Onex' Investment Committee declining to receive any variable compensation. The last item before I turn the call over to Q&A is to remind you the contribution from wealth management represents the results of Gluskin Sheff only since its acquisition in June. Pro forma for a full year of Gluskin, the asset and wealth management segment generated $94 million or $0.90 per share in 2019. And those earnings are in a year with no carried interest from our private equity platform and are over and above the $63.77 or just shy of CAD 85 of investing assets attributable to every share of Onex you own. That completes my comments on the financial results. We'd now be happy to take any questions.

[Operator]

[Operator Instructions] Your first question comes from Geoff Kwan with RBC Capital Markets.

[Geoffrey Kwan, Analyst]

First question was just -- you mentioned the $1.8 billion in cash. And, Bobby, you mentioned the pipeline isn't as robust as you've had in the past but that there may be some deals that may come to fruition. I'm just wondering how you're balancing what may be coming down the pipe versus the stock trading at a relatively wide discount to NAV in terms of share buybacks.

[Christopher Allan Govan, Senior MD & CFO]

Yes, Geoff, I think, obviously, the events of the last couple of days changes that calculus quite a bit. Overall, big picture, I don't think our approach to that has changed. We are always looking at the opportunities that we see in our pipeline and the returns we expect from investing in that versus where the stock is trading and the returns we think shareholders would enjoy from buying back our stock over time. The actual stock price is a factor. It's not determinative. But as I said, you can imagine that, that calculus has moved in favor of buying back some stock given performance in the last couple of days.

[Geoffrey Kwan, Analyst]

Okay. And then my next question was in refocusing on a narrower set of industries and then also going deeper within those industries, for those parts of those industries that maybe you're looking at that are, call it, newer relative to what you may have done beforehand, given the pullback in the markets, like are you -- have you gone deep enough that if an opportunity presents itself, that you could pull the trigger? Because I know you guys tend to be pretty thoughtful in terms of expanding into various subsectors or various sectors as you've done in the past.

[Robert M. Le Blanc, Senior Managing Director]

Yes, hi, it's Bobby. The 4 verticals we're focused on, all 4 of them with the exception of software within business services has been the areas where we've had long-term success at Onex, is industrials, health care, financial services and business services. And we have been and are continuing to go deep thematically within those 4 verticals, and we are more than ready to move quickly if an opportunity presents itself given the current environment.

[Geoffrey Kwan, Analyst]

Okay. And just one last question I had is, you talked about the ESG and the approach there. Just wondering how important is ESG when you're looking at an investment opportunity just in the context of -- I mean, at least right now, I think we've seen some companies that score well on ESG metrics and seem to be getting a bit of a premium. Like how you balance that out relative to maybe if there's a company that doesn't score as well on ESG metrics but maybe the return looks a little bit more attractive.

[Robert M. Le Blanc, Senior Managing Director]

So again, as I mentioned in the comments, we've always sort of had responsible investing as part of our culture. I mean we look at it at every deal we do. And if something doesn't fit in terms of what we're -- we'd be proud to own, we just won't own it. We won't take a great return to own something that we're not proud to own. But with that said, people are monitoring it more closely, and we need to do a better job reporting on it and do a better job of articulating to the shareholder how we've always done that. And that's what the processes will do from this point forward. Todd, would you add anything to that?

[Todd Clegg, Managing Director]

Yes. I would just probably add, with the recent adoption of SASB, which is the Sustainable Accounting Standards Board, what that's very helpful for us is just being more transparent and systematic about what we do. As Bobby has said, it's not a change. It just marks our ability to perhaps be more transparent to our LPs and indeed, ultimately, to our shareholders about what we do.

[Operator]

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

[Scott Chan]

Just relating to the coronavirus. When you span through your private equity portfolio, is there any kind of direct exposure that you can maybe help us point out to help navigate kind of going through your companies?

[Robert M. Le Blanc, Senior Managing Director]

Yes. So obviously, we're looking at that real time by company and very closely. To date, it's been a minor impact, mostly in supply chain and logistics. But who knows where this ultimately goes? The place that worries me a bit, if people stop gathering in public places, some of our businesses could be impacted by that, but it's really too early to know. This is all pretty new, and the volatility of the last 5 or 6 days has got us -- has got our management teams really focused on the issue. But as of right now, we don't see anything material. But again, that can change, and we're monitoring the situation very closely.

[Scott Chan]

Okay. And Bobby, just on Gluskin Sheff, you talked about -- I guess you kind of said you did $23 million in performance fees for 2019. You talked about the change in the fee structure. Did you change the performance fee structure at all?

[Robert M. Le Blanc, Senior Managing Director]

I have to turn that one over to Seth.

[Seth Mitchell Mersky, Senior Managing Director]

Yes, we did. We eliminated performance fees on all of the long-only product. And later on this year, we'll be introducing tiered fees mostly for the benefit of our more substantial clients.

[Scott Chan]

Tiered fees, meaning the larger the client, the step down in fees? Is that...

[Seth Mitchell Mersky, Senior Managing Director]

Correct. That's correct.

[Scott Chan]

Okay. And Bobby, just lastly on Gluskin. You talked about the AUM being up 2% quarter-over-quarter since it closed in June. You talked about Q4 client additions. Was that implying that there was net sales at Gluskin within Q4?

[Seth Mitchell Mersky, Senior Managing Director]

So essentially, our sales have been benefiting from the introduction of Onex Credit products, then -- and the client withdrawals have been relatively stable. So as we said, together with some improvement in market performance, overall, we had net growth in AUM.

[Operator]

Our next question comes from the line of Nik Priebe with BMO Capital Markets.

[Nikolaus Priebe, Analyst]

Okay. I think most of my questions have been answered. I just have one on one of the portfolio companies. It looks like there was a bit of a step-up in earnings for Ryan Specialty Group. It looks like that was a company by -- also a decline in balance sheet leverage. Can you just give us a bit of color on what's been driving the performance of that business?

[Robert M. Le Blanc, Senior Managing Director]

Yes. So Ryan specializes in the same type of risk that Convex underwrites. So it's a specialty broker. Rates in the insurance market have been going up for underlying risk, which helps a business like Ryan because they get more dollars per unit of work. And just generally speaking, they're doing a great job of creating organic growth and stealing share in the market and doing accretive M&A. So they're having a very -- they've had a very good year last year in terms of both earnings growth and delevering as a result of those factors.

[Operator]

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

[Robert M. Le Blanc, Senior Managing Director]

Thanks for joining us, everyone. As always, if you have any questions, feel free to contact Emilie, and I hope you all have a really nice weekend.

[Operator]

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