Nov 13, 2015
Executives
Emilie Blouin - Director, IR Seth Mersky - Senior Managing Director Chris Govan - Chief Financial Officer Anthony Munk - Senior Managing Director
Analysts
Scott Chan - Canaccord Paul Holden - CIBC Bert Powell - BMO Capital Markets Geoff Kwan - RBC Capital Markets
Operator
Welcome to Onex Third Quarter 2015 Conference Call. During the presentation, all participants will be in listen-only mode.
Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded.
I’ll now turn the conference over to Ms. Emilie Blouin, Director of Investor Relations.
Please go ahead.
Emilie Blouin
Good morning, everyone, and thank you for joining us. We’re broadcasting this call live on our website.
With me today are Seth Mersky, Chris Govan, and a number of our Managing Directors. The third quarter MD&A and consolidated financial statements are on our website and have also been filed on SEDAR.
The quarterly report includes the How We Are Invested schedule. This is a good financial summary of our investments and includes Onex’s capital on a per share basis.
Our pro forma schedule of fees and expenses has also been posted on our website which is provided quarterly with LTM information. It should give you greater visibility into the revenue and expenses and our asset management platform and parent company.
As a reminder, all references to dollar amounts on this call are U.S. unless otherwise stated.
I also want to remind everyone of the usual forward-looking statements disclaimer and need to point out that all information relating to the fair value of our private companies is the view of Onex’s management. In addition, we will refer later in this call to collateralized loan obligations or CLO offerings.
We are required to remind you that these offerings are made solely to qualified institutional investors and to certain non-U.S. investors in private transactions not requiring registration under U.S.
Securities Laws. The securities are not and will not be registered under U.S.
Securities Laws and cannot be offered or sold in the U.S. without registration or exemption.
With that, I’ll now turn the call over to Seth.
Seth Mersky
Thanks Emilie, and good morning everyone. I would like to spend some time today discussing our private equity and credit platforms but first a few comments about what we’re seeing in the markets.
The third quarter was marked primarily by continued weakness in commodity and high yield credit markets, as well, I’m sure most of you on this call have begun to notice the steady delivery of downbeat earnings forecast from many of the publically treated industrial and retail businesses. In the states, headwinds are also felt from a very strong U.S.
dollar, as it becomes more likely that U.S. federal will be the early mover on interest rates.
A strong U.S. dollar obviously hurts exporters as well as businesses with substantial earnings coming from international operations.
In our part of the markets, the recent volatility and particularly the weak credit markets have slowed the pace of new acquisitions and in some cases, the ability to finance them. We’re happy, we found some opportunities earlier in the year as the current pipeline has thinned out considerably.
Overall, we invested about $2.5 billion in private equity so far this year of which Onex’s share was about $750 million. In doing so, we reduced our cash balance from $2.9 billion at December 31, 2014 to $2 billion at quarter end.
While we prefer to have more of our cash invested, it doesn’t feel all that bad having plenty of dry powder. Overall, our businesses are performing well and actually staying quite busy with acquisitions of their own.
Year-to-date, they’ve invested $1.4 billion in add-on acquisitions and capital spending. We probably talk a little more about cost reduction and the efficiencies and the like than add-on or tuck-in acquisitions, but they’re often a very important driver of value creation throughout our portfolio.
They could bring cost savings of their own for consolidation of functions or footprints and increase leverage with suppliers among other things. As well, they can expand product lines and extend the business’s geographic reach.
Maybe most importantly, giving the competitive markets we’ve been in recent years, add-on acquisitions often come at considerably lower multiples than our original investment, particularly after considering synergies. Probably the best example of implementation of the add-on strategy in our current portfolio is USI, our commercial insurance broker.
The management team at USI has completed close to 30 tuck-ins since we acquired the business in late 2002. They’ve added more than $90 million of post synergy EBITDA to the business.
And with an average multiple of six times, they’ve reduced our initial purchase multiple [ph] for USI by almost a full turn of EBITDA. In addition to add-ons, we did a lot of refinancing over the summer, just before the credit market started to alter.
About $1.3 billion, which brings our year-to-date total to $1.9 billion, of that total, approximately $650 million funded distributions to Onex and our limited partners. And finally, valuations, driven by improved performance; accretive acquisitions; and debt reduction, the value of Onex has interest in our private equity funds grew by 3% in the past quarter and 16% during the last 12 months.
Given the overall economic climate, we’re reasonably pleased with this growth. Moving on to our credit business, as I said earlier, the credit markets have turned quite weak.
We’ve got CLO-10 done, just under the wire as the CLO market today is virtually closed. With $512 million raised for CLO-10, our credit AUM is now approximately $6.6 billion.
Chris will talk about it in a minute, but the marks on our CLO equity were hard hit in the quarter, and that does get reflected in our published NAV. It’s very important to remember though that our CLOs are not affected by marks and the underlying portfolio is in very good shape.
We were fortunate to be underweighted relative to the market in energy and mining credits which has contributed to the stability of the portfolio. As we all know, the CLO market will reopen when it’s good and ready to do so.
And we expect our platform will continue to grow, given the regulatory changes, favoring well-capitalized multiplatform managers. Having said that, we’ve been off to a slow start in Europe.
For much of the year, we chased that market as it improved dramatically. That selectivity, while good for us in the long run, slowed us up a bit and makes the launch in 2015, now unlikely.
As always our culture, and we think our success is routed in the strong alignment of interest among all Onex stakeholders. Our team has significant personal investments in everything we buy.
In the nine months ended September 30, we’ve invested a $130 million in our operating businesses alone, brining our total investment to $2.3 billion across our companies, credit funds, and Onex shares. I’d now like to hand it over Chris Govan.
Chris Govan
Thanks Seth, and good morning everyone. My comments will focus on two supplementary schedules that Emilie mentioned earlier, How We Are Invested; and the pro forma schedule of fees and expenses.
Turning first to the How We Are Invested schedule, there are few quarter-over-quarter changes to highlight. The value of our Onex Partners private company investments increased to $2.5 billion, a $79 million increase from the end of Q2.
During the quarter, Onex invested $216 million in these businesses, principally as a result of the Jack’s and Schumacher acquisitions. Substantially offsetting these new investments was almost $200 million of distributions, primarily from the JELD-WEN and USI refinancings and the sale of Tropicana.
Our Onex Partners private company investments also benefited from a value increase of $61 million or as Seth mentioned, a 3% markup in the quarter. This value increase also impacted Onex’s unrealized carried interest, which closed the quarter at $160 million, up $11 million in Q3 and $45 million year-to-date.
The value of our ONCAP investments was $370 million at September, up $40 million in the quarter. The increase reflects new capital invested in Chatters and Mavis Tire, net of a distribution from PURE Canadian Gaming.
Also included here is an $11 million increase in value, as a result of a 3% quarterly increase in the underlying markets. In aggregate, Onex’s private equity investments generated about $100 million of value in Q3.
Turning to credit, there was a $27 million decrease in our investments there which was made up of two pieces: First a net increase of $36 million in capital allocated to CLOs; and second, a $63 million mark-to-market loss in Q3. Substantially, all of this mark-to-market loss was related to our CLO equity investment whose market pricing is more volatile than the underlying loan market.
The incremental volatility stems from the leverage inherent in the CLO structure and the relative illiquidity of the CLO equity market. The thinner CLO equity market also manifests itself in fairly wide bid/ask spreads, spreads of up to 20% of the face amount of some CLO equity as of late.
Even we mark our CLO investments on the bid size of that market, the recent widening of these spreads, contributed meaningfully to the mark-to-market loss in the quarter. However, we’re long-term investors in CLO equity.
In fact, we generally committed to hold our investments for the life of each CLO. So, we’re not watching the quarterly changes in marks but are instead focused on CLO’s cash flows and underlying defaults.
In that regard, things remain on track. All of our CLOs are comfortably onside their various coverage tests.
And we’ve received $36 million of distributions in the first three quarters of the year, including $12 million in Q3, and that’s on a $250 million investment in CLOs that have reached their initial distribution dates. Looking at the schedule as a whole, our capital per share at quarter-end was $54.52, which reflects a very little change in the quarter and year-to-date.
Given the significant portion of Onex’s capital and cash at the beginning of the year, strong growth in proprietary capital was going to be tough to achieve in 2015. But, a busy nine months of putting capital for work has positioned Onex for stronger growth going forward.
Our quarter-end investment in private equity really is the engine of any degrowth at Onex, stood at just over $3.3 billion and increased about $800 million or 32% since year end. While the How We Are Invested schedule and the changes in Onex’s capital per share are good measures of our investing activities, they do not reflect the value of Onex’s asset management activities.
Our private equity and credit platforms manage approximately $16 billion of other investors’ capital, most of which is committed by long-term institutional investors. The pro forma schedule of fees and expenses is one measure of the contribution that Onex, the parent company makes over and above the return from its invested capital.
This schedule compares our asset management revenues to the total cost of running Onex and includes pro forma fees and carried interest on the 4 plus billion dollar of private equity capital, managed on behalf of shareholders. As a remainder, the pro forma amount assumes that Onex Corporation’s capital is subject to the same fee structure as our institutional limited partners.
This pro forma schedule reflects the full scope of our asset management platforms. And we think it’s useful when trying to assess the value of those businesses.
In comparing the results for LTM September 30th to calendar 2014, several items merit discussion. Aggregate private equity management fees of $141 million, up $49 million or 53% from calendar ‘14.
As we’ve talked about on previous calls, this is driven by the inclusion of Onex Partners IV, where we again calling fees in August of last year. Our current run-rate private equity management fees are about $134 million, which includes $39 million of pro forma fees on Onex’s capital.
However, the increase in private equity management fees was more than offset by the impact of fewer realizations so far this year. Both carried interest and variable compensation were affected and combined for a net $235 million decrease compared to calendar ‘14.
This is an usually large swing since 2014 was a record year for realizations, whereas 2015 has been quiet on that front. Overall, our private equity asset management platforms contributed $56 million in the September 30 LTM period, down from $242 million in 2014.
As a remainder, we include carried interest in this schedule on a realized basis and as such, the amounts reported here will be lumpy since private equity realizations will always be episodic. However, it’s worth noting that in the 12 months ended September 30th, Onex’s unrealized carried interest on other investors’ capital, grew by about $65 million and with the pro forma amount on Onex’s capital, the total increase in unrealized carried interest in the last 12 months is about $105 million.
Now, while this accrued amount will not be recognized on the schedule of fees and expenses until it’s actually realized, my point here is that carried interest has been a meaningful source of value creation for Onex shareholders, again this year. At credit, the steady growth of the CLO platform and the associated management fees continued.
Run-rate management fees for credit were $36 million at quarter-end compared to the $28 million reported in 2014. Overall, the credit manager contributed $15 million in the last 12 months compared to $9 million in calendar ‘14.
Stepping back, you will see the total contribution from the parent company and our asset management platforms in the LTM period was $40 million or about $0.34 per fully diluted share. I also think it’s interesting to note that if one were to exclude the pro forma amounts, the total contribution remains positive, and that’s in a year with almost no carried interest, meaning the parent company’s operations are contributing positively to NAV growth, or as some of our shareholder see it, their capital’s being managed for free.
And that’s been the case every year since we started publishing the schedule in 2010. Finally, before we open it up to questions, an update on our stock buyback program where we continue to be active.
In the four months ended October 31st, we repurchased almost 0.5 million shares for C$35 million. That brings our total repurchases this year to more than 3 million shares at an average cost of C$70.63 per share.
That completes my comments.
Operator
[Operator Instructions] And your first question will come from the line of Scott Chan with Canaccord.
Scott Chan
My first question is for Chris. Chris, just on the schedule’s fees and expenses, if I compare Q3 to Q2 in terms of the credit and the parent segment, the CLO investment income loss and also the interest and other treasury income is omitted this quarter.
What was the rational of that; is that going to be continued going forward?
Chris Govan
Yes, Scott. I guess we started a omitting that from the pro forma schedule back at Investor Day.
I think our thought is that when we’re presenting that schedule on a pro forma basis, we’re really focused on the asset management activities in Onex, but we’ll continue to provide you insight into the actual performance of the CLOs, as we did on this call. Obviously the investment returns from both the treasury income and the CLOs are reflected in the asset values on the How We Are Invested schedule.
But for now, we’ve decided to drop that -- those numbers from the facility.
Scott Chan
Okay, great. And Seth, just on your opening remarks, in terms of your comment on pipeline thinning out a considerably, is that mostly due to where the kind of markets stand today, or is that more of a macro issue?
Seth Mersky
I don’t know.
Scott Chan
I don’t know if you can quantify at all either in terms of may be what it was three or four months ago versus what it is today, the pipeline?
Seth Mersky
I think just as you saw with us in 2014, there was an awful lot of activity over the last couple of years. And I think that really has led to a little bit of a dearth of inventory left on people’s shelves.
The credit markets and just the choppiness of them have also probably made vendors or the sellers a little tentative about wanting to come to market in what is always a six to nine months process, not knowing where those markets are going to be when they end their process. So, I think it’s probably both the significant levels of activity in 2014 and the market volatility in 2015, probably both contributed to a slowing down right now.
But it changes a lot, and we’re never really quite sure why. And that’s why it remains a very episodic business.
Scott Chan
And just on your comment on the CLO market, obviously headwinds there as well too. So, you commented that the CLO market is basically close right now.
What factors we have to see for that market to open up again; is it closed short-term, or is this more of a medium-term thing?
Seth Mersky
Again, hard to say definitively. But, I think the problems in the oil and gas industry and to a lesser extent, the mining industry have caused more elevated level of defaults in the overall credit markets, and that in turn pushes some fear or concern into the funding side of the CLO market, the AAAs specifically.
And so what we’ll need to see is a more -- a tightening of spreads in the AAA market and a return of those participants to the market. And I expect that to happen, as soon as the credit markets start correcting on themselves.
So, whether that’s this quarter or next quarter, I’m not really sure but we fully expect it to happen sometime in the next couple of quarters.
Scott Chan
So, on your CLO portfolio, if you take out the resources in the mining, how is the overall other parts of the portfolio, like how do you feel about that?
Seth Mersky
It’s, as I said in my comments, very good actually. The default environment really is mostly impacted just by energy.
Operator
Your next question will come from the line of Paul Holden with CIBC.
Paul Holden
So, first question I guess would be related to the disposition or potential for dispositions assume the comments you apply to the acquisition pipeline, also think about how you would -- or would impact, how you think about the potential monetization. So, is that a fair statement?
Chris Govan
It’s a generally fair statement, yes. And again, we had a loss activity last year, so we’re having put $2.5 billion to work this year would probably more focus now on building value and the existing portfolios and we are in harvesting.
Paul Holden
Okay. And can you comment at all on the potential transaction between yourself, AIT or ATI and -- or AIT, sorry, and Spirit, is that still something that could be on the table?
Seth Mersky
We don’t make any comments on that sort of thing.
Paul Holden
Okay. That’s all the questions I had then.
Thanks.
Operator
[Operator Instructions] And your next question will come from the line of Bert Powell with BMO Capital Markets.
Bert Powell
Thanks. Seth, just back to pipeline, does that extend -- the thinning, does that extend also to the pipeline for add-ons as well?
Seth Mersky
Not necessarily, because of their much, much, much smaller acquisitions. And whether it’s by us or by others, they are generally financed with on-balance sheet cash.
So, they are much, much, much less credit market dependent. And they usually just depend on the ebb and flow of business owners and their retirement and real practical aspects of life.
Bert Powell
So, given what’s generally going on for the bigger transactions, that’s likely to be an increased area of activity for the investee companies this year and that’s as probably a more disproportionate source of value creation in 2015 or 2016?
Seth Mersky
I think that’s a safe statement, I’d have to do a little mental inventory of the cost reduction plans and some of the recent acquisitions as well but certainly because a handful of our business is that we own today are going to make use of tuck-in acquisitions, so I think that’s probably reasonable -- directionally safe statement to make.
Bert Powell
Okay. And then I guess, we’re just crossing or crossed over anyways four years with JELD-WEN and the -- it seems like the rate of improvement is accelerating, and I’m just wondering if you can give us an update in terms of how you are thinking about that business today.
I mean housing starts have come back up, just a general sense of a business, it seems to be performing quite well. Can you…
Seth Mersky
Matt Ross or Anthony Munk who -- I’m sure one of -- or both of them are on the line. I’ll ask them to comment on JELD-WEN.
Anthony Munk
Yes, it’s Anthony Munk speaking. I would say that your comments are accurate.
We feel very good about the results to-date. We’ve crossed on an LTM basis a $300 million mark, as of this quarter.
And so, effectively, we’re pretty well doubled from where we bought the business, from a profitability standpoint. If you recall the original investment thesis that was based very much on cost reduction, productivity improvement, and the fact that the cycle was going to turn in the overall environment for operational improvements, we’re going to get better.
And we’ve seen that. But frankly, we think that there is a quite bit more to come.
So, if you look at the progress to-date, it’s come principally from pricing. The pricing environment’s been a quite a bit better than it was during the downturn, obviously, and cost, overhead reduction.
And while we still think that there is more to come on those fronts, we think that the contribution, going forward, is going to shift more towards productivity. So, I would say, if I were to rank the contribution, up until now, it’s been pricing, number one; overhead reduction, number two; and to a much lesser degree, productivity.
And I would say over the next few years, we’ll see productivity move to the head of the pack. And I think we’ll see decent progress on that front.
And we’re very optimistic in improvements in a number of areas that will contribute to that. Pricing, we believe, will remain positive in the market.
We think the dynamics are such that the environment will remain conducive to improvements on pricing, on a number of fronts. And then, we’ll see contribution from sourcing that hasn’t really been a big area of contribution to-date.
So, I think that within the Company, there is a lot going on that we’re optimistic about. And then from a macro perspective, while we’ve seen decent improvement from the lows that we saw three or four years ago, we still think that we’ve got a ways to go.
So, I think we’ll just continue to see the improvements or repositioning the business. And we’ll wait for the right opportunity to think about monetization.
Right? I don’t think we’re in any rush.
And we’ll just wait and see what comes in the future, in terms of potential public offering or possibly doing something with somebody in the industry. But again, I think that our objective is try to maximize the underlying operations and the profitability that we think that we can achieve at the Company.
And while we’ve made good progress, we think that there is a quite bit ways to go. And frankly, we just don’t want to give that up any time soon.
Bert Powell
Yes. When you say productivity, do you mean uptick in volume from housing starts or…
Anthony Munk
No.
Bert Powell
Are you talking about plan throughput?
Anthony Munk
Yes, I’d say -- I’d sort of classify it as operational excellence. There’s just a number of areas that we’ve been able to improve the profitability of the business by taking costs out, by implementing new link throughout the operations, consolidating the footprints.
So, there’s just a number of things that we have done and continue to do that will -- that we think will continue to improve profitability. The other thing that we were active in during the quarter, which you may have read about, was on the M&A front.
And it sort of picks up on what Seth said earlier in terms of activity at some of our portfolio of companies. We did four acquisitions -- or three acquisitions in the third quarter, we announced the fourth in the fourth quarter.
They’re all very complementary, either in terms of providing the extension of product lines or geographic reach. And we think that will be another engine of growth, going forward.
So, we think that despite some of the comments that were made with respect to the credit markets, we’ve got a strong balance sheet; we did refinancing earlier in the year; and we think we’re really well-positioned to continue to find nice add-ons that are bolt-on size deals that we think will contribute to the growth, going forward.
Operator
The next question will come from the line of Geoff Kwan with RBC Capital Markets.
Geoff Kwan
I had two somewhat related questions, just going back to the pipeline comments. Is that -- I’m guessing, I mean it’s probably both in the U.S.
and Europe where you’re seeing it slow down, but is it a little bit one more than the other? And then my second question was just around Europe when you are looking at doing transactions over there.
Can you remind me in terms of which kind of countries or areas that you would prefer to do deals and which ones you generally would, at least for now, prefer not to do types of transactions?
Seth Mersky
I’d say things still little busier in Europe than they do in North America. So, yes, the activity levels there, I think are little more robust -- in North America.
We don’t really have a firm view on which countries are good and which countries are bad. Most of what we’ve done thus far have been in Northern Europe and activity levels are at little higher.
Northern Europe or UK, I should say. But, we don’t have a particularly rigid view on what private Europe we like or dislike.
Geoff Kwan
Okay. But if I remember correctly, was -- don’t a lot of the or a number of the countries in Southern Europe usually have labor laws that tend to be less favorable versus maybe some of the Northern European countries, and that may directionally play into how you think about transactions?
Seth Mersky
The labor laws throughout Europe are bit different than most of the regions of North America. But, they do also have a relatively clear history and kind of a known pattern, if you will.
And you can price that into what you think an opportunity is worth. So, just because we are not afraid, in fact welcome the opportunity to work with labor unions and the like in North America, we feel the same way about Europe.
Operator
That concludes our question-and-answer session. I’ll now turn the conference back over to Seth Mersky.
Seth Mersky
Thanks everyone for participating in the call. We, as always, really appreciate your support and your coverage of Onex.
Please feel free to contact Emma or Emilie, if you have any questions.
Operator
Thank you. That will concludes today’s conference call.
You may now disconnect.