Onex Corporation (OTCPK:ONEXF) Q3 2022 Earnings Conference Call November 11, 2022 11:30 AM ET
Jill Homenuk – MD, Shareholder Relations & Communications
Gerald Schwartz – Founder, Chairman & CEO
Robert Le Blanc – President
Christopher Govan – Senior MD & CFO
Conference Call Participants
Welcome to Onex Third Quarter 2022 Conference Call and Webcast. [Operator Instructions].
I will now turn the conference over to Jill Homenuk, Managing Director, Shareholder Relations and Communications at Onex. Please go ahead.
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’s President and Head of Onex Partners; and Chris Govan, our Chief Financial Officer.
Earlier this morning, we issued our third quarter 2022 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 amount 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.
Thanks, Jill. Good morning, everyone, and thanks for joining us today. I’m thinking back to when Onex was created nearly 40 years ago. It was built to perform consistently in a wide range of market conditions. Our focus today remains as it did then, on the virtue of disciplined investing. This includes a bias towards value, prudent and conservative underwriting and ample liquidity. This approach has allowed us to convert market dislocations into moments of opportunity.
We saw this dynamic at play during the great financial crisis of 2008 and again during the pandemic. Today, as markets continue to fluctuate in the face of macroeconomic and political uncertainty, I am confident that our strong culture, client relationships and financial position will allow us to emerge even stronger. To that end, we also have to keep our eye on the future to ensure continuity and a strong path for growth and success.
On that note, it is my pleasure, and I really mean a pleasure, to announce our proposal to appoint Bobby Le Blanc as Chief Executive Officer, following our 36th Annual General Meeting in May of next year. I’ve had the pleasure of working alongside Bobby for 23 years. A consummate professional with a wealth of investment and management experience, he’s the ideal person to lead Onex and drive value for our partners, investors and shareholders.
Over the last 2 years, Bobby, as President, has played an instrumental role in our strategic plan and has led many of our firm-wide initiatives. In addition to his work with Onex Partners, he’s also been actively engaged with our business platforms and is a strong advocate for our One Onex approach.
As Founder and Chairman, I will certainly continue to remain involved with Onex and to work with Bobby to be part of our growth. This proposal is conditional upon an amendment to the multiple voting shares to maintain their current voting entitlement following the transition of rules. In addition, a 5-year sunset provision will be added to the MVS. Shareholders will, of course, be asked to approve the proposal at our next AGM.
We believe that this is the right approach, creating an appropriate balance between continuity and planning for the future. We wanted to provide shareholders with a clear and orderly indication of our succession plans. I want to thank the entire Onex team for their remarkable support in this time of great change and opportunity.
With that, let’s turn it over to Bobby for more on the quarter. Bobby?
Robert Le Blanc
Good morning, everyone, and thank you, Gerry. I’ve had the privilege of being at Onex for 23 years and seeing the organization grow and evolve. Today, we benefit from a nearly 40-year track record of strong investing, combined with the momentum, culture and drive to succeed.
We continue to execute on our strategic plan and remain focused on delivering growth and shareholder book value. I am honored to have the support of Gerry and the Board and look forward to engaging with many of you in the months ahead. Gerry has been a terrific teacher, mentor and friend to me, and I am grateful for our continued partnership.
While it was important to provide clarity on our leadership transition, our main priority remains the day-to-day management of our businesses. We’re navigating industry and market challenges effectively, maintaining a clear focus on performance and long-term growth opportunities.
Our private equity portfolio performed well in Q3, outpacing the broader equity indices. We are actively working with our companies to mitigate near-term macroeconomic impacts and execute on strategic initiatives.
I previously mentioned value creation plans, the comprehensive road maps we develop with our portfolio companies early in our ownership. With our partners, these plans allow us to build consensus around priorities and the pathways to achieve them.
We recently completed a new plan at Tes Global and are already seeing the benefits including strong revenue and EBITDA performance, the completion of two add-on acquisitions and other value-added initiatives. Recently, we held the first close for Onex Partners VI, with the next close planned for early in the new year. We reached aggregate commitments of approximately $2 billion, including Onex’s commitment of $1.5 billion and welcome some of our long-term partners as investors.
As I’ve said before and has been largely evident across the industry, this is a tough fundraising environment, and we expect this fund raise to be longer than what we have experienced with previous funds. We continue to have deployment flexibility in OP V with room for one or two more investments.
ONCAP is also now actively fundraising, with an expected first close for its new fund, ONCAP V, before the end of the year. ONCAP IV still has capacity for one more investment. And despite the general slowdown in activity, the team continues to find interesting opportunities within the sectors of emphasis.
Overall, the industry has experienced a significantly slower deployment environment with a tighter financing market and continued valuation expectation gaps between buyers and sellers. Conditions should improve as markets normalize. In the meantime, we maintain our usual robust discipline to diligence new opportunities.
Turning to credit. Our strategies are holding up well despite the challenging conditions. Investors continue to be attracted to credit given the rising interest rate environment and the need to achieve return objectives without stretching for risk. These conditions create a healthy tailwind for our credit business and are supportive of our longer-term growth objectives.
We had our first close for Onex Falcon VII in early November. The fund, which has a target of $1.5 billion, closed on approximately $430 million of committed third-party capital. We’re also actively fundraising with institutional investors for Falcon’s direct lending strategy and expect to have more to report in our next quarter.
Looking at our other platforms. Onex Transportation Partners has also officially begun fundraising for the first close expected in the first half of next year. Our private wealth platform, Gluskin Sheff, completed its fourth consecutive quarter of net positive inflows, a nice accomplishment in today’s market. Dave Kelly and the team continue to execute our strategic initiatives to allow us to scale the business more rapidly, both from a client and adviser perspective. And we continue to enhance our wealth planning offering, most recently with the addition of a team of seasoned insurance advisers with expertise in both tax and estate plan.
Progress is being made across all of our businesses within our One Onex approach, driving incremental opportunity and growth. Our diversification in recent years has been key to reducing our reliance on any one part of the market, broadening our revenue streams and allowing us to begin to deliver on our long-term objectives.
Before closing, I wanted to say a few words about our investing capital, which ended the quarter just above USD 90 a share or CAD 123. At these levels, Onex shares are trading at a substantial discount to their intrinsic value. The discount is even more stark when considering our cash position and public holdings.
While sentiment towards the broader market and alternative asset managers, in particular, is challenging right now, we have great confidence in the intrinsic value of our business. As a reminder, within private equity, we have a robust valuation process that we undertake every quarter to mark our investments. They are reviewed and audited each quarter and are the same marks we provide to our limited partners. Moreover, history has shown that our valuations tend to be conservative compared to ultimate realizations.
We believe strongly in the value of an Onex shareholders own and are backing that up with the investment in our own shares. Although it’s an opportunity we prefer not to have, we believe we know a good value when we see one.
On the start of the year to October, we bought back 4.7 million shares with 3.5 million of that in the last 4 months alone. We will continue to be opportunistic and believe that existing shareholders will be rewarded. We know it’s our responsibility to continue to deliver shareholder value, and we’re committed to doing it. We have built a strong platform and by remaining true to our investing principles and sticking to our plan, we have confidence we will succeed.
I’ll now hand the call over to Chris.
Thanks, Bobby, and good morning, everyone. Investing capital per share was down less than 1% in Q3 and up 4% over the last year. As Bobby alluded to in his remarks, our PE results continue to provide outperformance compared to the public markets with the S&P 500 and the MSCI World Mid Cap Indices, down about 5% to 6% in the quarter. Moreover, share repurchases at a substantial discount to NAV contributed about $1.10 of value per share in the quarter.
The overall value of our PE portfolio was down 2% in Q3, reflecting continued market volatility, higher interest rates and other macro factors. However, $82 million or almost 70% of the Q3 mark-to-market decline in PE reflects FX losses from our non-U.S. investments. Notwithstanding the overall decline, there were pockets of outperformance, with PowerSchool up about 40% in the quarter as well as markups in other holdings with improved performance or outlook.
During the quarter, Onex realized $295 million from its PE investments primarily from the previously announced realizations of Partou, AIT and Ryan LLC. While market conditions for additional monetizations are less favorable today, we’ll remain focused on execution across the portfolio while we wait for this cycle to run its course.
Turning to credit. We generated a $10 million gain or a 2% return from credit investments in Q3, consistent with the Credit Suisse Leveraged Loan Index, which was up about 1%. Performance of our CLO assets remains strong as we received $19 million in regular quarterly distributions. Overall, our investing capital per share ended the quarter at $90.26, or CAD 123.71.
Now turning to the asset management side of the business. Our fee-generating AUM of $32.9 billion was down less than 2% in the quarter and flat from year-end. Market headwinds were largely offset by new capital raised this year, notably $1.4 billion of CLO AUM including CLO 25, which closed in the quarter. Excluding those mark-to-market and FX headwinds, fee-generating AUM is up just over 2% so far this year.
As Bobby mentioned, the fundraising markets are challenging, certainly more so than when we set targets for 2022. We now project raising about $3 billion in fee-generating AUM for 2022 once we close out Q4, about a 10% growth increase for the year. While short of our target, we believe much of the shortfall is timing and we can make up a good portion of that in 2023. We expect to have an update on 2023 plans for you next quarter.
Despite the choppy markets and to a degree because of them, we remain positive on our long-term prospects. We expect new opportunities at attractive entry valuations to drive strong investment performance for Onex and our clients. Moreover, our ability to invest across the entire capital structure continues to resonate with clients and bodes well for our ability to grow the asset manager going forward.
As we continue to build Onex’s capacity to generate FRE, let’s turn to where we’re at today. In the quarter, we had an FRE loss of $15 million, including a $6 million loss from the asset management platform. The year-over-year decline was driven by higher private equity expenses that include the buildout of Onex Transportation Partners. Onex again generated meaningful distributable earnings, $193 million in Q3 driven by PE realizations and CLO distributions.
And it’s important to remember the meaningful opportunity for value creation from Onex’s participation in carried interest. Although, as you’d expect, we had a reversal of unrealized carried interest in the quarter, we ended Q3 with $168 million of unrealized carry. And in the long term, we expect carry to generate significantly more value with shareholders having a stake in nearly $25 billion of carry-paying AUM at quarter end.
Finally, as Bobby mentioned, one attractive opportunity the markets have already presented is the ability to invest in the business we know best. In Q3, we repurchased an additional 2.4 million shares and remained through October, bringing our total repurchases this year to 4.7 million shares. These repurchases captured more than CAD 230 million of hard NAV for our continuing shareholders. As Gerry said at the outset, Onex’s approach has always included investing discipline and an appreciation for the value of liquidity. These cornerstones will serve us well in the current market.
Our diversified private equity portfolio remains well positioned to generate value going forward. Approximately 85% of the debt at our operating companies matures in 2025 or later and we continue to work with our businesses to execute on their value creation plans. And Onex itself benefits from a debt-free balance sheet, $1.3 billion of cash and near cash and consistent distributable earnings available for reinvestment. As a result, we’re able to execute on strategic initiatives while being ready to take advantage of the opportunities we expect the current markets to provide.
That concludes the prepared remarks. So we’ll be happy to take any questions.
[Operator Instructions]. And our first question comes from the line of Nik Priebe from CIBC.
I just wanted to start with a question on Onex’s share price and the discount to NAV. Are there any actions you feel could be taken to help narrow that discount? And just to float an idea, wondering if you would consider selling an LP interest in the secondaries market at a narrower discount to NAV and the stock trades in order to demonstrate value and then use the proceeds to accretively buy back stock. Or is there anything else that you might have in mind to help sort of illustrate value?
Robert Le Blanc
Yes. It’s Bobby. We think about those kind of things all the time. That secondary market that you referred to was very robust in the first half of the year. It since has fallen off a bit. And where that market would bid, our interest in one of our funds is not something we’d be interested now. But that trade exists. And when you think about secondary buying above 100 cents on the dollar in the first half of the year and the implied value of our PE portfolio when you adjust for cash and our public holdings, that arbitrage is real, whether it’s 100 today or 105 today versus a market that’s less, it’s nowhere — it is so much higher than the public shareholders are ascribing to the value of the portfolio.
So we’re thinking about that stuff all the time. We just want to — if we do something like that, we want to do it from a position of strength, not in a market where people will value our assets less than we believe they’re worth. But there are many things that you can do like that. And over time, we’ll look at them. And when they make sense, I think that would be a good proof point to that, that the value is really there even though the market says it’s not.
Yes. And just as a follow-on. It’s Chris Govan. The other thing with that kind of trade, we also proved out an easy way, I’ll call it, to build out our fee-generating AUM. Because the other nice thing about those types of transactions, it’s an opportunity to take something off our balance sheet and put it in the hands of a fee-paying LP. So certainly something that’s on our radar.
Robert Le Blanc
That usually comes with a staple to the new fund. There’s a lot of moving parts in there, but it’s something that we are — we always — we’ve been considering for the last whole while. I think it would be a very tangible proof point.
Yes. Okay. And then just moving on to the fundraising side. A lot of the alternative asset managers in the U.S. have emphasized how under-penetrated private alternative asset classes like private equity are among high net worth investor portfolios and how that’s a source of upside longer term in terms of third-party demand. You do have access to captive distribution in that channel of Gluskin, but as you advance fundraising efforts for OP VI, are you making a greater effort to target commitments from high net worth investors? Or how do you think about that opportunity in general?
Robert Le Blanc
No, I think that is a very big opportunity for us and for OP, for ONCAP, for Onex, just generally speaking, for all of our products, credit as well. I think the high net worth channel, Northwest is very underpenetrated, especially in Canada, where our brand is really good. We do have Gluskin, as you mentioned. And I think as you know, we publicly talked about it, we’ve distributed $1 billion of our credit product through that channel, and we’ll be distributing our both ONCAP and OP products through that channel. But we’re also working with other Canadian and U.S. banks that have really good high net worth channels to try to penetrate those as well. So I think you’ll see more activity from us trying to tap that channel and not to so much diversify away from institution but to have another avenue of growth for fee-generating AUM. And so it’s an opportunity we’re quite excited about.
Yes. Okay. And then it’s no secret the fundraising environment is challenging this year, in part because of the denominator effect and also the outperformance of PEs and asset class. But another factor, of course, influencing fundraising success is historical investment performance. And I know returns on OP V are strong, certainly strong in absolute terms. But private equity has also been very strong as an asset class in the last few years. How would you say OP Vs returns measure up against other funds of a similar vintage who might be in the market at the same time as you?
Robert Le Blanc
So I think OP V is off to a very good start. These quartiles early on in the fund’s life can move around. I think it’s really important to note that, historically, we’ve never utilized financial leverage — subscription lines to be specific to manage IRR. Like if you were to make that one adjustment, which we’ll do for an OP VI going forward, Fund V is easily a front — sorry, first quartile fund right now. So we feel really good about that. I think as 2023 plays out and that portfolio for OP V becomes more seasoned, I think it’s going to give LP’s confidence that all the changes we’ve made for the last 3 or 4 years at the OP side are working.
And it is like — to touch on it, it is a challenging fundraising environment. We had that — this first close that we referred to on the call. But — and we will be in the market for a long time with OP VI. But I think as OP — every quarter OP V has that reinforces its relative performance, I think it’s going to help.
And our next question comes from the line of Geoff Kwan from RBC Capital Markets.
Gerry, I just want to start off a question for you. Just with the move up to being the Chairman, you talked about still being involved, but just how would you describe how that involvement in the company looks like when that happens versus what you’re doing now in terms of both time commitment, nature of the work that you would be doing with the company.
Geoff, it’s Chris Govan. I think today, we decided to communicate this change early to provide clarity on the planned leadership transition and certainly, we believe that this next step is evidence of a well-planned and orderly succession and it’s going to be viewed as a positive for our shareholders.
The other reason we announced today was to provide us lots of time to proactively engage with our shareholders over the next 6 months. And we don’t want to get too ahead of those discussions on today’s call. So really would sort of direct you in the meantime as we roll out that communication plan to direct any detailed questions you might have to our shareholders’ relations team. But we’re going to be very proactive and out there with our shareholders and making sure they have a full understanding of what’s proposed prior to the circular being published in the spring and in advance of the May AGM.
Okay. And then just on the fundraising for OP V, I know it’s hard to generalize, but is there anything you can talk about in terms of just the nature of the commentary you’re getting back from the LPs that you’re talking to? And then in terms of final close, do you have an idea because you talked about it being longer than usual. Like what does that time line look like in terms of how you’re thinking about what the fundraising process would be? And does that impact with OP V being almost fully vested kind of the appetite in terms of looking at new investment opportunities?
Robert Le Blanc
Yes, there’s a lot in there, so let me try to address all of this. So 2022, I think we’ve been very vocal about how crowded the market was, and it was. And we had a couple of our long term — some of our long-term LPs in the first close. We’ll have a second close early in ’23, as I mentioned, because people were just out of capacity in 2022. That is a common theme that we’re hearing as well as we like the improvement we’ve seen in OP IV over the last couple of years. We like the way OP V looks. And I think you’ll see, hopefully, more confidence build. And it’s again, that’s a positive — all the changes we may have been viewed as a positive with actual results.
How long we’re going to be in the market? Technically, you have 18 months from the first close. So that could put you into Q1 of 2024 or through Q1 of 2024. I’m not sure whether we’ll need that or not, but that’s sort of the technical time line we have. And it’s just tough to know. It’s tough to know what the fundraising environment will be in 2023. But the more quarters we have with OP IV stabilizing at a decent gross IRR in the sort of 13%, 14% and OP V looking as good as this. Hopefully, that gives people the confidence that we’re on the right track here.
And if I can maybe just sneak in one last question. Just from a strategic perspective, how much do you think about being a traditional private equity now, you’ve got credit but moving into other asset classes because when you have some of your peers offer other types of products and different asset classes there, just whether or not that’s a competitive advantage for them or not when thinking about the fundraising aspect and dealing with the LPs that you do?
Robert Le Blanc
Yes. So look, I think there’s usually value and diversification. So we historically have been a private equity firm only. In today’s markets, a lot of our credit products are in really high demand. So we ought to be able to see some growth there. As we look to the future strategically, we’re in the early stages of asking ourselves where else should we be competing in not only PE and credit and transportation as a form of PE, but are there other asset classes that we should think about that would create more enterprise value for Onex.
Again, early innings, we could do that organically like we’ve done with Onex Transportation Partners. Obviously, given our pristine balance sheet, we could do that inorganically as well. But I think it’s too early to tell. But I think the value of diversification in a market like this is good. And I think I like the fact that we’re in credit and these other things because it’s just given us — it just kind of mutes any weakness that you might have on any product at any point in time.
[Operator Instructions]. And our next question comes from the line of Graham Ryding from TD Securities.
I just want to start with, I guess, the change in the multi-voting structure. I think originally, the terms were in the — a change in the CEO would trigger the collapse of the multi-voting structure. So why are you proposing now to extend the voting and the Board rights for another 5 years as opposed to staying with the original terms?
Graham, it’s Chris Govan again. I think you’ve got to look at the transition as a whole. And we believe that what we’ve done over the last 2 years and what we’re proposing to do going forward reflects a really well thought through transition for the company and puts it on the right path for growth going forward and believe that when you look at it together, that what’s being proposed is a positive change for the company, and we believe shareholders are going to agree.
As I said, we’re going to have lots of proactive discussions with our shareholders in the run-up to an actual vote in May. So I’m not going to go sort of any further on specifics around the proposal on this call.
Okay. Understood. On the PE fundraising side, so your commitment for OP VI, $1.5 billion, I think that’s lower than your $2 billion commitment for OP V. Should we be interpreting anything there in terms of the targeted size for this next fund? Or you think it is going to be lower than OP plus?
Robert Le Blanc
No. So we’ve told our OP VI LPs that our commitment would be between $1.5 billion and $2 billion. When we set the $1.5 billion as the initial close, we did that as a function of our liquidity and other things that we have going on internally at Onex because we just want to make sure that we have plenty to fund commitments as they come, but you shouldn’t read anything into that. We’ve told the OP VI LPs it will be between $1.5 billion and $2 billion. And if our liquidity continues to be as good as it is, I wouldn’t be surprised if it is $2 billion in this case.
Okay. So there’s no — you haven’t actually put out a targeted size for OP VI overall?
Robert Le Blanc
Sorry, I missed that question.
You haven’t established a targeted size for OP VI overall. It remains fluid. Is that what I think?
Robert Le Blanc
I think where we sit today, it needs to remain fluid, just because I don’t — I really don’t know what 2022 — like we’re going to have a fund like don’t get me wrong. Like there’s — Onex Partners is going to have a fund. We have a $7 billion balance sheet like — this is a moment in time of a bumpy road in the fundraising environment. How big the fund is going to be relative to OP V, I think it would be — it wouldn’t be fair to meet it to guess. I think what we ought to do is each quarter, tell you how we’re doing. And as we get further into it, have an idea of the band of which high versus low and where we expect to come out and we’ll communicate that with you every quarter.
Okay. Understood. Chris, maybe — Chris, can you just give us an update or remind us sort of what to expect here in terms of the implications for run rate private equity fees as you’re transitioning from first closes on OP VI and ONCAP and then full year invested funds?
Sure. And I’ll just focus on OP because those numbers are a little bit more memorable for me, but happy to offline take you through the math because I think you can sort of based upon our public disclosures, kind of do the math easily. But I’m happy to take you through ONCAP offline.
If you looked at OP with about $500 billion of — excuse me, $500 million of third-party capital. If OP V, if it’s investment period was to end today and OP VI was to go active, our run rate fees for private equity would temporarily be reduced annually by about, call it, $35 million. Now as Bobby mentioned, we’ve got, I think, call it, around $600 million, $650 million of capital remaining to invest in OP V., so we’re not expecting that to happen anytime real soon. But that would be the impact if it was to kind of happen today with $500 million of third-party capital in OP VI.
Now as a reminder, as we complete subsequent closes in OP VI, as Bobby said, potentially through early 2024, all investors in the fund do pay management fees back to the effective date of OP VI. So there will be this timing issue between what I kind of think of as economic management fee revenue and reported GAAP management fee revenue probably kind of over the next 15 months or so. But that — I don’t know if that’s answered your question, but I — again, I don’t have those numbers for ONCAP handy, but I could take you through that offline.
No, no, that’s helpful. And then so what is the trigger then for your fees to move from — for OP V to move from sort of a committed run rate to an invested? Is it just once you get that last investment in?
That’s right. It’s once we make the determination that essentially, once we make the determination that we’re now in the market hunting for an investment for OP VI as opposed to still looking for investments to close out OP V. And so that’s at least one investment away, but potentially two.
Understood. Okay. And then my last question, if I could. Just maybe an update on the CLO side. Can you give us some commentary on how you see that market performing? I understand there’s been some pullback broadly from sort of the investor base given the volatile markets, but also the supply of loans, I think, is lower just given the lower PE activity. So maybe some commentary there, please?
Robert Le Blanc
Yes. Our CLO portfolios held up quite well. But the new issuance is quite slow for the reason you just outlined. There’s just not a lot of M&A activity right now, particularly on the PE side, as the rates have risen quickly sort of the buy-ask spread on new PE deals has caused volume to slow down, which obviously is directly correlated on the CLO side. But again, the rising rates, assets, liabilities like that all seems to be working reasonably well right now, and we’ll continue to keep an eye on it. But the distributions are coming in as normal, as Chris mentioned, and no red flags there as of now.
This does conclude the question-and-answer session of today’s program. I’d like to hand the program back to Gerry Schwartz for any further remarks.
Thank you, operator, and thanks again to everyone for joining us today. We really appreciate your continued support, and we look forward to speaking with you again next quarter. Until then, we wish everyone a safe and joyous holiday season. Talk to you later.
Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.