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Edited Transcript of OCX.TO earnings conference call or presentation 8-Nov-19 4:00pm GMT

Q3 2019 Onex Corp Earnings Call

Toronto Dec 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Onex Corp earnings conference call or presentation Friday, November 8, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anthony Munk

Onex Corporation - Senior MD

* Christopher A. Govan

Onex Corporation - CFO

* Emilie Blouin

Onex Corporation - Manager of Funds Group & Director of IR

* Gerald Wilfred Schwartz

Onex Corporation - Founder, Chairman, President & CEO

* Robert M. Le Blanc

Onex Corporation - Senior MD

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Conference Call Participants

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* Nikolaus Priebe

BMO Capital Markets Equity Research - Analyst

* Paul David Holden

CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research

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Presentation

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Operator [1]

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Welcome to the Onex Third Quarter 2019 Conference Call. My name is Catherine, 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.

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Emilie Blouin, Onex Corporation - Manager of Funds Group & Director of IR [2]

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Thank you, Catherine. 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 other members of our leadership team.

Earlier this morning, we issued our third quarter 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.

As you may recall, at the beginning of the year, 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 third quarter 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. With that, I'll now turn the call over to Gerry to discuss our recent activity.

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Gerald Wilfred Schwartz, Onex Corporation - Founder, Chairman, President & CEO [3]

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Thanks, Emilie. Good morning, everyone. Today, I'll provide an update on our activity within our private equity, our private credit and our wealth management platforms.

In private equity, we've been really quite active with monetization. So far this year, we've realized about $775 million, of which approximately 70% was received in the third quarter. The majority of this came from the Onex Partners for sale of Jack's Family Restaurants, which, by the way, generated a terrific result with a gross return of 3.6x our capital and a 38% IRR. We spoke about this on our last call, so I'm not going to revisit it today.

Our other realization activity in the quarter came in the form of secondary offerings at both Clarivate Analytics and SIG Combibloc. These businesses have together driven great value over the years as well as in this quarter, and today, represent our largest private equity holdings.

As you know, our funds typically acquire control positions, and we focus on execution rather than macroeconomic trends. This allows us to drive important strategic decisions and effect change at the operating businesses. This takes work and time. Results are rarely immediate. But like everything we do, we're focused on the long term. Clarivate and SIG are pretty good examples of when we can do that well.

With Clarivate, which was acquired in 2016, we spent the first full 2 years of our ownership, beefing up the management team and working to successfully carve the company out of Thomson Reuters. We also began the process of enhancing the organization's commercial capabilities by investing in its well-known products and streamlining its cost structure. In addition to that, we completed 3 tuck-in acquisitions and divested 1 division.

At SIG, our thesis in buying it was based on working with the management to implement and secure cost savings and to improve the effectiveness in particular of its sales force. This is exactly what we focused on through the first 3.5 years of our ownership. We also accelerated growth through geographic expansion and worked to invest in and innovate the company's portfolio.

Within the last year or so each company has gone public and has returned to us a significant amount of capital. We've realized about half of our initial investment in Clarivate and more than 70% of our investment in SIG in the form of secondary offerings.

Based on closing prices at September 30 and including realizations to date, our investments are each valued both of these companies at more than 2x our cost. We're really happy with these outcomes.

We remain the largest shareholders of Clarivate and SIG and hold about $1.4 billion of public market shares in these companies combined. We're excited to work with management of these companies on their respective growth trajectories.

Let me now look at the investing side. We've deployed $155 million of capital in our private equity platform this year. And that, of course, doesn't include Onex V -- Onex Partners V's pending acquisition of WestJet Airlines.

ONCAP completed its eighth investment with the acquisition of the International Language Academy of Canada, known as ILAC, which is the largest provider of English language training in Canada.

Let me move on now from private equity to our credit platform. At the credit platform, we currently manage approximately $12 billion of capital. This is an increase of approximately 14% in the first 3 quarters of 2019.

In the third quarter, we closed our 17th U.S. CLO and started warehouses for our next U.S. and European vehicles. Conditions though, for new CLOs have been challenging. Funding costs have been moving higher, while credit spreads for the loans that we like to invest in have remained constant. We are taking our time finding the right assets that meet our risk-return profile, but slowly but surely, we're building up these warehouses for new CLOs.

We're focused on growing our credit team. More specifically, we're building out our origination capabilities for our private debt platform. We have 2 new people who joined us last month, and that brings the origination team to 5, and we expect to add a couple more people to round out our expertise in the next few months.

I'll now provide an update on our wealth management platform, Gluskin Sheff. Having completed our first full quarter of ownership, not very much, I'm happy to say the outflows we saw in the first half of the year have slowed significantly.

Client capital under management is up 1% for the quarter with investment performance offsetting a modest net outflow. We've begun to introduce senior debt from Onex Credit through the Gluskin clients. And thus far, we've got -- we've received a really nice reception, and they've invested a significant amount of money.

We've also begun to expand our wealth planning services. We have 2 new team members joining us and expect several more hires in the coming months. The reason for this is that thoughtful planning and onboarding of new clients is an important value-added service for Gluskin clients. As well, we're just beginning the integration of Gluskin and Onex support functions. We'll have more to talk about on that in the coming quarters.

So to wrap up, we've had a good quarter of monetization activity. We continue to have a strong balance sheet with about $1.6 billion of cash and near cash, and have more than $5 billion of committed uncalled third-party capital available to deploy in new private equity investments. We've also been laying the building blocks to support growth and to build value within our credit and wealth management platforms.

One last comment. One of the cultural facets of Onex is our team's alignment and personal investment in everything we do. Today, our team is $1.9 billion invested across our private equity platform, Onex Credit, Gluskin products and Onex shares. We all share in the risks and hopefully, the rewards of our business. And together, we're focused on one thing, and that is growing shareholder value. Let me now turn the call over to Chris.

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Christopher A. Govan, Onex Corporation - CFO [4]

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Thanks, Gerry, and good morning, everyone. Onex reported net earnings of $100 million or $0.99 per share in Q3. As I've noted in prior quarters, my focus during these calls will be on segment earnings, which we believe best reflect Onex' results.

Onex' segment earnings are computed before deducting stock-based compensation and the amortization of intangibles and most of our PP&E. We've defined 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.

Q3 segment earnings were $131 million or $1.27 per share. As has been the case in every quarter this year, Q3 segment earnings were driven by the investing segment which contributed $1.26 per share.

Onex continues to have the vast majority of its investing capital at work in private equity. So investing segment earnings will typically depend on the performance of our private equity funds. A 4% gross return from Onex' private equity portfolio in Q3 resulted in $146 million of net investment income. The returns were primarily generated in Onex Partners IV which contributed a gross value increase of $235 million.

Q3 is a continuation of a solid year for Onex private equity, with a gross return of 15% in 9 months. The private equity gains in the quarter were partially offset by net losses on our credit investments of $18 million. Most of this is attributable to mark-to-market losses on CLO equity, which was negatively impacted by a somewhat weaker quarter for the broader loan market and lower demand for structured credit.

But as those of you who were at our Investor Day last month know, we focus on our CLO platform's cash flow, not mark-to-market fluctuations in the value of the investments. And on that basis, Q3 was another steady quarter for the CLO platform. $21 million of regular quarterly distributions and $11 million of management fees, so $32 million of gross cash in the quarter on a little less than $500 million of invested capital.

This next schedule details Onex' shareholder capital at quarter end and provides Q2 and year-end amounts for comparison. As you can see, there's not been any fundamental shifts in Onex' capital allocation. However, exposure to private equity did decrease in Q3 to just over $3.9 billion, mainly due to $540 million of realizations, including the sale of Jack's and the Clarivate and SIG secondaries, which Gerry discussed earlier. These distributions from the funds were partially offset by net value increases primarily in OP IV.

Looking near the bottom of the schedule, you'll note that the total investing capital has only slightly increased from the hard NAV we reported at year-end. However, as I noted last quarter and at Investor Day, there are some onetime items that are making strong year-to-date investing results a little hidden. Once you make the necessary onetime adjustments, the change in investing capital is principally the result of our year-to-date investing segment earnings, $596 million or $5.79 per share, which represents a 10% return year-to-date, a strong 9 months.

With that, I'll move on to the asset and wealth management segment, which generated net earnings of $1 million or $0.01 per share in Q3. The private equity asset manager incurred a net loss of $1 million in Q3, down from a net contribution of $17 million in the prior quarter. This decrease was the result of a $17 million reversal of mark-to-market carried interest due to net decreases in the value of Onex Partners III. Since we're not yet accruing carried interest on Onex Partners IV, the net increases in that fund's portfolio did not generate carry to offset the carry reversal from Fund III.

The other item of note in the quarter is a $9 million contribution from wealth management. The first full quarter following our acquisition of Gluskin Sheff on June 1. Gluskin Sheff added run rate management fees of about $72 million, bringing the segment's annual run rate management fees to $328 million.

As Seth laid out in his Investor Day presentation, based on these run rate fees and a normalized level of private equity carried interest, the prospective annual contribution from our asset and wealth management segment is about $135 million, and we're working to grow that going forward.

That completes my comments on the quarterly results. We'd now be happy to take any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Nik Priebe with BMO Capital Markets.

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Nikolaus Priebe, BMO Capital Markets Equity Research - Analyst [2]

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I wanted to start with a pair of questions on 2 of the operating companies. I'll start with Parkdean. I noticed there was another sequential improvement in their earnings on a quarter-over-quarter basis. Is the inference there that the company had kind of experienced a better peak summer season with respect to bookings and occupancy? Or is there anything else that's driving that performance maybe on the expense side that we should be aware of?

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Robert M. Le Blanc, Onex Corporation - Senior MD [3]

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Yes, it was a little -- it's Bobby. It was a little bit of both. We had -- we did have better bookings in the summer, and we had better on park spend, and Steve Richards, the new CEO, has implemented some cost saves. So we have had nice year-over-year growth, and we hope to see that same type of growth in 2020 as that business seems to be on a better track.

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Nikolaus Priebe, BMO Capital Markets Equity Research - Analyst [4]

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Okay. Great. Got it. And then another thing that stood out to me was there was a pretty sizable decline in the net debt position of Carestream Health on their balance sheet. It just struck me as a better sequential improvement than I would have expected the quarterly cash flow to contribute organically. So I don't know if it was just something as trivial as some favorable working capital changes. But I was wondering if you could just shed a little light there on the improvement in (multiple speakers).

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Robert M. Le Blanc, Onex Corporation - Senior MD [5]

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Yes. We had an asset sale of a division of our medical digital business, and those proceeds were used to pay down debt.

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Nikolaus Priebe, BMO Capital Markets Equity Research - Analyst [6]

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Got it. Got it. Okay. And then last one from me. Just as we're approaching year-end here, it's clearly been a very strong year for equity and credit markets. I was just wondering if you're starting to get better visibility into the performance fee potential for Gluskin Sheff, just given that a lot of those fees are mostly crystallized at year-end.

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Gerald Wilfred Schwartz, Onex Corporation - Founder, Chairman, President & CEO [7]

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Yes. I don't think we'll be commenting on performance fees until we see them. They're driven by public markets, and public markets can go up and down at a moment's notice. So we'll consider them in the bank when they're in the bank.

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Operator [8]

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(Operator Instructions) And we have a question from Paul Holden with CIBC.

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Paul David Holden, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [9]

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Just have a couple of questions based on some comments that Chris Govan made. I guess the first one is related to lower demand for structured credit. Maybe you can just expand on that point. And what's driving lower demand for structured credit?

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Christopher A. Govan, Onex Corporation - CFO [10]

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Yes. It's obviously Chris speaking in response, Paul. I don't think there was anything fundamentally changing in the market. It was more of a marginal change, I think, in terms of people's risk appetite for structured credit, which had the CLO slightly underperform what you would have expected, if you simply extrapolated the performance of the broader loan index.

So I don't think there's anything significant afoot there, but there was just a, sort of a slight change, I'll say, in the relative yields that people are demanding from structured credit versus more traditional or higher-rated credit.

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Paul David Holden, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [11]

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Got it. So it's not structural. And your take on it is it's marginal versus significant in terms of the risk pricing for this asset category?

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Christopher A. Govan, Onex Corporation - CFO [12]

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Yes, that's right because -- just to put it in context, I think the CS Leveraged Loan Index was up like on an annualized basis, kind of in the 3% or 4% range in the quarter. But as you know, that class yields 5% or 6% or more.

So although it was up, it was actually up less than it yielded, which really means that pricing was off a bit. So you should expect that the CLOs were off a bit on a mark-to-market basis, and that was just a bit more than you would have expected because of the other issue.

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Paul David Holden, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [13]

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Got it. Okay. That's helpful. And then second question is related to the carried interest reversal in OP III. What was driving that?

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Christopher A. Govan, Onex Corporation - CFO [14]

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Yes. It's just mark-to-market, Paul. We're in a position where -- essentially, most of our carried interest that's accrued lies in OP III, whereas we're not yet accruing carry in OP IV. So we had nothing huge, but on an overall basis, there was a net mark-to-market write-down across the OP III portfolio in Q3, and that just flows through Onex' 8 points of carry on that fund, just flows through as a reversal of carry in the quarter.

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Paul David Holden, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [15]

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Sorry, and that's on publicly traded companies?

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Christopher A. Govan, Onex Corporation - CFO [16]

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Including publicly traded. Yes, yes.

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Paul David Holden, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [17]

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So was there some kind of markdown on non-publicly traded, the privately held?

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Christopher A. Govan, Onex Corporation - CFO [18]

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Yes. I think if you do the math, it's not all attributable to the public investments. So there were some relatively small write-downs in other parts of the portfolio. But as you know, we mark our portfolio to market every quarter. We don't have a rule of trying to keep things marked at the same level they were at the quarter before. We take a fresh look at everything each quarter, and so small fluctuations are going to happen across the portfolio every quarter.

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Paul David Holden, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [19]

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Sure. Got it. And then one final question from me, and this is more of a macro one, and I've probably asked this question 2 or 3 times in past calls, but going to ask it again. U.S.-China trade-related tariffs, potential for tariffs now maybe to get reversed. Can you remind us just what has been the impact, if any, from existing tariffs? And therefore, is there any potential benefit if tariffs are unwound here?

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Robert M. Le Blanc, Onex Corporation - Senior MD [20]

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I think Partner's perspective, the tariff issue has been relatively small. There would be a slight benefit for 1 or 2 of the businesses if that were to be resolved, but nothing meaningful. Anthony, on the ONCAP side?

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Anthony Munk, Onex Corporation - Senior MD [21]

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Yes. We have a few businesses with probably a concentration in ONCAP for where there is an impact from the tariffs. We've tried to mitigate the impact through price increases and cost reductions from vendors and value engineering of certain products. So we've done our best to try to offset that. To the extent that there's a reversal, that will be a benefit.

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Operator [22]

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(Operator Instructions) That concludes our question-and-answer session. I'll now turn the conference back to Gerry Schwartz.

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Gerald Wilfred Schwartz, Onex Corporation - Founder, Chairman, President & CEO [23]

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Thanks, everyone, for participating today. We appreciate your support. And as always, feel free to contact Emilie if you have any questions. We're looking forward to speaking with you, again, next quarter. And in the meantime, enjoy this absolutely gorgeous Toronto fall day.

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Operator [24]

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