Onex Corporation (ONEX) Earnings Call Transcript & Summary

Before we get started, I'm going to ask you to direct your attention to important disclosures on the Morgan Stanley research disclosure website/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Good morning. Welcome back to the Morgan Stanley Financials Conference. I'm Peter Kaloostian, Vice President on the brokers, asset managers and exchanges team from Morgan Stanley Research. Welcome to our fireside chat with Onex. We're excited to have with us today, Chris Govan, Onex' CFO. Chris joined Onex in 1998 and was appointed to the CFO role in 2015. Onex manages and invest capital primarily across its private equity and credit platforms on behalf of its own shareholders, institutional investors and high net worth clients from around the world. Onex has approximately $45 billion in assets under management, of which $7.2 billion is its own investing capital. Chris, thanks for joining us today. I'm going to kick off a discussion with some questions and leave time at the end for investors to make questions via the web portal.

So this may be the first look at Onex for a number of our participants. Kind of with that in mind, I thought it might be helpful if you start off by walking through what drives Onex' earnings? And how Onex is differentiated from other publicly traded alternative asset managers?

Sure. And first, Peter, let me say thank you to you and Morgan Stanley for the opportunity. Really happy to be here. And hopefully you're right, hopefully we're getting to meet virtually a lot of new potential shareholders. So thanks for that. Yes, maybe where I'll start with that in mind is just a little history, right? So Onex was founded in 1984 and went public in 1987. It's a global alternative asset manager, as you mentioned $45 billion of AUM across our platforms. We are headquartered in Toronto and listed on the TSX, but we have significant teams in New York, New Jersey, Boston and London. And so really, the vast majority of our investing activity is in the U.S. And in fact, we report in U.S. dollars. So just a little bit of cover there. And although we've been around since 1984, for more than 15 years, we really were focused on investing our own capital off of our balance sheet purely in private equity. And really only began to build out our asset manager really in the last few years around credit, where we already had a nice CLO business but are building out beyond that. And then most recently, our acquisition of a wealth management platform here in Canada in Gluskin Sheff. So although we've been around a long time, I think the asset management story is relatively new and growing. And we do look at our results and how we drive value in those 2 buckets, investing and then asset management. As you mentioned, on the investing front, we have about $7.2 billion of shareholder capital or investing capital on our balance sheet. That's principally invested in our private equity platforms. And at March 31, about 75% of that was invested in private equity with the balance kind of split between credit products and cash. And so when you kind of think about our investing returns, it's really going to be driven by our private equity platform, which has performed really well through the pandemic. Although everyone was nervous, I'm sure with their portfolios back in April of last year. When we kind of look back over the 15 months, our returns across private equity back to December 2019 have been strong. And in fact, our overall growth in investing capital per share was just shy of 30% as a result over those 15 months. And so we're really happy with how we've exited, hopefully exited this pandemic phase. And think we're really well positioned to deliver growth and returns going forward on the investing side. Although, obviously, with that exposure to private equity, quarter-to-quarter, our results are going to be impacted by the underlying equity and credit markets for sure. On the asset management side, ignoring Onex's capital, we've got about $31 billion of fee-generating AUM. And we like that business for all the same reasons, other alternative asset managers like that business. We believe there's very strong underlying trends in terms of increasing allocations and relative stickiness of commitments and relationships. However, as I sort of alluded to, we're in the fairly early innings, I think, of building out our asset manager. And I think we've got a lot of runway to continue to do that in private equity, credit and then over time, other asset classes. And I think that playbook, if you will, fairly well trodden. And I think we have a right to succeed. I think we got the track record, the reputation and the existing relationships with the LP community to execute on that. And that's really what Bobby has been focused on since his appointment to President late last summer, where we're focused on integrating our businesses across all our platforms, most importantly and obviously on the fundraising side. He's bringing operational expertise to our private equity investing. Most recently, the addition of Wes Pringle. And then Onex Credit is in the market, raising capital across several strategies to really build its AUM to match and more than doubling of the size of the team over the last year. And I think we've got the culture and the HR building blocks to succeed at that. So big picture, I've never -- I'm at Onex for 23 years, I think, as you indirectly mentioned and -- but I've really never been more excited about the future that we've got ahead of us.

And Onex shares have been trading at a significant discount to NAV. That gap is starting to close, but it appears the market is still missing something. How do you think about the value proposition in Onex stock today?

Yes. I think 2 things. I do think there's an immediate value opportunity, right? When you step back and you just look at what I usually refer to as our hard NAV, so just our investing capital ignoring any value for our asset managers. That was at March 31, just shy of CAD 100 a share, I think it was CAD 98.50 per share. And given where our stocks trading, like that's about a 13% discount to that hard NAV, again, before any value for our asset manager. And so again, I think there's an immediate value opportunity there to be captured. And as I said, I think we're well positioned to continue to grow that number, particularly given that we're sort of at a bit of a cyclical high in terms of having 87% of that capital currently in the ground and at work. So on a relative basis, a lighter cash drag than the often have. The other element of it is, I -- as I think, I said earlier, I think shareholders today are really entering at the fairly early innings of this game of us building out our asset manager. We've got some immediate and obvious opportunities. ONCAP IV, which is the current active fund for our mid-cap platform. It's right around 75% invested, Onex Partners V, which is the active fund for our large cap platform is now, I think, over 60% invested and committed. And so when I kind of look at 18 months, I see fundraises in private equity that are going to create that kind of step function in terms of AUM and fees that are going to be additive in terms of value to our asset manager. And then as I mentioned, we've got 3 or more strategies at credit, where there are new strategies for our credit business at Onex, but we're raising those around teens and individuals who brought track records with them to Onex. And we see a real -- an obvious path forward to build out meaningful from a management fee and carry generating AUM credit business and return that business to the margins that we used to have by 2023. You're buying in today at a depressed earnings level because of some OpEx -- significant OpEx that we've put into the business to grow it. And then lastly, I think we've got positive momentum at Gluskin Sheff, our wealth management platform. We've turned that net sales around to positive and really, for sure, demonstrated that the demand from those clients with alternative products. We placed over $1 billion of alternative products into that client base in the last year and a bit. So there's a lot to execute on in the next 18 months, but I think a really big opportunity for shareholders and for Onex on the asset manager side. Now I think the key to that is to make sure that gets captured in the value of our stock. And I think Jill Homenuk, who joined us to head up shareholder relations late last year has made a real difference in that regard. And I think here we started to provide a more transparent disclosure, some guidance and milestones that shareholders can track and measure us by. And we're going to continue that over the course of this year, including the important our Investor Day on September 30. And then add to that is just rolling up our sleeves and doing more of these meetings to really try to get the word out and have more buyers and sellers.

And your recent Q1 results showed the third quarter in a row with good momentum with continued improvements in fund performance and NAV growth. You've also been pretty active so far in 2Q, including a few announced private equity transactions. How do you think about the year that Onex has had so far?

Yes. We're off to a great start. We're really happy with the start to the year. Our earnings and in particular, our investing capital per share has grown nicely. It was up 7% in the quarter. As I mentioned, that's up 26% going back to the end of 2019. And I think we're really well positioned with companies that really came through the pandemic as a whole as a portfolio very nicely. And so we're well positioned to grow going forward, including maybe taking advantage of some weaker competitors that have not done as well during the same cycle. On the private equity side, very active start to the year in terms of putting capital to work in opportunities that sort of right in our wheelhouse, very much squaring upward with the 4 industries that we focus on. We've already, I think, committed over to work $1.9 billion this year versus $2.5 billion and all of 2020. Realizations have not been as significant. And that's one thing, if I was telling you, I had a crystal ball, I'd say at the back half of the year may very well be much more active in that regard. If you just sort of think about private equity, and we're typically sellers, only when we can be sellers, we only want to be selling in strong markets in good markets that support high valuations. So there is a bit of a backlog, if you will, of businesses that we own, where we've executed on a substantial part of our investment thesis and are ready to sell them. And obviously, we've got very good capital markets to support those sales. So if I had a guess, I think realization activity in private equity will catch up with investment activity in the back half of the year. Credit, the big news in credit is on the fundraising front. And what we're trying to accomplish there. We more than doubled the size of that team, starting with Jason New and then attracted a lot of talents around him. And then, in fact, made a strategic acquisition with Falcon late last year. And really the next 18 months is about raising the AUM to go with that cost base and get us back to kind of the 40% margins we think that business should generate. We've got good momentum. It's -- all of these fundraisers are kind of new funds, as I mentioned. So it takes a little longer to get them done. I think we'll have much better visibility on truly how we're doing. Kind of later in the year, but positive signs so far. Yes. So overall, we're really happy with the start and expecting positive through the back half as well.

A few years ago, your large-cap platform, Onex Partners, narrated its focus to 4 core industry verticals. What drove that decision? And how has that impacted your business?

Yes. So I think a couple of things drew on it. One was the market generally. One of the long-term trends in private equity has been what I would say is the slow evolution of what was very entrepreneurial, very much a cottage industry 23 years ago into something that's more institutionalized. And as that has happened, I think the competition for investment opportunities. And the processes surrounding them have become much more concentrated, short time lines and very focused. And so I think one of the reasons to focus our industry coverage was to ensure that our teams were being positioned to be ahead of the curve. So that when new opportunities were coming to market, we were already knee-deep in -- outside-in research and building relationships and knowing which of those opportunities we really wanted to go hard on and focus on. And I think that the secondary factor was we had a period there with Onex Partners for kind of 2018 where we underperformed, we had a couple of capital impairments in that fund. And we undertook a strategic review of our Onex Partners platform as a business. And one of the things that came out of that review and the data was around the success rate and the benefit of concentrating in what are really our historic industries. And that really just married up where I think the market was sort of already pushing us, which was to become more focused and more nimble in terms of responding to opportunities. And I think it's worked out well, by the way. I think we've had -- we're off to a great start in Onex Partners V, both in terms of early returns. Those are early returns, the funds only about 50% invested, but also pace of investment. So far so good, and I think we're all very happy with change.

And can you talk about some key learnings with respect to how your investments performed through the pandemic? Anything that you'd like to point to that drove the portfolios relatively good performance?

Sure. Yes, I think, I guess one of the learnings is the diversity helps, right? I do think that having, I think, whatever it is close to 40 companies across our large cap and mid-market private equity funds does position you to withstand those types of shocks better than having a concentrated portfolio. And so there's certainly an advantage there. I think as well, and I sort of alluded to this earlier, I also do think it's a testament to one of the just features of private equity that makes it a good place to invest. And that's having control and accepting in the most dire of circumstances never being forced to settle. You've got the opportunity to work with management and navigate those types of situations so that you come up the other end still fighting and still with the opportunity to execute on your thesis. When I think about our portfolio, the one thing I sort of typically comment on is how fortunate we were with a couple of investments that were directly exposed in terms of Emerald Expositions and Parkdean Resorts. One's a business-to-business trade show business and the others a caravan resort business in U.K., both right in the crosshairs. On those 2 we -- good solid businesses that we know and love, but we also got a little lucky in that we -- both those businesses also had pandemic-specific insurance. Very rare, but -- so we also had some good fortune come our way in terms of supporting some of our businesses that were most adversely affected. And I think that's one of the key contributors to the overall performance of, I'll call it, that pocket of our investments.

And 2020 seems like an important year for Onex' Credit platform. Can you provide a bit of history on Onex Credit, the recent build-out of the platform and what you're most focused on looking forward?

Sure. Yes. So I think for a number of years, we first invested in Onex Credit in 2007. But that was obviously ill-timed given the financial crisis of '08, '09. So the business kind of did go sideways for a handful of years. We got refocused on it in partnership with Mike Gelblat and Paul Travers, built out a really good CLO business over 5 or 6 years leading up to 2019. And had real success there in terms of raising capital and providing Onex, I think, an attractive opportunity. I think collectively, we saw an opportunity. And there's lots of examples out there, an opportunity to build a much broader and larger credit business. As I said, I think there's dozens of firms. There are many multiples the size of our credit franchise. And so we proactively, but focused on doing that. And we brought on Jason New to really head up that fund -- that platform, excuse me. And Jason attracted a ton of great talent around him. And so we positioned ourselves, I think, with new talent, both in sort of distressed and opportunistic credit and structured credit, all of which align strategically, really well, I think with our existing senior credit CLO business and sort of at the other end of the spectrum with our private equity business. And then late last year, we made a strategic acquisition in Falcon where we bought a great franchise, particularly sort of, I'll say, in the mezzanine debt space. But what we also bought was some origination capabilities that come out of that mezzanine investing that we saw as critical to help us build out a direct lending arm within credit. We had tried to do that in-house. Came to the realization after a 1 year or 2 that it was going to take a lot longer and cost a lot more than we originally thought to build it on our own. And went the route of really sort of buying, if you will, those capabilities in Falcon. So today, as I said, if you look at the profitability of our credit manager, it's hovering sort of just above breakeven, but that's the result of a ton of investing in OpEx that's really positioning us to add 25% to 20% fee generated AUM over the next couple of years each and every year and get ourselves back to what we would think of as acceptable margins for those businesses on a much higher base of fees and importantly, with a large portion of that new capital also subject to a carried interest opportunity that Onex retains 50% of. So as I think I said earlier, there's a lot of work to be done there by Jason and his team and Jessica Brennan our team at fundraising inside the house. But we're really excited by it. And as I said, I think there's -- it's not -- we're not trailblazing, there's a playbook here, and we think we've got the talent, the track record, the resources to do it. So it's going to be an execution story for the next 18 months.

And I just hope you can talk about how your Gluskin Sheff platform adds strategic value for Onex. Do you see the benefits more with the product development side or through your distribution network and capabilities?

Yes. So that's a good question. I would say, primarily, we would see it out on the distribution side. And I think about that as being twofold. One, it absolutely provides a new avenue for us to distribute alternative assets, particularly in the Canadian marketplace. And as I said, there's been a real appetite from that client base already for that product with over $1 billion placed on what was a 7-or-so billion platform to begin with across all the strategies that you can manage. But importantly, the other side of that is we think that exposure to alternative assets is very beneficial for that client base. Which in a Canadian context, is a bit starved for it. It's not as easily accessible as you'd see in the U.S. in wealth management platforms. And so we think the clients are really well served by getting access to that, and that's going to create, we think, deeper and stronger relationships with Gluskin Sheff, and I'll call it its core wealth management platform. On the product side, I mean the other, I'll say, hidden gem within Gluskin Sheff would be the Blair Franklin fund runed by Peter Zaltz. And where we think that has, we believe, real legs in terms of being able to attract meaningful capital outside the Gluskin Sheff wealth management client base. It already has some meaningful capital from, I'll call it, product investors, institutional investors, but we think that's sort of a bit of an untapped opportunity and one where we can leverage Onex' institutional sales force to create additional value. So it's a bit of both, but it was primarily really that distribution aspect of it.

And I'm getting some audience questions. And I know you hit on this a bit earlier, but can you talk about the fundraising trajectory for the firm?

Sure. And it's difficult to go into too many details here, as everyone knows, we're subject to certain limitations with private placements. But I think on the private equity front, there's some real clear and obvious short-term visibility there. We got ONCAP IV, which is $1 billion, call it, just over $1 billion U.S. fund today at about 75% invested. And ONCAP just has a tremendous track record, going back to, I think, 1999 and across 4 funds, they've yet to have any capital impairments across any of their investments. So just a terrific track record and a great team. And honestly, the opportunity to raise capital there and the size of that fund is really more limited by what we believe is prudent for the space and the team to invest over an appropriate time frame. So we're very excited about that next fundraise and feel very confident about where we stand there. Onex Partners V, so currently a $7.2 billion fund, just over 60% committed. That would be a fundraise you'd expect more kind of in the back half of next year or middle of next year. And again, I think we're extremely well positioned to go to market there. As I mentioned, it is -- it continues to be sort of a GP market with some really good tailwinds in the market generally. And we've had some really strong recent performance in Onex Partners IV. So our immediately preceding fund, which is really important to the fundraise for Onex Partners VI because that funds lot more mature than Onex Partner V, and it's performed really well over the last 2.5 years which is -- has really increased, I think, everybody's confidence about where Onex Partners VI is going to go. And as I said, Vs off to a great start. So we're feeling very confident about our ability to go out and raise the right amount of capital for that platform as well. Yes. And then credit, a lot going on. And really, the short story there is, as I said, kind of 25% or 30% this year, 20%, 25% next year in fee-generating AUM increases. Some coming from the -- most of it coming from those new strategies, some of it coming from our existing CLO business and really putting credit in a position where on a run rate basis, in 2023, we get the business back to 40% margins, but probably of more than doubling the underlying base of revenue. So that's -- I think those are things to look for. And I think it's -- at least in my time with Onex, it's the busiest 18 months I look forward to from a fundraising perspective. And hopefully, we'll be sharing successes with you as we go.

And cash as a percentage of NAV was at 13% as of Q1, which is the lowest level in recent history. How do you think about overall cash management? Is there a minimum cash balance you need in order to fund your investments and to continue to buy back stock?

Yes. So cash is at a sort of a cyclical low, if you will at 13%. I think one thing for shareholders to keep in mind is that as an investor who makes significant commitments to our private equity funds, cash is necessary -- liquidity is necessary because you can all manage or predict either pace of realizations or pace of investing. So as long as this is our business model, there's going to be a meaningful amount of cash on our balance sheet. I think as much as the percentage, it's also important to realize that at 13%, that's still close to $1 billion of cash, which is very significant liquidity and positions us more than comfortably to meet our commitments to our existing investments for the foreseeable future. There's really no concern there. As I said, I think we'd all be quite optimistic that the back half of the year will probably be one where realizations start to catch up with asset acquisitions. On the stock buyback, it's always a bit of a two-factor equation for us. One is just where the stock is trading? And then where our liquidity is at and what are our other investment opportunities and commitments, right? So we're always balancing those 2. Last year, I kind of think about both of those as being flashing green lights, right? We bought back a lot of stock last year. The stock was trading -- we bought at extremely depressed bundles. And we had strong liquidity. And so we took advantage of that, and we're going to be happy to do so. At the valuation of our stocks at today, I'd say that's still a flashing green light. We're still interested in buying back our stock. But I do think relative to the pace that we're buying back last year, I think until you see some of that realization activity, increasing our cash balance, it will be at a much smaller pace than what you saw last year. So we're just always kind of balancing those 2 things. And -- but for sure, our stock is trading at a discount to just the pure hard NAV setting aside our manager and knowing that we know those businesses far better than any new acquisition we're going to make. It's a really attractive investment opportunity, I think, for the company and the shareholders that stay in.

And just changing gears a bit. Onex announced a new Head of ESG last week, which is a new position for the firm. How has Onex approached ESG to date? And how do you expect this to look like going forward?

Yes. Yes. We're really excited by Judy joining the firm. I think she's going to be a terrific addition and more importantly working for -- so I think backing up, I think we'd always start by saying we think we've always been a responsible investor. We think we've always thought about ESG issues as part of underwriting our investment and our thesis and our exit rate. I think what we believe we can do better is take a more systematic and continuous approach to ESG across our portfolio. And I'm sort of focused at the moment on our private equity portfolio, but it applies more broadly than that. And I think that's, in our mind, super important as a private equity investor because we just think it positions us and our investors to maximize value on exit, right? If you can minimize or reduce ESG issues or even more importantly, create value through managing those aspects of the business, it's just a smart thing to do. But I think what we're going to bring to is a lot more rigor. Hand-in-hand with that rigor, there's a bit of a pull here. You won't be surprised to hear from some of our stakeholders with limited partners and shareholders wanting more reporting, more transparency, a better understanding of how we manage ESG issues and what exposure they have through our existing portfolio. And that will be the other, I'll call it, half of the job, I'm sure it won't be 50-50. But the other half of it, which I think is a real benefit is really responding to those other stakeholders requests. And I think positioning us, therefore, to be a more attractive partner and have better success on the fundraising trail.

Great. We're nearing up on time here. So Chris, with your final comments, what are some of the areas that Onex has strategically focused on for the remainder of 2021 and 2022?

Yes. We've touched on a lot of it. I think the other things I would probably talk about are in the employee engagement area. And I'd kind of put it under this umbrella of sort of a 1 Onex, which has been a key priority for Bobby. As we've really begun to integrate all of our businesses more fully looking to take advantage of the synergies and opportunities that come across those platforms. One of our focuses have been making sure that our culture is the same and consistent across all those platforms and that we're doing just as good a job in every business and every group to attract, retain and really maximize the value of our talent. And so I think there's been a real push on the employee engagement front. That's become a firm-wide activity, both in terms of measuring and responding to those activities. And we've also have a -- had a real concerted effort around diversity and inclusion with the formation of a council co-chaired by Jill Homenuk and Bobby Le Blanc, which I think as a manager and leader, I just think is terrific. Anything we can do to make sure that we're getting access to the best talent and then making sure that once that talent is inside our 4 walls, when we eventually go back into the office, making sure that, that talent succeeds is terrific for the business and just makes every future manager's job easier. So I'd say other than the other stuff we've talked about, I think there's a lot going on in that HR front and talent management front. It's really critical to us executing on our plan.

Great. Well, I'm afraid we're out of time. Chris, thanks so much for joining us today.

No it was my pleasure, and again, thanks for having us.

Thanks.