Onex Beats P-E Peers Focusing on Capital Boost

Onex Corp., Canada’s largest buyout firm, hardly looks on paper like a company whose total return to shareholders would dramatically outperform its peers.

The Toronto-based private equity firm hasn’t reported net income since 2011 and has had a negative return on assets each year since then, according to data compiled by Bloomberg. Yet the company, led by founder and Chief Executive Officer Gerry Schwartz, has returned 161 percent to shareholders over the past five years, compared with a 69 percent gain in the S&P Listed Private Equity Index.

There’s a simple explanation for Onex’s outperformance, said Scott Chan, an analyst at Canaccord Genuity Corp. in Toronto.

“No one looks at the financials,” he said in an interview. Investors are more impressed by Onex’s ability to boost capital, and to buy and sell companies, he said.

In the U.S., investors in private equity firms like KKR & Co. LP, Carlyle Group LP and Blackstone Group LP tend to be more focused on quarterly returns. In Canada, a longer-term view is adopted. Investors remain confident Onex will be able to deploy about $3.8 billion in cash on its books as of Dec. 31 as a dry spell for acquisitions appears to be coming to an end.

“You’re betting on the investment team,” said Chan. “You’re betting on their investment process. You’re betting that they can drive added value to their investments over a five- or seven-year period and be able to sell it at a much higher valuation.”

Boosted Capital

Chan rates the stock a buy with a price target of C$82. The company has one other buy, four holds and one sell with an average target price of C$78, according to analyst ratings compiled by Bloomberg, after reaching a record of C$74.25 last month. The shares closed Wednesday little changed at C$72.25.

Onex has boosted invested capital by 63 percent since 2010 to more than $6 billion as of Dec. 31. Together with its partners, it has about $21 billion of assets under management, up 50 percent since 2010, according to company documents.

Because Onex owns more than 50 percent of the companies it’s invested in, it has to report earnings on a consolidated basis with them, Chan said. As a result, the profit and loss income statement is a poor reflection of what Onex actually does - buys businesses, fixes them up, and sells them for a higher price - and quarter-over-quarter earnings mean little, he said.

Dividend Difference

Investors in the U.S. view private equity firms, like Carlyle, KKR, and Blackstone, a little differently and tend to focus more on economic net income per share, according to Kenneth Hill, a New York-based analyst with Barclays Plc. As such, their shares react to earnings. Economic net income includes both realized and unrealized gains.

“It does swing around and people do follow it,” Hill said by phone. “It really just depends on what the focus is in the market right now and how much fear there is versus how much optimism. It’s not always logical.”

Another difference between Onex and U.S.-based private equity firms are the dividends paid. Onex has a dividend yield of 0.3 percent compared with 8.3 percent for KKR, 5.5 percent for Blackstone and 7.7 percent for Carlyle, according to data compiled by Bloomberg.

The main measurement for investors evaluating Onex is its ability to reach its target of growing capital per share by 15 percent annually, said Tim Caulfield, a Calgary-based portfolio manager at Franklin Bissett Investment Management, who helps oversee about $7 billion including shares in Onex.

Significant Value

“What you’re effectively doing is recycling capital over a fairly long period of time with the idea that you’re selling the investments you’ve made, after you’ve added a significant amount of value, for a much higher price,” he said by phone.

Since its inception in 1984, Onex has invested in almost 80 companies, completed more than 480 acquisitions by itself and the companies it invests in, and recorded losses on just six of those investments, said Emma Thompson, an Onex spokeswoman.

Onex’s investment in Spirit AeroSystems, the aerospace components manufacturer it bought from Boeing in 2005, produced an internal rate of return in excess of 200 percent. Onex and its partners increased their original investment of $375 million to $3.2 billion when the final stake was sold last year. Onex’s share of that investment grew to $979 million from $108 million.

The company’s $527 million acquisition of Hawker Beechcraft in 2007 was one of its rare losses. The Wichita-based business jet maker filed for bankruptcy protection in 2012 after a precipitous decline in executive jet sales in the fallout from the economic downturn.

Cash Position

Onex’s shares have benefited from divestitures in 2014 that have demonstrated its ability to return capital. Onex had a record $6.1 billion in divestitures last year, leaving about $3.8 billion in cash on its books as of Dec. 31.

That hefty cash position is now weighing on Onex’s ability to boost invested capital until it can be deployed, Caulfield of Franklin Bisset said. He said he wasn’t worried though.

“It’s not as easy to keep track of from one quarter to the next,” he said. “But what you do have is a very long-term track record of Onex being able to achieve very impressive IRRs,” he said, referring to internal rates of return.

After a dry spell for acquisitions in early 2014, Seth Mersky, Onex senior managing director, said last month that a clampdown by U.S. regulators on leveraged loans is making acquisitions easier. The expectations of potential targets are becoming more reasonable after a prolonged period of higher valuations due to easy access to credit, he said.

U.S. Economy

As a result, Onex has been able to make several acquisitions in recent months, including the $4.4 billion purchase of Swiss juice-box maker SIG Combibloc Group AG in November.

With the majority of Onex’s holdings in the U.S., the company has also benefited from its exposure to the strength of the U.S. economy, and the weaker Canadian dollar has contributed to foreign exchange gains as well, analysts said.

“We believe Onex has attractive value for long-term investors looking for exposure to a private equity firm with a strong long-term investment track record,” Geoffrey Kwan, RBC Capital Markets analyst said in a note to clients, forecasting net asset value growth of 10 percent over the next year.

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