ONEX

[giofranchi]

Onex is trading at Proprietary Capital per Share. It is always surprising to me that a company, whose stated goal is to increase Proprietary Capital per Share in excess of 15% per year (see the presentation), might actually trade at Proprietary Capital per Share. What am I missing here? Let’s see:

 

1) It might be that Onex is over-promising. But this certainly doesn’t seem to be the case: under the expert lead of Mr. Gerald W. Schwartz, its founder, Chairman, and CEO, Onex has produced a 29% IRR since inception in 1984. Now, take a look at slide n.20 of the presentation: usually, they are 75% invested and keep 25% in cash. A 29% IRR, therefore, generated a 22% yearly increase in Proprietary Capital per Share. So, they are actually under-promising, if compared to their historical track-record.

 

2) Ok, a track-record is not enough: it might have been just plain good luck (not very likely, because it is tough to be sustained only by luck for 28 years!), or it might be an obsolete way of doing business, one that cannot hope to replicate the same good results in the future. Well, this doesn’t seem to be the case either. Please, take a look at slide n.22 of the presentation: Proven and Sustainable Process, Disciplined Investing (Value mindset, Strong franchises) + Active Ownership. What’s not to like about it?

 

3) By now they might be working with too much capital. Proprietary Capital is $4.8 billion and AUM are $15 billion: while certainly not a small amount of money, it is comparable to the $24 billion portfolio of FFH, and it is not even close to what Mr. Buffett has to manage.

 

4) Maybe the outstanding manager who founded the company and made it grow is leaving soon, and so results will inevitably suffer. Mr. Schwartz is 71 and, even though no longer young, could certainly go on leading Onex for the next 10 years.

 

If someone knows Onex well and has followed this company for some time, I ask you again: what am I missing here? Why is the market giving me the opportunity to partner with Mr. Schwartz at Proprietary Value per Share, when there is much evidence of the fact that he will be able to make it grow at a rate that exceeds 15% per year long term? In other words, why is the market giving me the opportunity to lock in a 15% CAGR of my hypothetical investment in Onex for the foreseeable future (next 10 years)?

 

Thank you very much in advance.

 

Link to the presentation:

http://www.onex.com/Assets/Downloads/2012%20Onex%20Investor%20Day%20Presentation.pdf

 

giofranchi

[frog03]

I did not know the company but a quick glance at MSN reveals a very wild ride...

 

http://investing.money.msn.com/investments/key-ratios?symbol=ca%3aocx&page=TenYearSummary

[ubuy2wron]

It has been a wild ride and MR. Swartz has perhaps his snout too deeply in the trough for some tastes. He has  the most complex and rewarding compensation agreement on Bay Street. If you compare his compensation with Mr Buffets and Mr. Watsa,s you can see that they both offer vastly superiors terms on their partnership.

[giofranchi]

Of course, compensation might be an issue. But the 15% yearly increase in Proprietary Capital per Share surely is after fees.

At least judging from page 6 (short-term track record) and page 21 (long-term track record) of the presentation, results seem to have been quite consistent, if not predictable.

Anyway, I am just beginning to read and study about ONEX.

ubuy2wron, you seem to already know the company quite well: do you think it is worthwhile on my part spending some time to understand it better?

Thank you,

 

giofranchi

[FrankArabia]

i follow Onex.

 

they have done fabulously over last 12 months and they were quite undervalued at $33 not too long ago.

 

the major headwind for PE firms is that they're unable to offload some of these securities in what are still tough equity markets.

 

though I don't think its a major issue, I think some are concerned about how they are valuing some of the assets on the book.

 

 

 

 

[ap1234]

Gio,

 

I have been a shareholder in Onex for several years. The company has performed well (i.e. solid NAV/share growth) and the discount to intrinsic value has narrowed (i.e. multiple expansion) over time.

 

That said, before you dig a little further, I want to clarify a few of your points below:

 

1) Onex has not historically grown NAV/share by 22% as mentioned below. I think it's important to understand the history of the company. Prior to 2000, the company managed their own proprietary capital as opposed to 3rd party capital. As such, the company had no annual revenue stream (i.e. management fees and carried interest) to offset the costs of running the business (salaries, bonuses, travel, etc.). Prior to 2000, if Onex generated a  28% IRR on their investments (even if we assume they were 100% invested), the shareholders in Onex Corp. would not receieve a 28% return as a result of leakage (i.e. the shareholders paid for Gerry and his team's salary, bonuses, etc.). One of the issues facing investors is that the company has only recently provided disclosures regarding their growth in proprietary capital.

 

3) I do not think the comparison to Fairfax is that applicable. As you mentioned, Fairfax has a $24 billion investment portfolio. However, this is largely a public investment portfolio consisting of bonds and equities. With the exception of small positions in credit and real estate, Onex is a private equity investor and their investment universe is very different from Fairfax.

 

I think Onex is an interesting investment vehicle for long-term investors. You get exposure to a high quality P/E firm as well as a small but growing asset management business. In the long-term, the argument could be made that the company deserves to trade at a premium to their reported NAV/share if they can continue to deliver strong investment returns and the asset management business provides an additional source of value.

 

That said, there are many risks. As you noted, there are concerns surrounding succession planning. The P/E market has evolved and there is a lot of competition for deals (ex. Onex has recently been acquiring companies from other P/E firms). Size is an anchor on performance. Onex is growing their business in credit which has historically not been a core competency. The company's ability to fundraise is dependent on maintaining strong investment results, etc. 

 

In any case, I remain a long-term shareholder but I wanted to provide some additional background if you decide to do further analysis on the company.

 

AP

[giofranchi]

Gio,

 

I have been a shareholder in Onex for several years. The company has performed well (i.e. solid NAV/share growth) and the discount to intrinsic value has narrowed (i.e. multiple expansion) over time.

 

That said, before you dig a little further, I want to clarify a few of your points below:

 

1) Onex has not historically grown NAV/share by 22% as mentioned below. I think it's important to understand the history of the company. Prior to 2000, the company managed their own proprietary capital as opposed to 3rd party capital. As such, the company had no annual revenue stream (i.e. management fees and carried interest) to offset the costs of running the business (salaries, bonuses, travel, etc.). Prior to 2000, if Onex generated a  28% IRR on their investments (even if we assume they were 100% invested), the shareholders in Onex Corp. would not receieve a 28% return as a result of leakage (i.e. the shareholders paid for Gerry and his team's salary, bonuses, etc.). One of the issues facing investors is that the company has only recently provided disclosures regarding their growth in proprietary capital.

 

3) I do not think the comparison to Fairfax is that applicable. As you mentioned, Fairfax has a $24 billion investment portfolio. However, this is largely a public investment portfolio consisting of bonds and equities. With the exception of small positions in credit and real estate, Onex is a private equity investor and their investment universe is very different from Fairfax.

 

I think Onex is an interesting investment vehicle for long-term investors. You get exposure to a high quality P/E firm as well as a small but growing asset management business. In the long-term, the argument could be made that the company deserves to trade at a premium to their reported NAV/share if they can continue to deliver strong investment returns and the asset management business provides an additional source of value.

 

That said, there are many risks. As you noted, there are concerns surrounding succession planning. The P/E market has evolved and there is a lot of competition for deals (ex. Onex has recently been acquiring companies from other P/E firms). Size is an anchor on performance. Onex is growing their business in credit which has historically not been a core competency. The company's ability to fundraise is dependent on maintaining strong investment results, etc. 

 

In any case, I remain a long-term shareholder but I wanted to provide some additional background if you decide to do further analysis on the company.

 

AP

 

AP,

thank you very much and welcome to the board! This board is just great: when I don’t know something, and it happens very often, I only have to ask, and someone, who is much more knowledgeable than me, answers!!  :)

So, I will take advantage of it, and ask you some more questions:

 

1) Do you share Frank’s doubt that they might be reporting an inflated value of proprietary capital? Or do you think that management is honest and trustworthy?

 

2) From 1984 until 2000 proprietary capital showed a gross IRR of 27%: do you know what growth in NAV/share it translated into? I understand that salaries and bonuses might take away a big chunk, but it is hard for me to believe that, after achieving a 27% gross IRR, NAV/share hasn’t at least increased in between 15% and 20% annually… Am I being too naïve here? Could salaries and bonuses really amount to so much money?! ???

 

3) I understand that the comparison with FFH’s portfolio of investments might not be applicable. But what about Mr. Buffett? It has been many years now that he is much more interested in “big elephants” than the stock market. And he constantly looks for private businesses to purchase. Can we make the argument that, among private businesses, Onex’s universe is larger that Mr. Buffett’s (because they are dealing with much less capital), and therefore their task is easier?

 

4) Finally, on succession: has Mr. Schwartz ever communicated his plans to shareholders? Do you see him retiring soon? If that were the case, is there someone younger, who has already proven himself, and who could replace Mr. Schwartz at the helm of Onex?

 

Thank you again!

 

giofranchi

 

[no_free_lunch]

I don't know the company at all, just started researching them after reading your post.  The one thing that I noticed more or less off the bat is that while their long-term results are good, they haven't been performing well more recently.

 

http://www.onex.com/Onex_Share_Performance.aspx

 

If you look at their performance they slightly outperformed the S&P500 over the past 5 years (8% vs 5%), and underperformed over the last 10 (113 vs 116).  Their very high growth rate was the preceding decade.  It makes me wonder if they won't have yet another sub-par decade.  Now of course maybe they just had a bad decade and I'm being too short-sighted but a decade is a decent chunk of time.  It is also possible that the business has changed or maybe they have grown too large. 

 

I think it is this 113% over a decade (8% per year) that the market is pricing at.

[ap1234]

Gio,

 

I will try and touch on some of your questions below. I apologize in advance if this too lengthy of a reply but I hope the additional color will help in your analysis of the company.

 

1) On a quarterly basis, Onex provides disclosure of their invested capital along with a breakdown of their net asset value (NAV). Unlike GAAP book value, NAV is non-GAAP measure and there is no standardized approach to arriving at the figure. One of the potential concerns is that several of the businesses are privately held and as such are difficult for an outside investor to value. Onex does not provide “fair value” disclosures on the individual companies but rather a lump sum valuation for an entire fund (ex. Onex Partners III). As such, an outside investor is not aware if some companies have experienced permanent impairment whereas as other companies have increased materially in value (we only know that the entire private portfolio has appreciated by X% on a quarterly basis).

 

That said, there are a lot of reasons to believe that Onex is not reporting an inflated NAV. I have provided some of the reasons below:

 

1. The marks that Onex publishes to shareholders are the very same marks that Onex provides to their LPs on a private basis.

2. Onex has no incentive to overstate their valuations on a quarterly basis. The company generates carried interest upon the sale of an asset not on the quarterly valuations they provide.

3. Onex has a very sophisticated client base (LPs) that consists of pension funds and sovereign wealth funds. It is not in their interest to overstate the fair values from quarter to quarter as over time they would lose the integrity/trust of their client base.

5. When Onex sells an asset, it is typically well in excess of the mark that they were previously carrying it on their NAV calculation.

6. Onex does not disclose the valuation of the individual holdings because they would then have a hard time selling it for a higher price in the future. Why would another investor pay 1.25x for a company that Onex has stated they think is worth only X.

7. Onex has generated a 28% IRR on their realized sales since inception. This track record is based upon dispositions and not their internal fair value markings.

 

2) From 1984 until 2000 proprietary capital showed a gross IRR of 27%: do you know what growth in NAV/share it translated into?

 

Onex has never provided this information which I alluded to in my earlier post. That said, I have spoken with Onex management in the past and I believe they mentioned at the time there was approx. 11% leakage (ex. Onex generated 29% IRR and shareholders earned 18%) as a result of the cash drag + expense burden that shareholders previously paid for.

 

On a side note, I should caution that the 28% IRR that Onex reports is not the same as a typical mutual fund earning a 28% annualized return. Firstly, the 28% IRR is based upon investments that Onex has sold (i.e. does not incorporate unrealized gains/losses). Secondly, the company has a significant cash drag at the parent corp. level of 20-30%. Imagine if you ran a mutual fund and only reported performance of companies you sold and did not report the returns on the cash drag in your portfolio! I would hazard a guess taht your performance would look a lot better than your actual reported returns.

 

However, one of the most interesting aspects of the Onex investment thesis today is that the expense burden is no longer a drag on shareholder returns. Onex manages $2 of 3rd party capital for every $1 of internal capital. The fees from 3rd party capital more than offset the costs of running their internal capital. As such, if Onex generates a 15% IRR going forward, shareholders should actually receive in excess of 15% if we exclude the cash drag.

 

3) I understand that the comparison with FFH’s portfolio of investments might not be applicable. But what about Mr. Buffett?

 

Onex's investment universe and philosophy is quite different from Berkshire. They are both value-oriented investors with fantastic track records. However, Onex is a P/E investor with the focus on acquiring an assets, unlocking value and selling the business several years later. The company uses more leverage in their acquistions (although less than the typical P/E firm) than Buffett. The comparison is not clear as Buffett's business model is based upon leverage (a permanent source of leverage). When Buffett buys a company he is a passive investor (i.e. he doesn't advice management on how to run the business with the exception of capital allocation). Onex is an active investor who takes control of a business and brings about change (ex. cost cutting, etc.). When Buffett buys a private company, his holding period is forever. Onex has a fund life (typically 10 years) and needs to sell the companies and return the capital/profits to their LPs.

 

4) Finally, on succession: has Mr. Schwartz ever communicated his plans to shareholders? Do you see him retiring soon? If that were the case, is there someone younger, who has already proven himself, and who could replace Mr. Schwartz at the helm of Onex?

 

I believe that succession planning is a significant concern in any asset management business and in particular in the case of Onex. Very few asset management firms have successfully transitioned to the 2nd generation of employees. Gerry has had a profound influence on the company’s success in terms of investment performance, client relationships, culture, etc.

 

However, there are several mitigitants that make me feel more comfortable with successfion planning. Over time, the company has evolved as they have built out a diverse team of investment professionals which now consists of over 30 members and 8 Managing Directors. The management team behind Gerry is very strong. These are seasoned private equity professionals who have decades of experience and have been immersed in the Onex investment approach. The senior management team has been at Onex for an average of 16 years and collectively the team has over 166 years of experience in private equity investing. Of the eight managing directors, the most recent hire joined the firm in 2004. At the top level, the company has had extremely low turnover which is remarkable considering the competitveness of the industry. It is not clear who the heir apparent will be but some analysts have suggested that Seth Mersky or Bobby Leblanc are the most likely candidates.

 

In terms of business development, Onex will begin fundraising for a new flagship fund (Onex Partners IIII) in early 2013. The LP investors (pension funds, etc.) will be committing capital for a minimum of 10 years. These are sophisticated investors are willing to commit capital to another organization with the understanding that Gerry is likely not actively involved in Onex at the end of that period. Despite this, it appears that clients are still willing to give Onex their money as they believe in the philosophy, process and ability to generate above-average returns over the long-term.

 

It is impossible to quantify the impact on company culture if Gerry Schwartz leaves. However, I do get the sense that Onex is well prepared for that eventually and have made significant efforts to institutionalize both the investment process and culture to strive after he is gone. The experienced management team, low staff turnover and unique ownership structure and incentives should help Onex maintain their business even after Gerry leaves. I think it is safe to say that Gerry's influence on Onex is significantly less than Buffett's contribution to Berkshire.

 

I hope these answers help in your analysis.

 

AP

 

[Matson125]

Great post AP. 

 

You mentioned Bobby LeBlanc as the successor.  Reading his bio on the Onex site shows that he worked at Berkshire in the past and still sits on the board of an insurance sub.

 

Robert M. Le Blanc

 

Managing Director

 

Joined Onex: 1999

 

Industry focus: Healthcare, Financial Services

 

Since joining Onex, Bobby has led all of Onex’ acquisitions in the healthcare sector, which include the acquisitions of Carestream Health; Emergency Medical Services Corporation; Skilled Healthcare Group; Center for Diagnostic Imaging; Res-Care, Inc.; and Magellan Health Services, Inc. He also led of the acquisition of The Warranty Group.

 

Bobby is a director of Magellan Health Services, Inc., Res-Care, Inc., Skilled Healthcare Group, Inc., The Warranty Group, Inc., Cypress Insurance, First Berkshire Hathaway Life and Connecticut Children's Medical Center.

 

Prior to joining Onex, Bobby was with Berkshire Hathaway for seven years after starting his career at General Electric.

 

Bobby holds an M.B.A. from New York University and a B.S. from Bucknell University.

[giofranchi]

I hope these answers help in your analysis.

 

AP

 

Well, AP, your answers ARE my analysis!! ;D They were very clear and useful!

Thank you for sharing your knowledge with us and congratulations for your successful investment in Onex!

 

giofranchi

 

[giofranchi]

I don't know the company at all, just started researching them after reading your post.  The one thing that I noticed more or less off the bat is that while their long-term results are good, they haven't been performing well more recently.

 

http://www.onex.com/Onex_Share_Performance.aspx

 

If you look at their performance they slightly outperformed the S&P500 over the past 5 years (8% vs 5%), and underperformed over the last 10 (113 vs 116).  Their very high growth rate was the preceding decade.  It makes me wonder if they won't have yet another sub-par decade.  Now of course maybe they just had a bad decade and I'm being too short-sighted but a decade is a decent chunk of time.  It is also possible that the business has changed or maybe they have grown too large. 

 

I think it is this 113% over a decade (8% per year) that the market is pricing at.

 

Well, what you pointed out is recent share price performance. And actually it seems to have been not bad, but neither stellar. Return on invested capital, on the contrary, looks very good to me:

 

Onex Partners I, 2003-2006, Net IRR = 39%,

Onex Partners II, 2006-2008, Net IRR = 11%,

ONCAP I, 1999-2005, Net IRR = 33%,

ONCAP II, 2005-2011, Net IRR = 12%

 

From the notes:

Net IRR is based on total investments and represents returns earned by third-party Limited Partners in the Funds after payment of performance fees, management fees and expenses.

 

Those are recent results and look very good to me. Furthermore, OCX Proprietary Capital per Share increased 16% in 2009 and 17% in 2010, both exceeding their 15% stated goal.

 

giofranchi

[Liberty]

Was looking at ONEX and found this old thread. It stops on a cliffhanger...

 

Gio, did you ever look deeper? Did you end up investing in ONEX or did you find something that turned you off?

[giofranchi]

Gio, did you ever look deeper? Did you end up investing in ONEX or did you find something that turned you off?

 

Hi Liberty,

No, actually I have never dug deeper than this first very superficial analysis about ONEX… therefore, of course I have never pulled the trigger… sincerely, don’t know why! ::)

I guess something else might have interested me more, I simply didn’t find the time to do more work on ONEX, and after a while I just forgot about it…

 

Gio

 

[Liberty]

Ok, thanks. I was curious so I checked; It's up 63% since your last post (plus a little in dividends).

 

Seems like an interesting company, but it's probably going in the 'too-hard' pile for me.

[giofranchi]

It's up 63% since your last post (plus a little in dividends).

 

You can always count on the fact that, when something goes up, Gio is somewhere else instead! ;)

 

;D ;D

 

Gio

[Guest Dazel]

 

 

I bought Onex at about $15 it was an old Peter Cundill holding (I am getting old!)....it has been a wonderful story...did not buy enough!

It is the best run private equity firm in the world...

 

Dazel

[ap1234]

I have been a shareholder for the past 5 years. The company actually just held their Investor Day this week. It is worth looking at the slides/reading the transcript to get a better understanding of what makes Onex different from other P/E firms. In previous years they focused on discussing the companies they were investing in. This year’s focus was on the franchise value of Onex Corp. and why it is an attractive business model. Even if you aren't interested in investing in Onex, I would still recommend checking out the presentation.

 

The valuation of Onex no longer as attractive as it once was (it went from a large discount to NAV to a 20% premium to NAV) and the trajectory of NAV/share growth over the next few years is likely to be slower than it has been for the past 5 years (the company is sitting on a pile of cash and many of the large holdings have already been sold/monetized).

 

That said, I continue to hold my position as my view is the company can compound capital at attractive rates over the next 5-10 years (even if the next 2 years have the potential for lower returns).

 

[no_free_lunch]

ap,

 

How do you calculate NAV on this one?  It looks like the balance sheet has equity at under $2B but then they have this thing called Capital per Share which is at $52.77.

 

Also, everything is now expensive so I am still interested despite the NAV surplus.  Do you have any idea of what the discount/surplus to NAV was back in the 06-07 time frame?  Or I can just calculate myself if I could figure out how to do so.

[ap1234]

No_free_lunch,

 

If you get a chance, it’s worth reading the earlier posts on this thread as there is a discussion of the company’s history as well as the methodology they use to report their NAV.

 

You can’t analyze Onex based upon their financials used for accounting purposes (i.e. income statement, balance sheet, etc.). Metrics like P/BV are meaningless. That said, on a quarterly basis, Onex provides disclosure of their invested capital along with a breakdown of their net asset value (NAV). See the link below (How We are Invested Schedule) for more info:

 

http://www.onex.com/How_We_Are_Invested.aspx

 

Onex’s reported NAV is not a perfect science but it’s a reasonable proxy for what they think their investments are worth. Don’t forget that Onex uses the same NAV for outside shareholders and their LPs (i.e. they don’t have an incentive to game the system). In a rising P/E market, Onex’s NAV is likely understated and in a declining market it is likely overstated.

 

Today, it is relatively easy to value Onex given that approx. 50% of their NAV is sitting in cash (they have made an investment in both Onex Partners and ONCAP since Sept 30th).

The reported NAV is $52.77/share USD or $59.50/share CAD. The stock price is $62 or 1x NAV.

 

What is not included in the reported NAV?

 

This is not an inclusive list but a good starting point:

 

1. Value of the asset mgmt. business: If you think they will generate more fees than their overhead (salaries, bonuses, etc.), then you get the asset mgmt. business for free at today’s price.

 

2. Future carried interest: Onex’s NAV includes the current carried interest based upon the fair value marks they apply to their P/E portfolio. As they deploy their cash into new ideas, it will likely generate future carried interest which you aren’t paying for at today’s price.

 

3. Future growth in NAV/share: Onex has historically grown NAV/share at healthy rates (see discussion above). If the P/NAV multiple stays at 1x forever, your holding period return will approximate the NAV/share growth (their dividend is very modest).

 

4. USD appreciation: If you think the USD will continue to appreciate relative to CAD, then NAV/share will grow. If you think the opposite, then NAV/share will decline.

 

5. Share buybacks: Onex is sitting on a lot of cash and has been repurchasing shares in the open market. In addition to putting some cash to work at attractive rates, the fact that management is buying back stock at or above 1x NAV highlights what management thinks about the value of the business (insiders are the largest shareholder group after all).

 

As I noted in my previous post, I think the returns of the past 5 years are unlikely to be repeated over the next 2 years. The company has monetized many of their investments (which was the right thing to do) but it also means they are sitting on lots of cash earning nothing. Even if they find stuff to do with the cash (which is difficult), it will take some time for their new investments to increase in value (i.e. increase the NAV/share). Also, attractive P/E deals are still hard to come by today (it’s still more of a sellers market than a buyers market).

 

If you have a 5+ year horizon, I think it is an attractive investment idea at today's price. If you have a 12 month horizon, I would think there are better investment opportunities.

 

If you are interested in analyzing Onex further, I would highly recommend watching their last Investor Day which provides a good overview of their business.

 

[no_free_lunch]

Wow!  Thanks for the detailed response.

 

I actually did read your previous emails, that is what got me to the point of trying to understand their financials. :)  However I am still very stuck at valuing the company.  At this point I can't find their NAV estimates looking through their historical reports.  All they talk about is the investments they have made and the amount they are managing in the various funds.  I have seen the current estimates on the link you provided but that only goes back to December 2013.  I basically am trying to figure out how they pegged NAV in the 2006-2008 time-frame as a comparison. 

[Xerxes]

The situation must be concerning for ONEX that bought Westjet for $4B or so for its fund.

 

[K2SO]

Onex is in the eye of the storm. An airline, asset management (Gluskin Sheff), private equity, private debt.

I'm holding on as they have shown themselves to be astute investors throughout several cycles.

 

[Xerxes]

The only thing with ONEX is that they tend to put in a larger portion of their own capital in their funds vs. Third party, so they are more “on the hook” sort of speak. They are more of an investor than asset manager.

 

I think Gleshkin deal was meant to help them be more fee based. Or taking step in that direction.

[Xerxes]

Letter to shareholder from Gerry S.

 

https://ml.globenewswire.com/Resource/Download/4bdb91ff-7bb5-4f32-b5fb-f82d4a1e2de5