Those magnificent men and their fee machine |
Date: Saturday, June 23, 2007
Author: Boyd Erman, The Globe and Mail
Buyout expert Onex is looking to get bigger - but not too big, as it branches out with new funds
The initial public offering of Blackstone Group, the 13th-largest IPO ever,
could not have come at a better time for Onex Corp. Investors are gaga
over Blackstone, giving the firm a market value bigger than Bank of Montreal's,
because of the massive fees it generates running hedge funds, buyout funds,
real estate funds, almost any kind of fund. It's a money machine, and it's a
model Gerry Schwartz and his team at Onex are out to copy.
Onex, known for its buyout expertise, is set to branch into real estate
funds and hedge funds, changing the face of the firm and creating the
"machinery" to earn billions in fees.
"People are starting to recognize the value of the machinery,"
says Mr. Schwartz, Onex's founder and controlling shareholder. "It wasn't
until Blackstone and Fortress went public in the
How valuable is that machinery?
Blackstone is on pace to earn more than $1-billion (U.S.) in fees this year,
running its mix that caters to big investors such as pension plans that are
trying to spread their risks beyond just standard stocks and bonds.
So-called "alternative asset managers" like Blackstone, Fortress
and Canada's Brookfield Asset Management Inc. rake in the money by charging
backers hefty fees to manage their money. Some critics say the fees, which
include a flat management fee and a big share of any profits, are too high, but
judging by the amount of money pouring into alternative asset classes such as
buyout funds and hedge funds, investors don't mind.
Private Equity Intelligence, a London-based firm that tracks the business,
estimates that pension plans, university endowments and other institutions
anted up almost $100-billion last year for new real estate funds, and will pour
$85-billion into hedge funds in the next year.
Onex, with about $9-billion of assets under management, is nowhere near the
size of Blackstone, but with the new funds coming in to tap some of those
dollars from investors, the fees are set to soar.
Mr. Schwartz argues that investors haven't fully caught on to just how much
money the new Onex can make once the transformation he plans is complete. Yet,
the new Onex almost wasn't to be.
Debates are always heated at Onex, where every Monday the firm's deal makers
and Mr. Schwartz argue the merits of transactions and strategies.
In person in the firm's anachronistic offices, where old-fashioned
sliding-sash windows open only onto the sheet glass of the modern skyscraper's
facade, or by phone from the road anywhere in the world, the team members take
turns dissecting transactions.
One dissenting voice is enough to raise serious doubt. Two naysayers and an
idea is all but left for dead.
Many debates five years ago centred on a strategic switch that had the
potential for huge rewards, but came burdened with a risk to the firm's
culture. Should Onex, instead of largely investing its own money in takeovers,
begin to raise large private equity funds from other investors such as pension
plans?
The solo approach had paid big dividends: The firm was successful, and Onex
didn't have anybody but shareholders looking over its shoulder.
On the downside, when Onex didn't have enough money of its own for a
takeover it had to go hunting for partners, a time-consuming process.
Bringing in money from outside investors such as pension funds for a
billion-dollar-plus buyout fund would mean cash instantly on tap, enabling the
firm to move fast on bigger deals. And the fees for running such funds could be
massive, tens of millions of dollars a year even for a relatively small fund.
But doubters highlighted a risk: Rather than patiently searching for the
perfect takeover, the lure of the management fees could put pressure on Onex to
make deals quickly, putting money to work fast so the firm could raise more
from backers and generate yet more management fees. Quantity of deals could become
more important than quality. The pure deal-making ethos that had driven the
firm could be compromised.
"We were worried," Mr. Schwartz now acknowledges, sitting in a
conference room with the blue sprawl of
But it was the way the private equity world was headed, and proponents at
the firm argued that Onex could manage the risk. Compensation schemes could be
reworked to link bonuses to the successful and profitable completion of deals,
not just to finding takeover targets. The firm would invest big chunks of its
own money in buyouts, as would individual partners, to ensure that nobody was
tempted to cut corners on returns.
It was decided. Onex would raise its first big buyout fund, and begin in
earnest to build what Mr. Schwartz calls "the machinery" that today
fuels profits, and soaring executive pay, at firms like Onex and Blackstone.
Mr. Schwartz estimates that machinery is now worth about $2.5-billion.
That's the value of the annual fees and the performance bonuses Onex and its
top managers can earn on its three current funds, assuming the firm can
maintain its long-term batting average of a 29-per-cent return a year on
investments since the firm's founding in 1983.
Add the hedge fund, the real estate fund and another buyout fund that could
get rolling in the next year, and those fee numbers could get a lot bigger.
The way the firm is set up, 40 per cent of the performance bonuses, known as
"carry," go to Onex itself. The rest goes to Mr. Schwartz and his
management team for finding the deals.
But it's those very fee numbers that have some in the buyout business
concerned that the industry could be headed for a fall. The lure of fees and
the availability of capital from investors is pushing some asset managers to
create ever bigger funds, but before they can do so they have to put to work
the money they already have.
Private Equity Intelligence reckons that $300-billion of new capital could
flood into the buyout industry in the near future, on top of the $1.5-trillion
that's already there, creating a pool of money 1½ times bigger than Canada's
annual economic output, all looking for takeovers.
Critics say that with so much money afoot and the fees so huge, some buyout
firms are lowering their standards, and the higher returns that have made
private equity and hedge funds so attractive to investors could vanish. The
worst-case scenario could be massive deals gone sour, rocking confidence in the
stock market and the economy, all because buyout firms could not resist the
temptation to make deals too quickly.
It's not happening at Onex, Mr. Schwartz argues.
"It could. It could. And it has at some firms, but it doesn't
here," he says. "It's very important for us to maintain our record
because it makes it so easy to raise money, and if we blow it, it's 24 years
down the drain. So there's no inclination here to shovel money out in order to
get another fund raised."
One way to fight that temptation is to stay relatively small. Onex expects
to raise $6-billion for its next buyout fund -- a fraction of what investors
would be willing to give the firm, says Andrew Sheiner, one of the managing
directors. By comparison, Blackstone is raising a $20-billion buyout fund and a
$10-billion real estate fund that will both set world records for size.
"We think it's smart to keep the fund size reasonable," Mr.
Schwartz says. "And if we need more money we will raise another fund, rather
than having a much larger fund which would put some of the pressure on us to
just get money invested."
Staying small may help the Onex team hang on to one of the most cherished
parts of its reputation - that of a bunch of very rich cheapskates. Not necessarily
when it comes to lifestyle, but certainly when it comes to takeovers.
It's a perception the Onex crowd courts, pointing out often that the firm
has a history of paying less than many rivals in the buyout business, a game
that revolves around finding firms to take over and then ways to increase their
value.
It's a business that is a whole lot easier if you don't pay much in the
first place, but with billions a day pouring into private equity funds that are
all scouring the globe for acquisitions, cheap deals are harder and harder to
come by.
The result of that pickiness and parsimony has been consistency - only two
major losses in 150 takeovers by Onex.
It also means that the list of companies Onex has looked at and hasn't
bought - Chrysler and Air Canada's maintenance and overhaul arm are among the
more recent examples - is perhaps longer than the list of companies it has
purchased. Lately, buyouts include the health care imaging arm of Eastman Kodak
for $2.6-billion (Canadian), half of business jet maker Hawker Beechcraft in a
deal valued at $3.8-billion and Spirit AeroSystems from Boeing Co. for
$1.1-billion.
"We get a few transactions done, and we miss a lot," says Mr.
Schwartz, giving no inkling that fact bothers him. "This year has been a
great year for winning silver medals."
Perhaps the firm's highest-profile target right now is BCE Inc. Onex is a
minority player in a bid led by the Canada Pension Plan Investment Board and
Kohlberg Kravis Roberts & Co., joining the group as a late entrant.
"Whoever buys it needs to have a substantial amount of Canadian
ownership and by adding us into the group, it not only added to the Canadian
equity but if we're fortunate enough to be the winning bid we'll add to the
sense of Canadian control over the business," says Mr. Schwartz, who
started his career at a New York investment bank with Henry Kravis, who went on
to found KKR.
Mr. Schwartz, rarely loquacious, declines to say more about the firm's
participation in the bidding for BCE, or the team's plans for the company if
the CPP-led group emerges as the winner.
Until this week, many handicapping the race were betting that Onex's team
would come out on top. But now, with Telus Corp. considering a bid and having
the advantage of synergies, BCE too may end up being a silver medal for Onex.
But there will always be another deal. Onex is shown the book on almost
every company that comes up for sale in
The firm prefers to find its own transactions, hunting far and wide for
listless assets hidden in big parent companies that can be peeled out and
energized, or small companies that can be snapped up and built into big ones.
The planned hedge fund, in addition to broadening Onex's appeal to investors
and generating new fees, is also expected to turn up new buyout targets.
"It would look at buying shares in a business the way we look at buying
a business," Mr. Schwartz explains. "We think that in addition to
being an excellent asset category it also will generate ideas for us for our
leveraged buyout business."
Mr. Schwartz, from his perch 49 floors above
"It's a very good time in private equity," he says. "Low
interest rates, huge liquidity. The only negative is there are a lot of very
expensive things that have been sold."
The Onex team argues that the buyout industry is a boon to the economy.
"I think the private equity has brought a lot to the North American and
world business markets," Mr. Schwartz says. "More discipline about
utilizing assets. More discipline about focus on growth."
While some commentators point to a recent increase in interest rates as a
possible roadblock for buyout firms, because it will make the loans to finance
transactions more costly, the Onex head is unconvinced. He argues that there is
so much money in the hands of lenders that they won't be able to charge much for
loans.
"There is enormous liquidity in the market and that liquidity keeps
interest rates down," he says. "Even though the government may raise
interest rates a little bit to keep inflation down, there's still enormous
liquidity."
But if it should happen that rates rise and the buyout economy goes sour,
Onex has a plan for that, too: a fund to invest in distressed debt. The idea
has been kicking around Onex for years, but the economy has been so good there
are few investment opportunities.
"It's on ice at the moment, but it's something we'll keep on looking
at," Mr. Schwartz says.
And what of Onex? Where will it be in five years? Mr. Schwartz ticks off his
goals, key among them getting bigger while still maintaining Onex's culture.
"More people. More transactions. Larger amounts of capital. Identical
philosophy," Mr. Schwartz says.
And what of Mr. Schwartz, who at 65 is trim and stylish, sporting a narrow
tie of the latest fashion. Where will he be? Doing deals at the helm of a much
bigger, more profitable Onex, he says.
"I've got a long time. I've got a long time. I've got 25 to 30 years of
this. Maybe longer."
Onex compared
ONEX CORP.
(OCX on TSX)
Specialties: Buyouts and private
equity
Market capitalization: $4.7-billion
(Canadian)
Assets under management: $9-billion
(
(BAM/A on TSX)
Specialties: Real estate, infrastructure,
lending
Market capitalization:$24.6-billion
(Canadian)
Assets under management: $70-billion
(
FORTRESS INVESTMENT GROUP
(FIG on NYSE)
Specialties: Hedge funds, private
equity funds
Market capitalization: $9.9-billion
(
Assets under management: $36-billion
(
BLACKSTONE GROUP
(BX on NYSE)
Specialties: Buyout funds, real estate,
private equity
Market capitalization: $38.4-billion
(
Assets under management:
$88.4-billion (
The deals
Onex so far has 'had a great year
for winning silver medals,' jokes Gerry Schwartz, alluding to the fact that
with prices for assets rising, Onex is getting outbid in some auctions. But the
company has also had its share of golds. Here's a look at some of the big hits
and misses of late.
Gold medals (Recent deals
that Onex made)
Spirit AeroSystems
In 2005, Onex bought aircraft
factories from Boeing Co. for $1.1-billion. The firm cut costs, added customers
and took Spirit public last year. The company now has a market value of
$5-billion (
Hawker Beechcraft
In March, Onex teamed with the
private equity arm of Goldman Sachs to buy the maker of business jets in a deal
valued at $3.8-billion (Canadian), with an eye to increasing market share in a
growing business.
Carestream Health
This spring, Onex finished the
$2.6-billion acquisition of Eastman Kodak's medical imaging arm, betting that
Carestream will thrive as doctors and dentists switch from film to electronic
imaging.
Silver (Deals Onex missed)
Chrysler
Onex teamed up with Canadian auto
parts maker Magna International Inc. to bid for troubled auto maker Chrysler,
but owner DaimlerChrysler AG instead chose Cerberus Capital Management as the
winning bidder. Onex and Magna have never disclosed their proposal.
Qantas Airways Ltd.
Onex was part of a consortium of
private equity firms bidding for
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