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Executives

Emma Thompson – VP, IR

Bobby Le Blanc – Senior Managing Director

Don Lewtas – CFO

Analysts

Geoff Kwan – RBC Capital Markets

Paul Holden – CIBC

Scott Chan – Canaccord Genuity

Bert Powell – BMO Capital Markets

Anoop Prihar – GMP Securities

Onex Corporation (OTCPK:ONEXF) Q2 2013 Earnings Call August 8, 2013 11:00 AM ET

Operator

Welcome to the Onex Second Quarter 2013 Conference Call. (Operator Instructions). I will now turn the conference over to Ms. Emma Thompson, Vice President, Investor Relations. Please go ahead.

Emma Thompson

Good morning everyone and thank you for joining us. We’re broadcasting this call live on our website. On the call are Bobby Le Blanc, Don Lewtas and a number of our Managing Directors.

Our press release includes the how we are invested schedule. This is a good financial summary of our investments and includes their proprietary capital on a per share basis. The second quarter MD&A and consolidated financial statements are not yet available as one of our subsidiary companies Spirit AeroSystems has not yet filed the quarterly results. Once they have done so, we will be providing MD&A and consolidated statements on our website and on. We expect to file by August 14. If you have any follow-up questions, once they do file, please feel free to call us.

I want to remind everyone of the usual forward-looking statements disclaimer and I would also point out that all information relating to the fair value of our private companies is a view of Onex’s management. In addition, we will refer later in this call to CLO offerings by Onex Credit Partners. We’re required to remind you that these offerings are made solely to qualified institutional investors and to certain non-U.S. investors in private transactions not requiring registration under U.S. Securities Laws. The securities are not and will not be registered under U.S. Securities Laws and cannot be offered or sold in the U.S. without registration or assumptions.

I will now turn the call over to Bobby.

Bobby Le Blanc

Thanks Emma. Good morning everyone. It’s been an eventful year so far. We’ve bought a business, sold one at a meaningful gain, and received a significant distribution from Carestream, and spent much of our time as we always do working with our management teams to implement our profit improvement plans.

As Gerry discussed in our last call, if we are successful identifying and acquiring great companies and effecting the necessary changes, we will continue to be successful at creating value in those businesses and ultimately for our investors.

Our ownership of Carestream embodies this approach to investing. Since we carved out Carestream from Kodak in 2007, we felt we needed a transformation of the business that was central to our investment thesis. When we acquired Carestream, it was a division of Kodak that was no longer part of the parent company’s long term strategy. The division was primarily comprised of the declining film business and a growing digital business for the medical and dental industries.

During our ownership, Onex helped Carestream develop a standalone infrastructure, right-size its cost structure and shift its focus toward its digital products in emerging markets, which today each represent over 50% of the company’s revenue. We also continue to focus on maximizing the cash flow from Carestream’s film assets while exploring alternative future usage of those assets. These actions have helped improve the company's prospects and have increased the multiple we hope to achieve upon our ultimate exit. Importantly, Carestream has generated more than $1.2 billion of free cash flow since our acquisition.

The improvement in Carestream’s outlook along with its cash generating capability allowed it to complete a recapitalization in June. The company raised approximately $2.4 billion of debt, primarily to refinancing existing debt and to fund the $750 million distribution to Onex Partners II of which Onex’s share was about 300 million, including carried interest. To date, we’ve received 265% of our initial equity investment and still own 92% of the company.

Based on Carestream’s improved business mix, we expect EBITDA to grow by more than 5% this year and its annual free cash flow to be almost $200 million pro forma for the recent recapitalization. This is a great outcome for Carestream and its shareholders. It’s worth noting that a number of our other businesses also took advantage of the strong credit markets in the first six months of the year.

Including Carestream, our companies collectively raised or refinanced a total of $5.9 billion of debt. On Tuesday, Allison Transmission priced a secondary offering. Net proceeds from the offering to the Onex group will be approximately $252 million of which Onex’s share will be about 84 million, including carried interest. Pro forma for the offering, Onex and its partner, The Carlyle Group will collectively own 70% of Allison Transmission.

ONCAP recently had a wonderful outcome of the sale of BSN SPORTS. Over the course of our ownership, ONCAP and its partners grew the business through accretive acquisitions or rebranding initiative and then expansion of the sales team. This was done while improving efficiencies by building a new IT system and an upgraded distribution infrastructure. This was a considerable undertaking that was accomplished in less than three years. The successful execution of our investment thesis resulted in a return of approximately 4.2 times capital invested at net proceeds of about $103 million to Onex. We are delighted to have found such an excellent partner in Adam Blumenfeld, the company’s CEO and wish him and his management team continued success in their next phase of growth. This is just another example of the out-sized private equity returns that ONCAP has consistently achieved. Congratulations to Michael Lay and the entire ONCAP team.

There are other many other examples of ongoing initiatives to create value throughout our companies. As a result of these efforts, the value of Onex’s interest in Onex Partners and ONCAP’s private businesses grew by 20% and 16% respectively during the first six months of this year.

On the acquisition front, we were pleased to acquire Emerald Expositions in June, a corporate , a corporate carve-out from its parent company Nielsen Holdings. As a reminder, Emerald is one of the largest producers of the business to business trade shows in the US, primarily selling booths to exhibitors. We were attracted to the company’s exceptional free cash flow and its growth potential both internally and through add-on acquisitions.

The credit markets continue to be supportive of new acquisition but there remains a dearth in corporate disposition activity. In order to broaden our opportunities, our team remains focused on originating proprietary transactions like we did with Tomkins, JELD-WEN, and most recently, BBAM. With $1.4 billion of cash and near cash and no debt of a parent company, Onex is in a very strong financial position to move quickly when investment opportunities arise. In addition to our own cash, we have approximately $1 billion of undrawn committed capital from our limited partners and our two current private equity funds.

With Onex Partners III, almost 90% invested, Onex recently launched the fundraising for Onex Partners IV, targeting 4.5 billion of total capital commitments of which Onex will commit approximately 1.2 billion. A new fund would contribute to Onex’s stream of annual management fees and a potential to earn carried interest on invested LP capital. Onex’s partnership agreements typically have a 10-year term and provide predictable management fees.

Turning to Onex Credit Partners, we will continue to grow our credit investing platform which is accumulating assets in anticipation of a fourth CLO offering. Our credit investment team has the capacity to place a number of offerings each year should market conditions permit. This business is another source of recurring management fees creating additional value for shareholders above beyond our net asset value.

Lastly, and importantly, I would like to remind you that a key tenet of Onex’s investment philosophy is the alignment of our team with Onex, our shareholders, and our limited partners. The team shares in the success and failure of our operating companies through our significant individual investment in everything that own. Today, the value the team’s invested in Onex shares and its businesses is about $1.7 billion. This year we have a direct commitment of approximately 5% in each new investment and collectively we remain the largest shareholder of Onex. As a result, the team represents about $0.12 of every dollar invested.

And now I will ask Don to provide financial highlights for the quarter. Don?

Don Lewtas

Thank you, Bobby and good morning everyone. As Emma noted, our consolidated financial results have not yet been filed. My comments will focus on “the how we are invested schedule”. As Bobby noted earlier, the value of Onex’s interest in Onex Partners and ONCAP’s private investments grew by 20% and 16% respectively during the first six months of the year. As a reminder, these valuations are prepared each quarter for our private companies. Overall Onex’s capital grew by 9% on a per share basis since year end. On a 12-month basis, Onex’s capital per share increased 18% compared to our stated goal of growing our NAV per share by at least 15% per year.

As you know, Onex generates value in two ways as investor of our own capital and as a manager of third party capital. While the “how we are invested schedule” on our capital per share performance give us a good snapshot of Onex’s net assets. They don’t fully reflect the enterprise value of our asset management business. Onex’s capital does include estimated unrealized carried interest due to Onex of 144 million based on the quarter end valuations. What it doesn’t include is any value for management fees or for potential carried interest from future value creation at our companies.

Over the last 10 years, we’ve received carried interest of 28 million per year on average. So far in 2013, including the recent Allison transaction, Onex will have received 58 million in carried. The six acquisitions completed over the last 12 months will help to build our potential to earn carried interest over the next several years as we work with the management teams to grow the values of our businesses.

As indicated in the how we are invested schedule, Onex’s cash and near cash totaled $1.44 billion, up from $1.25 billion at March 31. The most significant factors in that change were closely 250 million Onex received from the Carestream’s distribution, about 95 million Onex received from the sale of BSN SPORTS and this was reduced by our share of the investment in Emerald Expositions of 85 million, 25 million Onex invested with Onex Credit in support of the fourth CLO offering and 25 million on share repurchases in the quarter – sorry, 27 million on share repurchases in the quarter.

Today we manage 11 billion of capital on behalf of other investors. The management fees Onex has received from that activity are predictable from quarter to quarter given that private equity capital is committed for initial terms of 10 years. Combined, fees and carried interest offset our ongoing operating expenses last year. As a result, shareholders’ capital is managed at no cost.

While that may not be the case every year, Onex has a business model that creates additional value from our shareholders. Ultimately our goal is to have the value of our investing and asset management activities reflected in our share price. This is supported by a longstanding quarterly dividend which was recently increased in a stock buyback program. In the first seven months of 2013, Onex repurchased 1.1 million shares for an average cost per share of Canadian 44.75. 568,000 of those shares repurchased in the second quarter at a total cost of 27 million. Over the last 17 years, we’ve repurchased approximately 78 million shares for a total cost of 1.2 billion.

At July 31, there are 113.4 million Onex subordinate voting shares outstanding. Onex’s shares performed well year to date. As of close yesterday, Onex’s subordinate voting shares were up 19% since the beginning of the year as was the S&P 500, while the S&P TSX was flat. That completes my comments and we’d now be pleased to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Geoff Kwan, RBC Capital Markets.

Geoff Kwan – RBC Capital Markets

The question I had was -- when you take the ratio of the value of the private companies versus the costs, I think it comes out to about 129% for the quarter and net, it looks like I guess about flattish quarter over quarter. I just wanted to make sure I have got that right and if there is any kind of color you have behind that?

Don Lewtas

There were a number of events in the quarter. You would have had a realization from Carestream which would have reduced the value partially and you would have had increases in other companies. So it’s a combination of the events. I wouldn’t look at that necessarily as a usual comparison from quarter to quarter because of the realizations that we had.

Geoff Kwan – RBC Capital Markets

And then the second question I had was just relating to the retail partnership you guys had announced last year. I know that it takes time to kind of start up a new industry specialty and finding various assets that might be interesting. Just wondering if there is any sort of update on that front?

Bobby Le Blanc

Yeah, I would say that to date we’ve been very pleased with the progress we’ve made since we announced the partnership with Neil Fiske, I guess just going back close to 18 months down. We’ve not been known as the private equity group who is actively involved in the retail restaurant space and since he’s joined the team, I would say that the quality and the frequency of opportunities that we are seeing now has meaningfully picked up. So having an operate partner like Neil really helps us on a variety of fronts. It gives us a lot of credibility when dealing with management teams, it makes sure that [Max] know that we are in a business as we’ve been looking at opportunities in retail and restaurants which probably wasn’t the case before he joined or not to the same extent, and it really helps us really evaluate an opportunity more effectively and trying to find that angle that gives us the cost as to want to put to work.

So these things take a little bit of time to ultimately result in a transaction. We are obviously patient, we really started from ground zero for all intents and purposes in retail and restaurant. But I feel really good about the pipeline and where we are today.

Operator

Your next question comes from the line of Paul Holden with CIBC,

Paul Holden – CIBC

I asked this question last quarter but I think I'm going to ask it again, because it seems like a very good environment to me for monetizing investments. The U.S. IPO window is open. Corporate balance sheets are flush with cash, and there’s lots of private equity money looking to find a home. So just wondering if your view differs from that at all or at least you can comment on sort of how you view the potential to monetize investment -- embedded investment gains today?

Don Lewtas

You know we don’t discuss our intentions – specific realizations but we are aware of how good the credit markets and the IPO markets are and we are constantly looking at our portfolio to see whether monetization makes sense. I think you will see us making them consistently over time as it makes sense, not only given the market but given where any given company would be at that point in time.

Paul Holden – CIBC

And then with the target size you provided for OP IV, does that provide some kind of indication of the demand and interest you’ve seen to date then for that fund?

Emma Thompson

No, I think – it’s Emma here – I think we feel that the amount of capital is right sized for our team and we’re obviously very comfortable to fund III, so we are comfortable with that level.

Paul Holden – CIBC

Is there any kind of color you can provide us, Emma, on interest you’ve been able to gauge so far?

Don Lewtas

We really can’t provide comments legally about the timing or size of the funds.

Paul Holden – CIBC

And then I have a few questions related to the “how we are invested”. I might normally get the answer to these from the MD&A but obviously we don't have that. So please bear with me. In terms of the Carestream distribution, Don, you pointed out that it’s $250 million positive to cash, but I think in your press release you said the net amount, including carried, was about $300 million. So is it just the carry that explains the $50 million difference, and will that hit cash in Q3 then?

Don Lewtas

Part of the cash flow on that was in this quarter that – the distribution, part of it was before June 30 and part of it was in early July. (inaudible) aggregate of the two.

Paul Holden – CIBC

So there will be another $50 million coming in Q3 then?

Don Lewtas

Yes. We have on –

Paul Holden – CIBC

In terms of Onex Real Estate Partners, the carrying value was reduced from $150 million I think last quarter to $127 million this quarter. Maybe you can talk about the markdown there.

Don Lewtas

So I think as I mentioned during our shareholder meeting last quarter. we have an NOI or a covenant test coming up in mid-June and when we are looking at where the net operating income is for our retail state in our Flushing project, we think there will be shortfall there and the markdown reflects our best estimate of what that shortfall might be relative to our cost right now. It may turn out to be conservative but we thought it was the prudent place to market at this point.

Paul Holden – CIBC

And then final question on JELD-WEN, the carrying value went down from $212 million to $200 million. Is that reflective of some kind of a sell-down on a co-investment or a portion of the debt you hold in it?

Don Lewtas

We received – there were certain assets when we acquired on JELD-WEN that we expected to receive on that were surplus to the business or not keep in the business and we continue to sell those down and that was part of what we received.

Operator

Your next question comes from the line of Scott Chan with Canaccord Genuity.

Scott Chan – Canaccord Genuity

My first question is a bit broad-based and I don't know if there is a real right answer. But getting questions on the recent rise in interest rates and I just wanted to get your commentary maybe using some of the historical examples on how that affects your private equity and credit business or what affected?

Don Lewtas

Yeah, so we will start with the private equity business. In a way rising interest rates often are the sign of a more healthy economy. So I think that’s good for businesses that we own if that’s the case. It’s probably good for activity including corporate disposition activity.

In terms of our current businesses and their balance sheets, we typically fix a good portion of the debt that we have outstanding to try to eliminate some of that rise in interest rates from a cost to borrow or free cash flow generation ability for the business. So we are always very cognizant of that especially on lower rate environments like we are in now.

On the credit side of the business, they tend to buy mostly floating rate credits. So I think as long as they do that, and they should be the beneficiary of a rising rate environment in terms of getting paid more interest although the market may go down in something they own given the higher interest rate at any point in time. Look, it’s something you have to manage, you have to think about what higher rates mean in terms of future value and what people maybe want to pay for your business as rates rise relative to a low rate environment. But we try to look at all those factors and make sure we are constantly studying everything we own to make sure we are protecting ourselves and taking the advantage of the upside that may occur.

Scott Chan – Canaccord Genuity

And just the second question, OP III is over 90% invested, and you're starting to fund raise for OP IV. Does that limit the availability for you guys to make new investments, or would you make capital calls on the existing ones? I'm just trying to figure out just the timing if an opportunity did come up that you guys with your good balance sheet and cash could make a significant investment?

Don Lewtas

Yeah, firstly we still have the dry power left in OP III, enough to easily do another transaction, and as well as we mentioned Onex has over $1.2 billion of cash on its balance sheet. So we are not worried given that the timing of fund-raise which you can’t get specific on it, we will run into a problem with that in regard to that topic.

Scott Chan – Canaccord Genuity

And I just wanted to double check an earlier comment, you said there was $15 million of carried interest that was earned this year so far?

Don Lewtas

58 million was we’ve received so far this year.

Scott Chan – Canaccord Genuity

Is that majority of Allison?

Don Lewtas

Carestream, mostly Carestream.

Scott Chan – Canaccord Genuity

Does that include any Allison? Because you guys felt --

Don Lewtas

There is a small portion for Allison.

Operator

Your next question comes from the line of Bert Powell with BMO Capital Markets.

Bert Powell – BMO Capital Markets

I know you guys can't comment directly on fund raising, but typically the expectation would be multiple closings over a 12 to 18 month period for a fund of this size. Is that still a reasonable expectation?

Emma Thompson

Bert, I think if you look at the broad fund-raising market that’s typically what takes place when you are raising a fund of similar size. I won’t specifically get into our fund raise, that if you look at the market that would be a fair assumption.

Bert Powell – BMO Capital Markets

And I know I asked this before, Emma, but is there any -- has there been any change either positively or negatively in terms of what people are looking for in terms of fee structures, either hurdle rates, those kinds of things for calculations on carriers that’s going to look substantially like what you have got in OP III?

Bert Powell – BMO Capital Markets

Yeah, I won’t specifically comment on LP perspective, I think if you look back at what our fee structure has been, and our LPAs that they are very current, given that we only started fund raising capital in the last 10, 15 years and I think we think that, that is commensurate with what’s in the market.

Bert Powell – BMO Capital Markets

And just on the manager side of the business and I apologize if you went over this, but can you just give us a sense as to what the P&L would look like for the manager in the quarter?

Don Lewtas

We don’t provide that on a quarterly basis.

Operator

Your next question comes from the line of Anoop Prihar with GMP Securities.

Anoop Prihar – GMP Securities

I just have one question remaining. Don, with respect to the Allison secondary, can you tell us exactly how much stock Onex sold and what were the net proceeds to you?

Don Lewtas

Sure. I have those details here, Anoop. In terms of what was sold, including the share, the offering to the public was 19.1 million shares and including the 15% share. Allison also repurchased 4.7 million shares so the total size was 23.8 million. And your question was in terms of what we own after or percentage ownership after new – so after the offering Onex and Carlyle owned 70% of the company or 127 million shares, and so our share of that would be approximately 54 million shares.

Anoop Prihar – GMP Securities

And what were the net proceeds for the offering to you?

Don Lewtas

84 million.

Bobby Le Blanc

Yeah, 84 million, Don, ex 252 million to the Onex Partners Group.

Operator

That concludes your question and answer session. I will now turn the conference back to Bobby Le Blanc.

Bobby Le Blanc

Thanks everyone for participating in this call. Please feel free to contact Emma if you have any further questions and we appreciate your time and everybody have a nice night. Bye, bye.

Operator

This concludes today’s conference call. You may now disconnect.

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